After a year of experiencing the bear market with multiple dips and recoveries, we had expected to at least wrap up 2022’s bloody crypto year with stability and consolidation. This changed however, with the FTX collapse catalyzing the downward trend.
But apparently, that was not the case. FTX, one of the largest centralized cryptocurrency exchanges, has filed for bankruptcy. We can predict that the impact will be devastating for the crypto market. You can expect new year-lows for Bitcoin (BTC), Solana (SOL), Ethereum (ETH), and the rest of the crypto market.
After the crypto company FTX went bankrupt and its founder, Sam Bankman-Fried resigned, customers were left in uncertainty. In addition to this, investors lost faith in tech’s next big thing.
Within a few days, the crypto world as we knew it had changed. If you’re confused about what happened, don’t worry. Here are the basics of the story of the FTX collapse.
What is FTX?
FTX is a digital currency exchange where people can buy and sell assets, such as bitcoin, dogecoin, and ether. These platforms have grown more popular in recent years because they allow people to invest without having to deal with the technicalities, like setting up a crypto wallet, and its ease of use.
FTX is a cryptocurrency exchange founded in May 2019 by Sam Bankman-Fried. SBF for short was also the founder of FTX.US, and quantitative cryptocurrency trading firm Alameda Research.
Who is Sam Bankman-Fried?
Sam Bankman-Fried was one of the wealthiest people in cryptocurrency. This was until his empire came tumbling down in November of 2022 due to the FTX collapse.
In 2014, after he graduated college with a degree in physics from the Massachusetts Institute of Technology, Bankman-Fried started his professional career as a trader at Jane Street Capital.
At Jane Street, he focused on arbitrage trading strategies that revolved around exchange-traded funds (ETFs). An arbitrage trade is where somebody buys an asset in one market and then quickly sells it for a higher price elsewhere, earning risk-free profit.
In 2019, he started FTX and turned it into one of the most popular exchanges for crypto derivatives. By early 2022, investors had given FTX and its U.S. operations a combined value of $40 billion.
After investors started withdrawing their money from FTX at an alarming rate, Bankman-Fried filed for bankruptcy for FTX. He also did the same for his other company, Alameda Research trading firm.
What Caused the FTX Crash?
CoinDesk, a crypto news company, has started to report that the balance sheet of Alameda, a crypto hedge fund owned by FTX’s founder Sam Bankman-Fried, holds billions of dollars worth of FTX’s own cryptocurrency FTT. If this is true, then a drop in value for FTT would damage both businesses given their shared ownership.
However, FTT itself has no value beyond FTX’s longstanding promise to buy any tokens at $22. This prompted fears that the whole institution was built on unstable ground.
Traders use FTT to pay transaction fees and other operations on the FTX exchange platform. Last year, Changpeng Zhao, the CEO of Binance, sold his stake in FTX back to Mr. Bankman-Fried. Mr. Bankman-Fried paid for part of the purchase with FTT tokens.
On Nov. 6, Binance announced that it would sell its FTT tokens due to “recent revelations”. This caused the price of FTT to drop significantly. Traders began to withdraw their money from FTX out of fear that it would be yet another crypto company whose bubble had burst. Some speculate that Changpeng Zhao knew that this would cause the collapse of FTX (Binance’s business competitor).
From there, things rapidly went downhill. The value of FTT sank, and FTX customers started withdrawing their funds in a panic. This was very similar to what happens during bank runs.
Reuters obtained a copy of a message Bankman-Fried sent to his staff this week. In this, he said the firm was hit by a “massive withdrawal surge” as users withdrew $6bn worth of crypto tokens from FTX over just three days. Normally, daily withdrawals only amounted to tens of millions at most. Bankman-Fried told his employees that this recent incident was therefore quite unprecedented.
Zhao stepped in to rescue FTX’s continuous sinkhole, with plans to buy the 2nd biggest centralized exchange amidst the crash. He then announced the day after that he was stepping away from the deal. “The issues are beyond our control or ability to help,” Binance said.
The exact events that led to the FTX collapse and their bankruptcy are still unclear. However, many analysts point to the fact that FTX’s management team took on too much risk and expanded operations too quickly. It seems they were unable to handle the immense amount of traffic generated by their users during periods of market volatility. This ultimately caused them to suffer heavy losses.
How Did This Crash Affect The Whole Crypto Industry?
