Crypto is in chaos as FTX files for bankruptcy; understand

In the space of a week, a 30-year-old entrepreneur who was once hailed as a modern day JP Morgan saw his digital empire, including billions of his own fortune, evaporate in a death spiral that shook the foundations of the trillion dollar cryptocurrency industry.

On Thursday (9), Sam Bankman-Fried issued a mea culpa: “I screwed up,” he wrote in a lengthy Twitter thread, apologizing to investors and customers of FTX, the exchange platform he founded in 2019. FTX said Bankman-Fried had resigned as CEO and that the company was filing for bankruptcy.

Failures are not uncommon in the murky and unregulated world of cryptocurrencies, but FTX is no ordinary cryptocurrency startup. Its near-collapse this week represents a potential turning point for an industry that many critics say has long been shunned.

Doubtful finances

Last week, cryptocurrency news website CoinDesk published an article based on a leaked financial document from Bankman-Fried’s hedge fund Alameda Research.

The report suggested that Alameda’s business rested on precarious financial foundations. Namely, that most of its assets are held in FTT, a digital token from Alameda’s sister company, FTX. This was a red flag for investors as the companies were, on paper at least, separate. The disproportionate holdings of the Alameda token, however, suggested that the two were much more closely linked.

On Sunday, the CEO of Binance, FTX’s much bigger rival, said his company was liquidating $580 million in FTX holdings. This set off a storm of loot that the platform didn’t have the money to facilitate.

Rivals unite

As of Monday, concerns over Alameda and FTX had spilled over into the broader cryptocurrency market. But Bankman-Fried was defiant, tweeting that FTX and its assets were “fine”. He also feuded with Binance CEO Changpeng Zhao, whose tweet fueled the run on FTX deposits.

There was clearly bad blood between the two, which is why it shocked the industry when the pair announced an interim deal on Tuesday for Binance to rescue FTX. “This afternoon, FTX asked for our help,” Zhao tweeted that afternoon, noting that there was a “significant liquidity crisis” at the company and that Binance would have to perform corporate due diligence before moving forward with any deal.

Almost immediately after taking a look under the hood, Binance started to backtrack. Meanwhile, Bankman-Fried’s personal fortune also plummeted.

According to the Bloomberg Billionaire Index, Bankman-Fried’s net worth dropped 94% in a single day, from more than $15 billion to just under $1 billion — the biggest one-day loss ever recorded by the index. (The estimate of his wealth was based on the assumption that Binance would eventually save FTX, where many of Bankman-Fried’s personal assets are held. Which means his net worth may have even more to go down.)

On Wednesday (9), cryptocurrencies continued to fall as investor anxiety about the FTX bailout spread. Bitcoin and ether, the two most popular tokens, hit their lowest level in two years.

The sale deepened after media reports emerged that Binance was inclined to walk away from the deal. Sure enough, on Wednesday afternoon, Zhao tweeted a withering assessment of FTX’s problems: “At first, our hope was to be able to support FTX customers to provide liquidity, but the problems are beyond our control or ability to help.” . He also alluded to allegations of “mismanaged funds” and investigations by US regulators. Binance was out. FTX’s best chance at a lifeline is gone.

FTX damage control

The full extent of FTX’s financial woes is not yet known, but multiple reports say the company is facing an $8 billion shortfall.

Without a quick capital injection, Bankman-Fried reportedly told investors on Thursday that the company was facing bankruptcy.

Since the Binance deal fell apart, Bankman-Fried has been struggling to raise funds. On Thursday, it tweeted that there were “multiple players” the company was talking to. “We are spending the week doing everything we can to increase liquidity,” he wrote in his apology thread. “Every penny” of that, plus the remaining collateral, will go towards making users complete, followed by investors and employees.”

How did FTX fail?

Despite its reputation as a reliable, low-risk investment platform, FTX’s trades appear to have been built on a complex and extremely risky type of leveraged trading.

Customers deposited their money to engage in cryptocurrency trading. But it appears that FTX took billions of dollars of that money and loaned it to its sister company, Alameda, to fund these high-stakes bets, according to The Wall Street Journal.

Bloomberg columnist Matt Levine put it another way: “FTX took their customers’ money and exchanged it for a pile of magic beans, and now the beans are worthless.”

At the end of the day, FTX experienced the crypto equivalent of a classic bank run. Customers wanted their money, and FTX didn’t have it.

In traditional finance, customer funds are protected by the Federal Deposit Insurance Corporation, which insures deposits. The FDIC does not insure stocks or cryptocurrencies, however, leaving the fate of FTX’s customers and investors in question.

One such investor was the Ontario Teachers’ Pension Plan, which said it invested $95 million in FTX International and its US entity “to gain small-scale exposure to an emerging area in the fintech sector.”

In a statement on Thursday, the plan noted that any loss on its investment would have “limited impact” as it represents less than 0.05% of its total net assets.

What’s to come?

After a chaotic week, FTX filed for bankruptcy. In a statement, FTX said that John Ray III has been named the new CEO and that many exchange employees are expected to remain to run the company as it goes through the Chapter 11 process. Ray said bankruptcy protection will give FTX the chance to “assess your situation and develop a process to maximize recoveries for your stakeholders”.

Regulators are now scrambling to investigate what went wrong at FTX, and some lawmakers are demanding a crackdown.🇧🇷

Securities regulators in the Bahamas, where FTX is headquartered, froze some of the distressed exchange’s assets on Thursday. Both the Justice Department and the Securities and Exchange Commission are investigating the FTX, according to the Wall Street Journal. (The DOJ declined to comment, and the SEC said it does not comment on the existence or non-existence of investigations.)

The FTX collapse is “a high warning sign that cryptocurrencies could fail,” Democratic Senator Sherrod Brown, chairman of the Senate Banking Committee, said in a statement Thursday. “And just as we saw with OTC derivatives that led to a financial crisis, these failures could have a ripple effect on consumers and other parts of our financial system.”