A cryptocurrency trading platform, FTX was theoretically based on a relatively low-risk business model, relying primarily on fees applied to transactions executed on it. It should thus have been able to have access to its customers’ deposits at any time. However, we now know that was not the case, due to the recently brought to light opaque financial relationship between FTX and its sister company – investment and brokerage firm Alameda Research.
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What were the triggers for FTX’s downfall?
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Several major steps precipitated the collapse of FTX:
- On November 2, the specialized site CoinDesk revealed that Alameda Research’s balance sheet consisted mainly of FTT tokens issued by FTX (3.66 billion FTT and 2.16 billion “guaranteed FTT”, either used as collateral , for assets of 14.6 billion). The token, whose usefulness is extremely limited, has also been used by Alameda as collateral to borrow funds. The company’s assets were also composed for a large part of other illiquid or FTX-related tokens (SOL, SRM, MAPS, OXY, FIDA).
- On November 6, the CEO of Binance, the largest crypto exchange, said his company will sell its FTT holdings. As a reminder, Binance had invested in the shares of FTX when it was created and obtained a significant amount of tokens (estimated at around $2.1 billion of FTT and BUSD) following its exit from the capital of FTX in 2021. This announcement prompted massive withdrawals of funds from FTX clients (nearly 6 billion in just 72 hours).
- On November 9, FTX suspended withdrawals and its CEO, Sam Bankman-Fried, announcement a “strategic transaction” with its competitor Binance aimed at ensuring that “customers are protected”. However, less than 48 hours later, Binance withdrew its takeover proposal citing mismanagement of customer funds and investigations by US authorities.
- On November 11, unable to overcome its liquidity problems, FTX along with 134 associated companies – including its US arm FTX US and Alameda Research – declared bankruptcy. The American press reveals that the platform would have lent more than half of its customers’ deposits (between 8 and 10 billion dollars) to Alameda to finance risky operations.
- A few hours later, the platform was the target of a massive hacking operation, with more than 600 million having been diverted from the wallets of FTX and FTX US. Many rumors quickly circulated on the possibility of an internal origin of these diversions.
The impact on crypto market liquidity will be significant
Liquidity in the crypto markets is mainly provided by a select number of companies, such as Wintermute, Amber Group, B2C2, Genesis, Cumberland and, until recently, Alameda. The disappearance of one of the largest market makers could therefore cause a significant drop in liquidity (“Alameda Gap”). The losses suffered by the other market makers, some of which (Amber Group, Wintermute and Genesis) have already confirmed that they have funds locked up in FTX, could contribute to increasing these liquidity problems.
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While a drop in liquidity is common during periods of volatility, the historic magnitude of the drop in liquidity seen last week could raise concerns that the liquidity gap related to the Alameda collapse could be long-lasting.
The situation seems particularly worrying on the much less liquid “altcoin” markets. Alameda had invested in dozens of projects and held millions of dollars in illiquid tokens for which it acted as a liquidity provider.
Crypto markets have decoupled from US stock markets
The collapse of FTX had a significant impact on the crypto industry, with bitcoin and ether dropping 21% and 23% respectively in the past week. The crypto market thus decoupled from the US stock markets, which ended the week sharply higher, benefiting from a slowdown in inflation. Thus, Bitcoin’s correlation with the Nasdaq fell to its lowest level since November 2021, while its correlation with ETH hit its highest level in over a year.
Risks of volatility in derivatives markets
The fall in prices on the “spot” markets led to cascading liquidations, worth an estimated nearly 900 million on November 8 and 9, on the crypto derivatives markets. Investor sentiment indicators such as the perpetual futures funding rate have deteriorated sharply. Investors’ perception of risk was also affected. Implied volatility, an indicator that reflects market participants’ expectations of future movements in Bitcoin and Ethereum, doubled in the past week.
Contagion
It is still difficult at this stage to assess all the consequences of the fall of FTX on the crypto industry before knowing how its main players have been impacted. Crypto lender Blockfi – with a funding facility from FTX US – has announced that it will be forced to suspend withdrawals from its customers. Investment fund Galois Capital has admitted that half of its funds are locked up on FTX. FTX investors, including SoftBank and Sequoia, have since reduced their stakes to zero, their value losing millions of dollars.
Everything suggests that the fall of FTX will have an accelerating effect on the regulation of the sector. Many centralized exchanges have already spontaneously published proofs of their reservations (note however that these do not reveal the composition of the liabilities and depend on the good faith of the reporters).