In the world of cryptocurrencies, FTX was one of the biggest names. It was growing at a fast pace and was among the world’s largest crypto trading exchanges. So when news about a sudden crash in its value and subsequent bankruptcy appeared, everyone was in for a surprise (or rather shock). Crypto experts are calling the FTX crash as the ‘Lehman moment’ of digital currencies.
Before we look at causes for its downfall, let us understand the key aspects in the entire episode.
What is FTX?
FTX was a crypto exchange, which enabled holding, buying and selling of digital currencies by individuals and companies. It was founded by ex Wall Street trader, Sam Bankman-Fried and was based in the Bahamas.
FTX and Alameda Research
Sam Bankman-Fried also founded another company – Alameda Research, a crypto trading firm. Both these were considered separate entities. However, this year it was revealed that these were quite related to each other through entangled holdings.
The FTX story – background
As reported by CoinDesk (a site specializing in digital currency news and updates), in 2019, the world’s largest online exchange for trading cryptocurrencies and FTX’s rival, Binance had invested in FTX, which then was a derivatives exchange as well as in FTT, (FTX’s own token).
In July 2021, Binance sold its stake in FTX, for which it reportedly received $2.1 billion in stablecoin and FTT.
The FTX timeline: What went wrong?
The year 2022 started on a cautionary note for the crypto world, with the best known cryptocurrency, Bitcoin going through massive volatility. In May 2022, two well known cryptocurrencies, TerraUSD and LUNA had collapsed and then some smaller crypto platforms had gone down in its aftermath.
On November 6, 2022, Binance’s CEO, Changpeng Zhao said in a tweet that his company will liquidate its entire stake in FTT.
Then on November 8, Binance said that it had signed an agreement to acquire FTX.com, a unit of FTX. Sam Bankman-Fried confirmed this development.
However, on November 11, FTX, FTX US, its US branch and Alameda Research – all filed for Chapter 11 bankruptcy. On the same day later, the company’s system was apparently hacked resulting in a wipe off of $600 million from user wallets.
What led to the crash of FTX?
There are various factors which contributed to the crash. Some of these are :
- Huge markdown in FTT
FTX’s own token, FTT, crashed the week before and impacted other digital currencies as well, like Bitcoin, Ethereum etc. These were also trading at their two year lows.
On November 2, a leaked balance sheet was reported on CoinDesk. This showed that Alameda Research was highly dependent on FTT for its own operations and had been using margin or borrowing from FTX. This rattled investors and markets alike.
- Mismanagement of funds
As Alameda Research was holding an unusually high number of FTT tokens, it raised many eyebrows. It pointed towards inter dependence which meant that any problem with one would have a ripple effect on the other.
- Withdrawal requests in huge numbers
When Binance announced on November 6 that it would sell its FTT stake, its (FTT’s) price went down suddenly. A large number of people wanted out and this created a huge pile up of orders, as the company found itself unable to fulfill these requests. It halted withdrawals on the system.
- Severe liquidity issues
On November 8, Binance said that it had signed an agreement to acquire FTX.com, a unit of FTX. This was subject to a condition, where Binance had the discretion to pull out from the deal at any time. Sam Bankman-Fried confirmed this and said that it would help in processing customers’ withdrawal requests.
- Deal Cancellation
Binance announced on November 9 that it was no longer acquiring FTX. The reason cited was ‘mismanagement of funds’ and ‘ongoing regulatory investigations’.
Did you know
Binance itself is currently under investigation by the Department of Justice for reasons ranging from fund mismanagement to possible violations of US Bank Secrecy Act. It has spent millions of dollars lobbying U.S. legislators to institute crypto – friendly regulations.
Impact on other cryptos
Cryptocurrencies have been around for a while now. The pandemic gave a boost to these digital assets, like many other new age tokens, coins, NFTs etc.
However, earlier this year with LUNA and now with FTX, there seems to be something wrong with the crypto world.
Let us look at its impact on the crypto ecosystem :
As we are aware, cryptocurrencies are mostly unregulated and there is no control of either governments or any other central authority on their functioning. They are managed by peer to peer computer networks running free and open source software. They have been lobbying hard with the regulators for concessions. The FTX episode will possibly lead to closer scrutiny and tighter regulations for customer protection.
There are many customers who are reported to have been affected with the $ 600 million wipeout as a result of the apparent system hack. The new CEO has also reported a ‘substantial portion’ of the company’s assets as ‘missing or stolen’. Customers are not sure if and when they will be able to access their funds on the platform. In fact, many have lost any hope of getting their money back.
Future of cryptocurrencies
The rise of cryptocurrencies has been quite extraordinary. It has created wealth for some while creating heartburn for many. Retail investors generally enter at the peaks and then get stuck. Investors should make it a point to put only a small amount in such risky products and that too, should be spread out.
Impact of FTX’s failure on Indian crypto investors
In India, there is no regulatory framework applicable on the crypto exchanges. Although scores of Indian investors have invested in these, no protection is available in case of any FTX – type crash. Thus investors should be very cautious and avoid taking any fresh positions till there is further clarity. They should look at investments which offer greater transparency and have a clean record.
Sam Bankman-Fried was hailed as a mercurial leader who had bailed out smaller crypto companies facing financial issues. A few days ago his networth was quoted as $24 Billion. With the crash of FTX, people are now wondering about valuation metrics, trustworthiness, checks and validations by marquee names, private investors and large businesses in crypto assets. With big names going down, the year 2022 has been quite volatile for digital currencies. Investors should brace for challenging days ahead.
Investing money in cryptos, or any other option should be based on various factors like – understanding of the investment product, return expectations, risks involved and safety of initial corpus as well.
Indian investors have no form of protection available in the case of cryptocurrencies. Customers have a hope of rescue in case of a bank failure, but in digital currencies, the risk is entirely borne by the investor.
You can move your digital assets from the crypto exchange to a Digital Wallet, on a separate platform online. It can also be moved offline, on a thumb drive with additional security features.