Why Did FTX Collapse?
In this article, we will discuss the infamous FTX collapse — an unexpected development that shook the entire crypto ecosystem.
- November 25, 2022
The FTX collapse spanned almost a fortnight, and we might even not have seen the end of it yet. The cryptocurrency exchange FTX was one of the largest in the world but it seems to be breathing its last after experiencing irreparable damage.
The exchange was helmed by CEO Sam Bankman-Fried, whose fortune peaked at $26.5 billion last year. FTX appears to have failed in part because of its close ties to Bankman-Fried’s trading firm, Alameda Research, and the fact that the bulk of its assets had been created from thin air.
FTX’s valuation plunged from $32 billion to bankruptcy in a matter of days dropping below $1 trillion. The company filed for Chapter 11 bankruptcy protection on Nov. 11, 2022. And the consequences of this decline may affect cryptocurrencies and even drag down broader markets.
On Nov. 16, 2022, a class-action lawsuit was filed in a Florida federal court, alleging that Sam Bankman-Fried created a fraudulent cryptocurrency scheme designed to take advantage of unsophisticated investors from across the country. There are also other celebrities named in the lawsuit, including Steph Curry, Shaquille O’Neal, Shohei Ohtani, Naomi Osaka, Larry David, and Kevin O’Leary, who allegedly helped Bankman-Fried facilitate the plan. The U.S. House Financial Services Committee said it will hold a hearing in December 2022 on the FTX collapse.
What is FTX?
FTX is a digital currency exchange based in the Bahamas and was launched by Bankman-Fried when he was just 28. FTX became one of the largest crypto exchanges in just three years with a valuation of $32 billion. On this platform people could buy and sell digital assets like bitcoin, dogecoin and ether. Such platforms rose in popularity in recent years as more people looked to invest in cryptocurrencies without the hassle of dealing with the technical side of such transactions, such as setting up a crypto wallet.
Bankman-Fried had built the business on risky trading options that are not legal in the United States and used aggressive marketing, including a Super Bowl ad campaign, and the purchase of naming rights to the home of the Miami Heat basketball team. He became known for his political lobbying and donations, as well as for working to support the cryptocurrency industry more broadly. When some cryptocurrency companies were struggling as a result of declines in token prices in early 2022 he facilitated deals totaling about $1 billion.
What Led to FTX’s Sudden Collapse
November 2022 has seen a dizzying downward spiral for Sam Bankman-Fried’s huge crypto empire. FTX crypto exchange has paused withdrawals, and a tentative bailout from rival Binance appears to be kaput. That could put depositor funds at risk, and certainly spells a major setback for not only Bankman-Fried but for the cryptocurrency industry as a whole.
Over the past three years, FTX has come to be widely regarded as a reputable exchange, despite not submitting to U.S. regulation. Bankman-Fried has himself become globally influential. These narratives about both FTX and Bankman-Fried are now clearly dead in the water, given recent evidence that everything was not as it seemed at the exchange, or at Bankman-Fried’s other firm, Alameda Research.
On Nov. 2, reporter Ian Allison published findings that roughly $5.8 billion out of $14.6 billion of assets on the balance sheet at Alameda Research, based on then-current valuations, were linked to FTX’s exchange token, FTT. This was explosive because of the very close relationship between Alameda and FTX. Both were founded by Bankman-Fried.
The exchange saw $6 billion in withdrawals in the 72 hours before things reached a head on the morning of Nov. 8, according to internal messages seen by Reuters. This led Bankman-Fried and his team to begin frantically shopping for an acquisition partner, approaching a variety of potential partners before Binance entered the picture.
The exchange promised users that it would not speculate with cryptocurrencies held in their accounts. But if that policy was followed, there should have been no pause to withdrawals, nor any balance sheet gap to fill. One possible explanation comes from Coinmetrics analyst Lucas Nuzzi, who has presented what he says is evidence that FTX transferred funds to Alameda in September, perhaps as a loan to backstop Alameda’s losses.
The Future of FTX
As of mid-November 2022, withdrawals are disabled and a notice on the FTX website says the company “strongly advise[s] against depositing.” FTX may further deter investors, who are already cautious because of concerns about stability and security. Customers on the FTX platform may not recover their assets, potentially triggering legal action.
The U.S. Securities and Exchange Commission (SEC) and other regulators may see the collapse of FTX as justification for tightening regulatory scrutiny of cryptocurrencies, and Congress may be more inclined to step in and create new laws governing digital tokens and exchanges.
FTX filed for bankruptcy on Nov. 11, 2022. And within hours of filing for bankruptcy, FTX was hacked. The exchange noted “unauthorized transactions” that may have stolen close to $500 million in assets, and which were spotted by Elliptic. The hacker continued to drain wallets for several days using what analysts called “on-chain spoofing.” The hacker reportedly then invested those funds into Ether (ETH).
To sum up, we can say that the cryptocurrency exchange FTX collapsed over a period of roughly 10 days. The exchange faced a liquidity crisis and tried to negotiate a bailout by rival Binance that quickly fell through. FTX saw its assets frozen, its CEO resigned, and it filed for bankruptcy within days. The ongoing implications for the future of FTX and the broader cryptocurrency industry are ongoing and difficult to assess.
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