The cryptocurrency industry has had difficulty earning trust from regulators, investors, and customers for a while now.
New investigations by the Justice Department and Securities and Exchange Commission have started as a result of the recent collapse. This was focused on whether FTX used customer funds to support Alameda Research inappropriately. Mr. Bankman-Fried just so happens to be the founder of said trading firm.
When the cryptocurrency market took a $2 trillion hit in May, FTX offered financial help to several struggling companies. In many instances, these companies were relying on FTX for their recovery. Now that FTX is on a continuous downfall, these companies FTX once saved have since been greatly affected. Unfortunately, this has led to continuous bankruptcies and halts in operations.
The price of FTT, a native cryptocurrency token for FTX, has tumbled more than 90 percent since Nov. 8 amid wider weakness in the digital asset markets.
Bitcoin is down about 19 percent this month while Ether has lost around 24 percent of its value over the same period. Being the mother coins of the crypto market, this has also crashed the whole market, creating new lows for the other altcoins. This cascading effect wiped out about $200 billion worth of money on the overall crypto market cap.
What are the next steps for FTX?
The company needs to find either billions of dollars to meet customers’ withdrawal demands or a way of reassuring users their money is safe in order to stem the exodus. That is never easy when so many customers are rushing for the door. As Bloomberg reported on Thursday, Bankman-Fried had said the firm needed $4bn to stay solvent, with a funding gap of $8bn.
There are also other questions that need to be addressed with this exchange.
Just a day before the company agreed to sell to Binance, Bankman-Fried tweeted that FTX was in good shape. It was stated that they did not trade with customer assets at all. But a message from Sequoia Capital, a VC firm that plowed $150m into FTX, said the company was facing not just liquidity issues but solvency problems. This means that FTX owed more money than it actually had.
This raised red flags and potential concerns for anyone considering investing or utilizing this exchange.
“SBF” reached out to the public once again the day after the sale fell through. In a series of tweets, he admitted his poor performanc. He tweeted “I f–ked up.” and communicated that he had wrongly concluded that the exchange could not face a lack of liquidity but was in fact solvent.
What can we learn from the FTX collapse?
The FTX collapse highlights some of the key challenges facing the crypto industry as a whole. One major issue is that many companies, particularly those operating in the centralized exchange space, have taken on excessive amounts of risk and grown too quickly. FTX itself expanded operations at an alarming rate. This led to an inability to handle sudden surges in traffic during periods of market volatility.
A more important lesson is to never give away your keys. As they all say, “Not your keys, not your coins.” Your keys are the letters and numbers that control your cryptocurrency. If you don’t understand how public-key cryptography works, then you’re at risk of losing your assets.
A lot of people let SBF and FTX hold their keys for them. Apparently, this is a textbook mistake if you plan to enter the crypto industry.
Another key lesson from this crash is that we need better oversight and regulation in the crypto space to ensure that investors are protected and that companies operate ethically.
Many critics have argued that decentralized exchanges offer a more secure alternative to their centralized counterpart. But, they are still not widely used due to various technical issues. People have still been heavily relying on centralized exchanges, and this is not a good step towards true decentralization.
FTT itself was not an asset with sound properties. It was essentially created from nothing by a centralized entity much like fiat is created by governments. FTX and its users were left with the bill when things went wrong, but it could have easily been avoided.
Instead of betting on highly levered exchanges through created cryptocurrencies, it may be more beneficial to seek assets that are tied to energy output. Assets that take work and energy to accumulate such as Bitcoin (through Bitcoin Mining’s proof of stake), tend to have more properties that are renowned and therefore, more trusted by users.
Centralized control and business attacks can be avoided by decentralizing and holding your own keys and coins. FTX is an example of what happens when that fails.
FTX Collapse in a Nutshell – Summary
The FTX collapse highlights some of the key challenges facing the crypto industry as a whole. As we can learn from this incident, companies need to be careful with how much risk they take on. They must also act ethically to thrive in this rapidly-evolving space. Regulatory oversight is also needed to ensure that investors are protected and that new entrants into the crypto ecosystem make sensible decisions.
Until these issues are addressed, we will continue to see more cases like FTX. We will see customers losing money and companies struggling to stay afloat. In the meantime, decentralized exchanges remain an attractive alternative for those looking for increased security and greater control over their assets.