The Collapse of FTX

Sam Bankman-Fried (SBF)…his name may not mean much to you, but he has become extremely popular within the cryptocurrency space… and not for good reasons. Until this last month, Sam was a crypto juggernaut. He began his crypto fame by co-founding a crypto trading firm called Alameda Research back in 2017. In 2019, Sam stepped down from his CEO role at Alameda Research to found FTX, a cryptocurrency derivatives exchange. FTX experienced immense success and was valued at $32 billion earlier this year. As the title of the article suggests, this success came to a drastic halt. On Nov. 11th, 2022, FTX filed for chapter 11 bankruptcy in which 130 affiliated companies are included in the proceedings.

So how does a company worth $32 billion suddenly file for bankruptcy? Put simply, fraud, corruption, and greed (the usual suspects). Shortly after FTX opened, they launched their own cryptocurrency called FTT. It is important to note that cryptocurrencies can be extremely volatile and their value is primarily based on public demand. There is no intrinsic or physical value. With the success of FTX exchange, the cryptocurrency (FTT) became popular and attracted a lot of buyers on both the individual and institutional level. However, with the poor performance of crypto this year, rumors began to circulate that Alameda Research’s balance sheet was in trouble. It is estimated that 40% of the balance sheet was comprised of FTT tokens. At the moment, the accusation is that Sam Bankman-Fried lent customer deposits and assets to Alameda Research without disclosing this practice to depositors. The trading firm would then use those assets as collateral to execute risky trades and bets. This operation of using customer deposits is not necessarily inappropriate if clients know about it. Large banks perform this action on a daily basis. The issue was that Alameda Research was using an asset with extreme volatility (FTT Token), to secure a guaranteed liability. As long as the FTT token performed well in the markets, FTX and Alameda would be in good shape.

The CEO of Binance, the world’s largest crypto exchange, heard the rumors of Alameda’s troubled balance sheet and announced that he would sell all of his FTT exposure (worth about $500 million at the time). This created panic and distrust in the FTT token which led to a bank run. FTX was unable to cover the sell orders customers were placing. In FTX’s turmoil, Binance and FTX agreed on a non-binding letter of intent for Binance to buy FTX. After Binance’s legal and risk management teams completed their due diligence, they determined that FTX’s financial gap between assets and obligations was too wide and withdrew their offer to buy. When companies pull an offer to buy due to a company’s financials, it is a corporate death sentence. Within the regulated financial industry this could be a scenario where the government would step in and bail out FTX. However, because the crypto market is unregulated, there is no government safety net. With no bailout and no companies lining up to buy the failed firm, FTX filed for bankruptcy.

The question now is where will the crypto market go? While the specifics are different, the actions of Sam and FTX are similar to the actions that led to the financial crisis of 2008. Companies working with high leverage and poor risk management. After 2008, Washington quickly drafted and passed the Dodd-Frank Act, which placed strict regulations on the financial industry. We will not know all the details of the FTX fallout for some time, but one thing is certain; Sam and FTX have made a great case for more regulation within the crypto space.