The FTX fallout:What next for crypto?

2022 has been a tough year for crypto. After the collapse of the Terra Luna ecosystem, multiple high profile court cases and a tsunami of layoffs, the industry was hoping for a calm final stretch to the end of the year. Cue the spectacular fallout of FTX.

A word of warning, the decentralised finance (DeFi) space is littered with abbreviations – so quickly: FTX (ill-fated cryptocurrency exchange), SBF (Sam Bankman-Fried, the former CEO of FTX), CEX (Centralised cryptocurrency exchange), FTT (FTX’s native token), CZ (Changpeng Zhao, the CEO of the world’s largest crypto exchange Binance.)

Background on SBF’s empire

Founded in 2019 SBF, Bahamas-based FTX quickly made its way to the top as the world’s second largest CEX. Backed publicly by leading institutions in finance and sports, including BlackRock and the Golden State Warriors, FTX soared to a $32 billion valuation.

Part of FTX’s meteoric rise was down to its aggressive marketing strategy, mainly in sport. Through spending $210 million to buy the naming rights to esports team TSM, $135 million to put its name on the arena of NBA team Miami Heat, and becoming the official crypto exchange of Major League Baseball, the name was everywhere.

SBF also founded a trading firm, Alameda Research, which he insisted was entirely separate from FTX. Alameda initially focused on arbitraging differences in cryptocurrencies in different markets, but as they faced more competition their strategy shifted, taking on riskier bets, before layering leverage on top.

So, from the second largest CEX, to filing for Chapter 11 bankruptcy – just how did it go so wrong for FTX and what does this mean for the industry moving forwards?

The Downfall

Back in 2019, Binance became an early investor and strategic partner of FTX, with CZ becoming SBF’s big brother in crypto. Binance helped FTX, FTX helped Binance – the bromance peaked.

Fast forward to 2021, CZ grew unhappy with SBF and the route he was taking FTX, so wanted out. FTX then bought Binance’s remaining shares in the company, approximately $2.1 billion – a large chunk of which was paid out in FTT (remember this, it’s important).

On November 2 2022, a leaked balance sheet for Alameda Research prompted CoinDesk to report that much of its reserves were based on FTT. FTX used FTT as a reward currency for trading discounts, and Alameda held far more of the tokens than traded on the market, suggesting its stake would be hard to liquidate.

A few days later, CZ announced that Binance planned to sell its FTT holdings which it has received from it’s FTX exit. CZ compared FTT to a previous token he had backed, the ill-fated Luna token. This announcement caused panic in the community, and FTT’s price began to wobble.

On November 8 FTX suspended withdrawals, its first visible sign of weakness. As word spread, Binance quickly offered its support by signing a nonbinding letter of intent to purchase its rival, subject to due diligence. In a tweet, CZ said that FTX “asked for our help” as it faced a “significant liquidity crunch.” However, this was not enough to save the FTT token, as its price dropped 75% in 24 hours.

The next day, Binance announced that it had reversed course and was backing away from the deal. The reason given? After less than 24 hours of due diligence, Binance unearthed issues with FTX’s books that they stated were beyond their control or ability to help. This set off alarm bells for US regulators, who swarmed FTX and Alameda to investigate reports of mishandled customer funds. Subsequently, in a series of expletive tweets to his over 1 million followers, SBF announced that Alameda would wind down trading in an effort to save FTX.

The liquidity crunch led FTX to file for Chapter 11 bankruptcy on November 11, and SBF stepped down as CEO. John J. Ray III, a lawyer who helped to run Enron post-bankruptcy, was consequently named CEO of the FTX group, with SBF remaining to “assist in an orderly transition.”

The following day Reuters reported that between $1 and $2 billion vanished after SBF secretly transferred $10 billion worth of customer funds from FTX to Alameda, through a back door that bypassed FTX’s security measures, which SBF denies.

This brings us up to the present day. Lawsuits have been filed and investigations started.

What next?

It is hard to predict where crypto will go from here. However, it is likely that regulation across the market will accelerate to establish more stringent consumer safeguards as regulators seek to prevent such an enormous fallout from happening again.

Blockchain has huge efficiency benefits and can bring greater speed and cost-savings to financial markets. There are many players within this space who are genuine innovators and wish to progress the industry through trust and transparency. Against a backdrop of heightened scrutiny, it is vital that digital finance companies have clearly defined services and offerings – and the ability to communicate this to their target market – if they are to fulfil this potential.

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