Why the FTX exchange went bust and what it means for investors

The crash of the FTX exchange made Sam Banker-Fried a dollar millionaire and shook the entire cryptocurrency world. What exactly happened and how did investors pay for it? Explore the background to the crash of one of the world's largest cryptocurrency exchanges in our article.
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Who is Sam Bankman-Fried anyway?

Sam Bankman Fried was originally cryptocurrency trader (trader) who, through his firm Alameda Research, earned millions of dollars in arbitrage (exploiting the advantageous difference between the buy and sell rates on different exchanges). He bought cryptocurrencies cheaply in the US and sold expensively in Japan.

This “superstar” of the cryptocurrency world then founded in 2019 a cryptocurrency exchange named FTX — later, according to some statistics, the second largest crypto exchange in the world.

In November 2022, to everyone's surprise, the FTX exchange declared bankruptcy and filed on itself application for insolvencyto protect itself from a so-called bank run — a condition in which a bank's clients make demands in bulk to withdraw their deposits.

The day after the bankruptcy filing, over CZK 16 billion in cryptocurrencies was mysteriously transferred from the exchange in unauthorized transactions.
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So why did the stock market fail?

The company declared bankruptcy after customers withdrew about six billion dollars from its platform within 72 hours, roughly equivalent to 141.2 billion CZK. The company apparently lacked the means to compensate for such a large outflow of assets and thus fell into bankruptcy.

The collapse set off investigations by the U.S. Department of Justice and the Securities and Exchange Commission. It came to light that FTX had apparently improperly used customer funds to support Bankman-Fried's second trading company, Alameda Research.

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What is FTX?

FTX is (or rather was) one of the largest cryptocurrency trading exchanges in the world. Similar to Coinbase, Binance and other exchanges, FTX allows you to exchange digital currencies with each other or for fiat currencies. The company, which is owned by Sam Bankman-Fried, is based in the Bahamas and has spent millions of dollars in the past lobbying US lawmakers for regulations in favor of cryptocurrencies, among other things.

The problems of the FTX cryptocurrency exchange dragged down the value of the entire cryptocurrency market. FTX has warned on its website that it has suspended all withdrawals and strongly recommends not making any deposits.

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Cryptocurrency Market Capitalization in USD

Insolvency administrator has never seen such a mess in finances

Following the resignation of Sam Banker-Fried, John Jay Ray III was appointed as FTX's new CEO (and insolvency administrator), who, in response to the critical state of the company, decided to sell the exchange or restructure its global empire.

John Jay Ray III stated in a bankruptcy statement that never seen a similar corporate control failure. The exchange, he said, lacked regulatory oversight and corporate control, and the firm was in the hands of “a very small group of inexperienced and potentially compromised individuals.” In doing so, Ray helped deal with the fallout from some of the biggest corporate failures in history, including the 2001 crash of Enron. Apparently, there was absolute chaos at FTX.

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FTT Tokens

The FTX exchange has issued its own tradable token, FTT. As recently as October 31, it was worth more than 26 US dollars per unit on the market. Two weeks later, it was only about $1.4. Indeed, it turned out that the assessment of the FTT was probably based on fictional foundations.

In a bankruptcy statement, FTX's new boss went on to describe several serious misconduct the company had committed. For example, it has been proven that she used software to 'conceal misuse of customer funds'. Ray also stated that he did not believe that the financial statements compiled under Bankman Frieda were accurate, and that “in his entire career he has not seen such a massive failure of control mechanisms and such a scant lack of credibility of financial statements.”

Gradually, it began to emerge that Bankman-Fried and his associates were using company funds to purchase personal items and moving vast sums of money without any record, whether it was millions of dollars for employees on properties in the Bahamas, or other billions moved to Alameda Research.

So far, John Jay Ray and his team have managed to secure about $740 million worth of cryptocurrencies as part of the crisis measure, which is said to be only a fraction of what he hoped to recover.

The company currently owes “only” the 50 largest creditors (clients of the exchange) approximately $3 billion.

At the same time, the exchange had millions of customers (exactly how many there were, apparently, no one knows, since the company allegedly does not even have a database of clients). There is probably a total of $8 to $9 billion missing, which was probably transferred to Alameda Research and is currently unknown where.

