The FTX bankruptcy: a closer look at what went wrong

This month, one of the world’s largest cryptocurrency exchanges, FTX, filed for bankruptcy, and its former CEO and founder, Sam Bankman-Fried, resigned. This collapse has been a shock to the cryptocurrency industry, and it has happened during a tough year for it.

Like a usual cryptocurrency exchange, FTX enabled customers to trade digital currencies for other digital currencies or traditional money, and vice versa. It was based in the Bahamas and, at its peak, the company was valued at $32 billion.

In order to understand better what happened, we need to look at Sam Bankman-Fried.

In 2017, he co-founded Alameda Research, a small quantitative trading firm that focused on arbitrage trading. That is, the company bought cryptocurrencies in one market and sold them in another, pocketing the difference.

In order to have more funds for Alameda to run its business, Sam Bankman-Fried decided to create FTX in 2019. FTX almost immediately created its own token, FTT, that worked like a loyalty program for customers. People could decide to use the token to trade cryptocurrencies with discounted transaction fees. At the same time, however, FTT was also bought and sold like a normal token.

To maintain the value of FTT, Alameda Research served as the token’s main market maker, which means it bought and sold most of FTT on the exchange. 

At the same time, however, Alameda also used FTT to make speculative bets on other cryptocurrencies, that is they used FTT holding as collateral for more loans to facilitate its trading activities. In other words, customers gave money to FTX to buy FTT, and this allowed Alameda to make risky investments, backed up by its FTT holdings.

Therefore, this meant that Alameda was very exposed to volatility in FTT, so if the value of FTT fell, Alameda would be unable to pay back its lenders.

When cryptocurrencies prices went down earlier this year, the price of FTT also went down. This implied that Alameda struggled to pay lenders back, and FTX helped the company by using funds that customers had deposited with the exchange.

The events that shook up FTX in early November are related to a CoinDesk article that questioned FTX’s solvency. In particular, CoinDesk reported that Alameda Research’s balance sheet of $14.6 billion had assets for FTT for a total of $5.5 billion.

After this report, the CEO of Binance, one of the biggest cryptocurrencies exchange, sold its FTT holdings, setting off a chain reaction of customers that began withdrawing assets from FTX. This made the price of FTT fall down even more, and FTX found itself in a liquidity crunch, unable to process all those withdrawals due to lack of money.

Binance later announced a tentative deal to buy FTX, but after finding too many holes and problems in the company’s finances it decided not to proceed with the offer.

After these events, FTX and several connected companies filed for bankruptcy and Sam Bankman-Fried resigned. The bankruptcy filing, done by the new FTX chief, described numerous corporate missteps, including the use of software to “conceal the misuse of customer funds”.

The price of FTT has dropped more than 90 percent since early November. Sam Bankman-Fried, instead, saw his wealth plummet by over 94%, from 15 billion to less than 1 billion in a single day.

Right now, FTX said that it owes its 50 biggest creditors nearly $3.1 billion. In total, the firm has $8 billion to repay.

Adding to the company’s problems, the Royal Bahamas Police Force said it is investigating FTX. Moreover, the U.S. Department of Justice and the Securities and Exchange Commission are already examining the company, in order to assess whether they improperly used customer funds to prop up Alameda Research.