Crypto’s Lehman Moment: What Is FTX And How Did It Collapse?

It is all over. Cryptocurrency trading platform FTX has filed for bankruptcy. 

Founded by MIT graduate Sam Bankman-Fried, FTX was the second-largest centralised crypto exchange in the world until a few days ago. 

With marquee investors like Sequoia, Softbank, and Temasek, FTX had quickly become the second-largest exchange in the world, with daily volumes touching $ 2 billion during its peak. Unfortunately, all of it came crashing down after the company could not gather cash to return its users’ funds. 

Ironically, during his heydays as a multi-billionaire (his net worth was once estimated at $26 billion), Bankman-Fried said he would consider buying out behemoths like Goldman Sachs and CME Group if FTX became the largest exchange. But that dream appears to be far off since FTX has now filed for bankruptcy as it is unable to meet its financial obligations.

What does FTX Do?

As an exchange, FTX’s only job was to connect buyers with sellers and collect commissions on the transactions. Users would deposit fiat money (US Dollars or other government-issued currencies) into their FTX account and then use the money to buy and sell crypto. After rumours began swirling about the poor financial state of FTX and its related party Alameda Research, the exchange saw frantic withdrawals by users. Still, the exchange didn’t have enough money to allow all withdrawals.

Usually, banks run into trouble when a large number of depositors withdraw money at once since banks lend money out and don’t have the deposit money with them. But FTX was only a middleman, and being unable to process all withdrawals was a dead giveaway of a serious financial issue. Even when an exchange lends to users who wish to make leveraged trades, it has mechanisms in place to ensure that it can recover the money.

How did FTX’s Problems Start?

Bankman-Fried began his entrepreneurial journey by founding Alameda Research, a proprietary trading firm that traded in crypto-currency. Later, Bankman-Fried founded FTX to move from being just a trader to becoming the market itself. FTX went ahead and created its own token, FTT. Anyone who owned FTT would receive benefits such as lower trading fees.

After Alameda Research faced losses in its business, funds were transferred from FTX to Alameda – and these funds included customer fiat money deposits and FTT tokens. As a result, nearly a third of Alameda’s assets, worth $ 14.6 billion, was held in FTT tokens.

Alameda’s balance sheet was leaked on Coinbase, which caused concern amongst users and investors, given the Group’s precarious financial situation. According to its balance sheet, Alameda had used its assets to borrow for its business operations and had around $7.4 billion in debt. It is speculated that its FTT tokens were collateral for the loans it took. And therefore, a collapse in the value of the collateral (FTT tokens) would have sent the entire Group into a tailspin. Hence, the value of FTT tokens gained immense importance for the FTX group.

Friend-turned-Foe Catalysed the Fall

Unsurprisingly, the collapse of FTX was partly catalysed by Changpeng Zhao’s tweets. Zhao is the founder and CEO of Binance, the world’s largest crypto exchange and FTX’s largest competitor. 

Before Zhao and Bankman-Fried became fierce competitors and rivals, they were friends. Zhao had invested $ 100 million in FTX just six months after FTX’s creation. However, there was friction between the two men, and FTX bought out Zhao’s stake for $ 2 billion. But in hindsight, FTX had shot itself in the foot with this deal since it made the payment with FTT tokens. Zhao and Bankman-Fried would later get into online skirmishes regularly.

After Coinbase came out with the story on FTX Group’s precarious finances, Zhao was quick to tweet that he was selling off the FTT held by him. Other holders of the token and users of the FTX platform panicked and began selling FTT and withdrawing their fiat money – which resulted in the liquidity crisis. 

Bankman-Fried, the second-largest individual donor to the Democratic Party after George Soros, is no longer a billionaire. The Group is under investigation due to the nature of the crisis and the large sums of money involved. It is estimated that FTX owes 100,000 creditors and has liabilities anywhere between $10 billion and 50 billion.