According to some reports, FTX was supposed to be making tens of millions of dollars a day before the crash, but now it comes to the surface that it was actually losing $3 billion in 2021.

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How did the FTX exchange get into trouble?

The largest cryptocurrency exchange in the world Binance was previously an investor in the FTX exchange. In 2021, Changpeng Zhao, a Binance CEO, sold his stake in FTX back to Sam Bankman-Fried, who paid for it in part with FTT tokens (reportedly worth $2 billion).

On November 2, cryptocurrency publication CoinDesk reported on leaked document, according to which Alameda Research -- a hedge fund led by Bankman-Fried -- holds unusual amount of FTT (FTX tokens). The two companies were intertwined more than it seemed at first glance. Problems in one shook the other, and apparently solved by sending tokens with artificially created value. This effect first manifested itself more strongly in the spring of 2022 during the decline of the cryptocurrency market.

On November 6, based on the findings of the exchange Binance announces sale of its FTT tokens, which set off a chain reaction of further sell-offs and a sharp drop in the token's price.

FTX within three days it received requests for withdrawals worth an estimated $6 billion and it got into a liquidity crisis (it couldn't pay deposits), so it had to suspend the processing of applications. That has caused even more concern among investors.

A competitive exchange has come up with the solution again Binance, which offered to buy FTX, She wanted to save the stock market. Based on due diligence (accounting, tax, economic and other audits of the company) but has retreated from the purchase.

FTX had to declare bankruptcy, which led to a drop in the prices of other cryptocurrencies including Bitcoin and the entire cryptocurrency market.

How about Sam Bankman-Fried? His lawyers reportedly did not wish him to speak to the media. However, on November 30, after a long pause in an interview with the New York Times, he commented that he “messed up”, had never tried to commit fraud, and was shocked by the FTX crash.

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It's not the first time (and maybe not the last time)

The FTX exchange is not the first crypto exchange to find itself in trouble. Perhaps the most famous is the crash of the stock exchange Mt. Gox of the Year 2014, when clients lost 11 billion crowns in the calculation and until now they have not received their deposits back from this exchange. Based on this experience, it is possible to predict that even settlements with FTX customers will take a long time and may not end well.

Another similar case from recent times is the case Centigrade Netzwerk (a crypto bank that provided interest on the embedded cryptocurrencies). The latter also had problems with the payment of deposits during a significant drop in prices on the market. It probably got into trouble because of speculative trades made with its users' funds. At the moment, the company is bankrupt and has applied for protection from creditors owes approximately $5.5 billion.

The crash of the FTX exchange also caused difficulties for other companies whose business was linked to the exchange. For example, the smaller crypto exchange Bitfront, which has declared bankruptcy, or the company BlockFi, which provides interest on stored cryptocurrencies.

BlockFi had to file an application for protection from creditors in a New Jersey court on November 28 because of the liquidity crisis. The company held cryptocurrencies on the FTX exchange while providing credit to Alameda Research, which defaulted on its obligations. BlockFi currently owes more than 100,000 creditors and plans to lay off two-thirds of its 292 employees as part of its restructuring and austerity solutions.

In the wake of the FTX crash, there are now growing concerns in the cryptocurrency world about the collapse of rival exchange Crypto.com.

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What to take from it?

The crash of the FTX exchange undoubtedly shook the entire cryptocurrency market.

The most valuable cryptocurrency on the market — Bitcoin — posted a loss of around 19% due to the affair, and went as low as $16,000. 

(At this time last year, Bitcoin was worth over $68,000, the most in history to date.) The entire cryptocurrency market lost more than $260 billion in value from November 6 to 21 of this year.

Whether cryptocurrencies recover from this shock and head back up, or continue to fall, it turns out that this the market is still very unstable, highly volatile and little regulated. (Although in this case it was more a failure of the human factor and the regulation of the functioning of the trading firm, rather than the “crypt” as such.)

The greatest certainty in the case of investing in cryptocurrencies for investors is provided by the holding of assets in the so-called. hardware wallets. But even this does not protect anyone from a possible drop in value. It is still more of a speculation than an investment as such.

In cryptocurrencies, we recommend Keep at most a small portion of your portfolio, for example, up to 10%, and supplement the portfolio with more conservative assets, which together with diversification will provide you with stable profits.

Indeed, even the world of cryptocurrencies does not seem to be able to defy economic gravity.