FTX Collapse: The Story Behind

The complete crash of FTX and the sensational retirements of its founder and his once-touted management team has sent shockwaves across the crypto space. In essence, the downfall of the company has screwed over retail institutional investors, leaving them utterly devastated and unable to recoup a single penny out of their holdings.

We know that it can be hard to analyze the happenings in the crypto sphere, especially given the fact that it’s crypto’s “Madoff moment.” Here’s how it went — and how it’s still going down.

A brief history of FTX

Bahamas-established crypto exchange FTX was launched in 2019 as an offshoot of Alameda Research, a trading brand headed by Sam Bankman-Fried. Since its launch, FTX has grown to be one of the world’s biggest and leading cryptocurrency exchanges, with partnerships across the industry, including major sports leagues, organizations, and well-known celebrities and endorsers. 

Essentially, FTX enables people to trade cryptocurrencies to and from fiat, while offering them other investment products similar to traditional finance for passive yield.

FTX, through Sam Bankman-Fried, has spent millions of dollars to lobby for crypto-friendly regulation — mostly in his firm’s favor. Bankman-Fried has also emerged as one of the Democratic Party’s largest contributors in the past election cycle.

The exchange had established its business on trading options that are illegal in the U.S. — and its monumental fall from grace has led to an overall deflation of the crypto space and the center of regulatory investigation in Washington D.C. and the rest of the world.

When did FTX collapse? A timeline

The first signs of an impending crash evolved November 2, 2022, when Alameda Research’s balanced sheet was leaked — with its holdings consisting of billions of dollars of FTT.

Changpeng Zhao, Binance CEO and direct competitor of FTX and Sam Bankman-Fried, said that he was selling off his brand’s FTT holdings on November 6, thanks to the commingling of funds between FTX and Alameda. Zhao compared FTX and Alameda’s situation to LUNA and TerraUSD this May.

Suspicions were raised when FTT token prices plummeted after Zhao’s announcement; namely, that FTX didn’t have the liquidity to stay afloat and honor transactions on its platform. This situation also sank the cryptocurrency market’s prices.

On November 8, Zhao and Bankman-Fried entered into a non-binding agreement for Binance to acquire FTX sans its US-based branch; this was essentially a bailout for FTX in the hopes of averting a crypto market crash.

Subsequently, on the same day, FTX put a hold on all crypto withdrawals on its platform, with Bankman-Fried sharing a series of non-apologies about FTX’s liquidity crunch:

On November 9, Zhao proclaimed that Binance was pulling out of the deal after conducting its due diligence on FTX, citing reports of systematic misappropriation of user funds and U.S. government investigation as his reasons for withdrawal.

Following the collapse of FTX, Bankman-Fried’s fortune went from upwards of $16 billion to nil within several days as his once-vaunted crypto empire went bankrupt on November 11.

Three reasons behind FTX’s collapse

The primary reason for FTX’s collapse begins with FTT — the native token of its ecosystem. FTT essentially was a security representing ownership in FTX that the latter issued and promised to buy back from their profits. However, it emerged that Alameda Research — the company’s trading arm — was using the token to make extremely risky plays, jeopardizing FTX’s viability as a company. The disclosure led to rival exchange Binance to dump its substantial FTT holdings. This initiated the “bank run” scenario as nervous clients rushed to the exits to pull out their funds.

Another factor was the supposedly siloed but undeniable relationship between FTX and Alameda Research: since FTX was incapable of receiving wire transfers, FTX clients would wire money to Alameda Research and the exchange would in turn credit their accounts. However, there were no customer funds that actually went into FTX — Alameda basically held over $8 billion of FTX customer funds that it gambled and lost in the crypto markets. In short, FTX had a liquidity crunch when investors started pulling out because the money that customers deposited into the exchange was never there in the first place.

Ultimately, the final nail in FTX’s coffin was the mismanagement and a lack of oversight, transparency, and controls. The new FTX CEO, John Ray III, responsible for managing Enron after its 2001 implosion, said the levels of “such a complete failure of corporate control” before FTX were unprecedented. Touché.

The link between FTX and Alameda Research

The line between Alameda and FTX was immensely blurred from the very beginning. Sam Bankman-Fried co-founded Alameda Research in 2017 as a small trading firm that would represent the building block of his crypto empire. 

Bankman-Fried launched FTX in 2019 after Alameda Research needed funding to run the latter. Since FTX’s collapse, the relationship between both “sister firms” has come under intense scrutiny, after it emerged that Alameda heavily traded on FTX and profited from customer losses. Bankman-Fried appointed Caroline Ellison as Alameda's CEO in 2019, but the rumor and innuendo were that Bankman-Fried maintained control of the trading firm’s investments and business decisions––and allegations of FTX diverting customer and corporate funds to prop up Alameda Research.

Conclusion

In a nutshell, FTX collapsed due to a liquidity crunch caused by a lack of oversight and straight-up misfeasance in the management of user funds. This was followed by a massive surge in withdrawals from unnerved investors pulling out of FTX. Ultimately, these three factors caused a “bank run” scenario that led to the value of FTT — FTX’s native token — falling through the roof and taking the rest of the market, including Bitcoin and Ethereum, along with it. 

Is it only the beginning or will we see the sequel of this show sometime soon? Hard to say now, but we will keep an eye on the situation. Stay tuned with SimpleSwap, we’ll keep you informed about the most interesting news and topics of the Crypto World!