What Happened to FTX and Could the Crisis Spill Over to the Rest of Crypto?
By Dan Milmo and Alex Hern
International exchange for crypto assets is in effect unregulated – and may have been built on sand
– Crypto exchange FTX files for bankruptcy protection in US
– How Binance played a key role as FTX collapse unfolded
FTX, the world’s second largest cryptocurrency exchange, is in a crisis and has pitched the digital asset market into another crash.
Here we look at what has happened to FTX, why, and what it means for the wider market.
What is FTX?
Officially headquartered in the Bahamas, FTX is managed from the US, with its biggest offices in Chicago and Miami.
It is a cryptocurrency exchange, helping people buy and sell crypto assets. Cryptocurrencies are all based on the same basic structure as their star asset, bitcoin: a publicly available “blockchain” that records ownership without having any central authority in control. FTX is big and important because, along with its rival, Binance, it processes the majority of cryptocurrency trades around the world.
Both FTX and Binance are “international” exchanges, the cryptocurrency equivalent of an offshore casino. Each also operates an arms-length US-regulated outlet, which closely follows what little regulation there is from the US government, but the bulk of the money that flows through their books is in effect unconstrained by regulatory requirements.
What happened to FTX this week?
On Wednesday last week, an article appeared in CoinDesk, a crypto industry news service, that triggered a crisis. It claimed that the balance sheet of Alameda, a crypto hedge fund owned by FTX’s founder, Sam Bankman-Fried, held billions of dollars worth of FTX’s own cryptocurrency, FTT, and had been using it as collateral in further loans. If this were the case, then a fall in FTT’s value could damage both businesses, given their shared ownership. But FTT itself had no value beyond FTX’s longstanding promise to buy any tokens at $22, prompting fears that the whole institution was a castle built on sand.
The slow-burn crisis was kicked into high gear on Sunday when Binance’s chief executive, Changpeng Zhao, tweeted that his company was selling its FTT holdings, worth about $500m, because of “recent revelations that have come to light”.
Things snowballed from there. The value of FTT collapsed, and FTX customers started withdrawing funds in a bank-run-style exodus. In a message to staff this week, cited by Reuters, Bankman-Fried said the firm suffered a “giant withdrawal surge” as users rushed to take out $6bn (£5.1bn) in crypto tokens from FTX over a three-day period. Daily withdrawals normally ran to tens of millions of dollars, Bankman-Fried told his employees.
Zhao then stepped in to rescue FTX, agreeing on Tuesday to buy the company but then announcing on Wednesday that he was stepping away from the deal. “The issues are beyond our control or ability to help,” Binance said, citing discoveries in the due diligence process and the launch of regulatory investigations in the US.
What next for FTX?
The company either needs to find billions of dollars to meet customers’ withdrawal demands, or to stem the exodus by finding a way of reassuring them their money is safe. That is never easy when so many customers are rushing for the door. Bloomberg reported on Thursday that Bankman-Fried had said the firm needed $4bn to stay solvent, with a funding gap of $8bn.
There are also deeper questions for the exchange. Just a day before the company agreed to sell to Binance, Bankman-Fried tweeted that FTX was “fine” and that it did not trade with customer assets at all. But a message to investors from Sequoia Capital, a VC firm that ploughed $150m into FTX, said the company was facing not just a liquidity crunch but solvency problems – meaning it owed more money than it actually had.
The day after the sale fell through, “SBF” resurfaced, and apologised for his failures. “I fucked up twice,” he wrote, kicking off a series of tweets in which he apologised for poor communications and said he had mistakenly assumed the exchange could not face a liquidity crunch, but argued that it was not actually insolvent.
Bankman-Fried’s apology only went so far, however, and users still had questions, particularly given other claims that he was making at the same time. The Wall Street Journal reported that FTX had loaned $10bn of customer funds to Alameda to gamble with, a substantial proportion of the exchange’s $16bn in assets.
Could there be a spillover to the rest of crypto?
There already is. Since the crisis at FTX began, bitcoin has plummeted from $20k a coin to $16.5k, its lowest value since 2020. The wider sector has fallen almost 5% in the last 24 hours, according to CoinMarketCap, and big companies and protocols that have exposure to FTX are having to prove their own liquidity. A popular token on the Solana protocol, for instance, that lets users of that blockchain trade bitcoin, relies on FTX for its value: if the exchange goes under, it is unclear whether any of the bitcoin on that protocol would be retrievable, wiping millions of dollars from existence overnight.
And, as with every crypto crash, all eyes are on Tether, the $70bn “stablecoin” that underpins much of the sector’s economy. On Thursday morning, the token slipped off its “peg”, trading at $0.98 to the dollar. The chief technology officer (CTO) of the company that issues Tether, Paolo Ardoino, tweeted to reassure investors, noting that the company had processed about $700m of withdrawals over the past 24 hours. “No issues,” he said, “we keep going.”
What about into wider markets?
The financial system’s resilience to wobbles in the crypto market has already been tested over the past 12 months with the onset of a new “crypto winter”. The value of the entire crypto market reached a peak of $3tn last November but then collapsed this year owing to a mix of crypto-specific events and wider macroeconomic issues and is currently hovering at around $800bn. Over that period, global financial markets have suffered, too, but that is because of much bigger issues, such as the Russian invasion of Ukraine and rising interest rates.
Carol Alexander, professor of finance at University of Sussex, adds that the extra blow to the industry’s credibility from the latest wobble will prolong the chill. “This crypto winter will go on a lot longer because of this.”
She added that contagion from the crypto industry into traditional financial markets was still unlikely because institutional investors, always searching for high returns from their investments, were now finding it easier to earn from conventional assets in a high interest-rate environment. “The fact is that traditional investments, like bonds, are becoming more attractive. This means crypto is less of a systemic threat.”