The FTX fallout and what’s next for crypto?

The story so far: On November 11, FTX filed for bankruptcy protection. One of the world’s biggest crypto exchanges collapsed after reports emerged about the platform’s CEO Sam Bankman-Fried using customers’ deposits to trade on behalf of FTX’s sister firm Alameda Research.

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The bushy-haired co-founder of both the exchange and the trading unit apologised and resigned after a potential takeover deal by rival exchange Binance failed to materialise. The 30-year-old billionaire’s crypto empire collapse is so significant that it dragged Bitcoin’s price to a two-year low.

Once the darling of the crypto industry with a valuation of $32 billion in January, FTX is now a cautionary tale. It is accused of financial fraud and misuse of customer funds. Mr. Bankman-Fried admitted he was ignorant of his platform’s true liquidity and leverage levels when customers requested for “roughly” $5 billion in withdrawals in one day.

What’s the genesis of FTX?

Mr. Bankman-Fried was a former quants trader at the global trading firm Jane Street. By the end of 2017, when Bitcoin’s price breaches $1,000 after years of price fluctuations, he moves base to Hong Kong to set up investment fund Alameda Research to trade in crypto tokens and derivatives. The skyrocketing rise of the de facto crypto benchmark asset sets off a new bull run for cryptocurrency. But the digital coins were not traded at the same price on different exchanges. Mr. Bankman-Fried sees an arbitrage opportunity from this inherent volatility in the crypto ecosystem. Two years later, in April 2019, when Bitcoin once again loses its sheen, Mr. Bankman-Fried launches FTX as a platform which traders can use to buy and sell crypto assets and derivatives.

What’s the platform used for?

FTX is set up as two verticals. One can be accessed by global users, and the other is specifically built in compliance with U.S. law. The latter, FTX.US, catered to U.S. residents as they could not legally trade on the FTX International platform. FTX claimed to have over one million customers in 2021.

FTX International offered investors an option to trade in tokenised stocks, which are digital coin-based derivatives of shares of actual companies. It also allowed users to bet on expected valuations of pre-IPO companies. Such features attracted users to the platforms.

What happens to investors’ money now?

At the time of filing for bankruptcy protection, FTX International, one of two websites of the crypto exchange urged visitors to not deposit funds. It also said it was unable to process withdrawals. But its U.S. arm allowed users to create an account on the platform. Withdrawals were open but trading might be halted on the platform.

As of November 18, it is not exactly clear how many customers have been impacted by FTX halting withdrawals on its platform. The latest crypto crash affected not just FTX users, but also traders investing in top cryptocurrencies like Bitcoin and Ether. Investors holding large reserves of the exchange’s own FTT token took a hard hit as it lost most of its value in just hours.

About 130 affiliated firms are now part of the bankruptcy proceedings, including Alameda Research and FTX.US.

According to a report by CNBC, based on the 23-page bankruptcy filing, FTX has more than 100,000 creditors, assets in the range of $10 billion to $50 billion, as well as liabilities in the range of $10 billion to $50 billion. By comparison, Lehman had more than $600 billion in assets and Enron had $60 billion.

What happens to FTX after this?

Insolvency professional John Ray III has been appointed to run the FTX bankruptcy. He earlier oversaw the infamous liquidation of Enron two decades ago. In a U.S. court filing on Thursday, he minced no words and said he has never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information.”

The scathing filing highlighted the compromised system’s integrity, faulty regulatory oversight, and concentration of control in the hands of a very small group. It also noted this group lacked experience and skill. The company did not have a clear account of its own balance sheet.

The volatile crypto market is now testing its limits. From here, the industry could face more regulation, according to some experts. Others point out that such events will weed out untrustworthy people.

How different is this from the Luna, Celsius, and Voyager collapses?

Nuance is key here. Terra [LUNA] is a cryptocurrency project (not a platform) which collapsed in May this year. Formerly one of the top cryptocurrencies by market capitalisation, its LUNA cryptocurrency and Terra USD [UST] stablecoin lost over 90% of their value. As billions of dollars were lost, the ensuing panic triggered customers to move their funds between platforms or withdraw them altogether. This caused liquidity shortages that prompted lending platforms like Celsius and Voyager to suspend withdrawals, which hastened their own collapse and legal woes.

FTX is a crypto exchange rather than a lending platform. In this case, customers’ loss of trust and ensuing withdrawals can be traced back to the company’s alleged balance sheet leak two weeks ago.

Furthermore, the drama of the high-profile FTX collapse was different because many crypto investors were familiar with its main players: Binance’s charismatic CEO Changpeng Zhao and FTX’s maverick former CEO Sam Bankman-Fried. Some analysts even presented the fall of FTX as a ‘Game of Thrones’ style battle between two crypto billionaires, though Zhao denied these claims.

At the end of the day, however, the emerging crypto sector is fearful and in shambles yet again.

What about the company’s share of donation to political parties and other events?

FTX wasn’t just a major player in the crypto sector. According to the Financial Times, Mr. Bankman-Fried spent $36 million on groups associated with the Democratic Party for the November U.S. mid-term election. However, Mr. Bankman-Fried, co-CEO Ryan Salame, and FTX.US were also reported to have spent millions on both Democrats and Republicans in the past year.

Apart from politics, the Miami-Dade County and the Miami Heat basketball team broke off their partnership with FTX after it collapsed into bankruptcy. The FTX arena in Miami is slated to get a new name in the future.