FTX Collapse Explained

đź“ŤPosted by: Max Power.

This week, FTX cryptocurrency exchange filed for bankruptcy. The spectacular collapse of a company previously valued at $25B, launched in May 2019, left clients (according to Reuters) at least $1.2B USD out of pocket. The ripple-on effect of the collapse continues to affect confidence in the industry with companies, users and investors this week.

FTX was a cryptocurrency exchange. One contributes money, fiat or otherwise, and in return receives a different cryptocurrency, or alternatively, withdraws one’s cryptocurrency for fiat money. The company in the middle takes a small percentage for its trouble. Easy.

According to FTX’s website, it is “a platform built by traders for traders” and its mission is to “…offer innovative products including industry first derivatives, options, volatility products and leveraged tokens”. The company is incorporated in Antigua and Barbuda but headquartered in the Bahamas.

FTX created its own utility token; the FTX token (FTT). The FTX trader buys the token to get efficiencies, discounts, rewards and leverage, which all increase with the more tokens the trader buys. FTX rapidly increased its user membership to over a million users by buying Blockfolio in 2020, (a company that provided cryptocurrency services for retail investors) and boosting its profile with such deals as a 19-year naming rights for Miami Heat, a deal with Mercedes-AMG F1 team, and a 10-year naming rights deal with e-sports franchise. In 2021 FTX made over 1000% more revenue than it did in 2020.

Bankman-Fried also founded an algorithmic, market-making crypto firm – Alameda Research. Bankman-Fried allegedly transferred customers money from FTX to Alameda without FTX executive’s knowledge. Alameda made money trading algorithmically, making millions of trades a day and additionally investing the profit in blockchain platforms that connected buyers with sellers. A large part of Alameda’s asset base was customer’s FTT related assets – at June 30 2022, 5.82B of FTT related assets against an asset base of 14.6B and liabilities of 8B. So according to Alameda’s balance sheet, over 88% of its 6.6B worth were FTT related. The market considered this and gave the company a market cap of 3.32B and thought Alameda was overvaluing its assets.

On November 2nd, Coindesk reported on Alameda’s troubled balance sheet from November 2, outlining the overwhelming percentage of FTT as its largest asset.

Changpeng Zhao (CZ), CEO of rival exchance Binance, subsequently announced plans to sell off Binance’s stockpile of FTT citing “revelations that have come to light”. CZ compared the FTT situation to the crash of TerraUSD and LUNA this year that tanked the crypto market.

People started to withdraw their funds. Binance was approached to help bail out FTX. A deal was originally agreed to, but subsequently did not go through after corporate due diligence was performed. CZ cited news reports of “mishandled customer funds” and “alleged U.S. agency investigations” as contributing factors in his decision to not acquire FTX.

Bankman-Fried told investors that Alameda owes FTX about $10 Billion USD, which FTX loaned to Alameda using customer desposits, according to a Wall Street Journal report. Prior to making this loan, FTX held $16B in assets.

On the evening of Friday 11th November, FTX and FTX.US wallets were drained in an apparent “hack”. More than $600 million was drained from the wallets, Coindesk reported. FTX released a statement on their telegram support channel, saying, “FTX has been hacked. FTX apps are malware. Delete them. Chat is open. Don’t go on FTX site as it might download Trojans.” This was followed by speculation of an inside-job.

None of this changes the advantages of distributed ledger technology and associated cryptocurrency. Algorithmic trading can still protect against large market swings. Ethereum still provides the utility to securely significantly reduce transactional time and costs in business dealings, and Bitcoin is still a secure online currency for transactions between individuals. However, with the same herd mentality that lost its mind and endorsed FTX now decrying the cryptocurrency industry in general, maybe it’s an excellent time to buy.

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