A cryptocurrency trading platform, FTX was theoretically based on a relatively low-risk business model, relying primarily on the fees charged to transactions executed on it. It should therefore have had access to its customers’ deposits at any time. However, we now know It was not like thisdue to the recently unearthed 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?
Several important steps hastened the collapse of FTX:
- On November 2, the specialized site CoinDesk has revealed that the balance sheet of Alameda Research consisted mostly of FTT tokens issued by FTX (3.66 billion FTT and 2.16 billion “guaranteed FTT”, i.e. 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 largely composed of other illiquid or FTX-linked tokens (SOL, SRM, MAPS, OXY, FIDA).
- On Nov. 6, the CEO of Binance, the largest cryptocurrency exchange, said his company will sell its FTT holdings. As a reminder, Binance had invested in FTX stock when it was created and obtained a significant amount of tokens (estimated at approximately $2.1 billion in FTT and BUSD) after its exit from FTX equity in 2021. This announcement has caused massive withdrawals of funds from FTX customers (almost 6 billion in just 72 hours).
- On Nov. 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 proposed acquisition citing mishandling of customer funds and investigations by US authorities.
- On Nov. 11, unable to overcome its liquidity woes, FTX along with 134 member companies – including its US arm FTX US and Alameda Research – filed for bankruptcy. The American press revealed that the platform allegedly 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 over 600 million being diverted from the wallets of FTX and FTX US. Many rumors quickly circulated about the possibility of an internal origin of these deviations.
The impact on cryptocurrency market liquidity will be significant.
Liquidity in the cryptocurrency 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 major market makers could therefore cause a significant drop in liquidity (“Alameda Gap”). Losses suffered by other market makers, some of which (Amber Group, Wintermute and Genesis) have already confirmed they have funds tied up in FTX, could contribute to these liquidity problems.
While a decline in liquidity is common during times of volatility, the historical magnitude of the liquidity decline seen last week could raise concerns that the liquidity gap related to the Alameda crash could last for a long time.
The situation appears particularly worrying on the much less liquid markets of the “altcoins”. Alameda had invested in dozens of projects and held millions of dollars in illiquid tokens for which it served as a liquidity provider.
The cryptocurrency markets have decoupled from the US stock markets.
The FTX crash has had a significant impact on the cryptocurrency industry, with bitcoin and ether down 21% and 23% respectively over the past week. The cryptocurrency market thus decoupled from the US stock markets, which closed the week sharply higher, benefiting from a slowdown in inflation. Thus, Bitcoin’s correlation with the Nasdaq dropped to its lowest level since November 2021, while its correlation with ETH hit its highest level in over a year.
Volatility risks in derivatives markets.
Falling 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. Indicators of investor sentiment, such as the perpetual futures funding rate, have deteriorated sharply. Investor perceptions of risk were also affected. Implied volatility, an indicator that reflects market participants’ expectations about the future movements of Bitcoin and Ethereum, has doubled in the last week.
It is still difficult at this stage to assess all the consequences of FTX’s fall on the cryptocurrency industry before knowing how its major players have been affected. Crypto lender Blockfi – with a funding structure of 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 in FTX. FTX investors, including SoftBank and Sequoia, have since cut their stakes to zero, losing millions of dollars in value.
Everything points to the fall of FTX will have an accelerating effect on the regulation of the sector. Many centralized exchanges have already voluntarily published evidence of their reservations (note however that these do not reveal the composition of liabilities and depend on the good faith of the reporting parties).