By Landon Manning
In a bankruptcy that is being compared to the sudden collapse of Lehman Brothers in the 2008 crash, FTX, one of the largest global cryptocurrency exchanges, has fallen dramatically, losing billions and declaring bankruptcy over the course of a few days.
The downfall of FTX has been sudden, monumental and chaotic for the world of cryptocurrency, which bitcoin is inadvertently lumped into. Just a few months ago, FTX was heralded as one of the major movers and shakers by the media as it bailed out other exchanges, did business with the world’s largest investment banks and even entered into talks with world governments. So for many investors and observers, it came as a terrible shock on November 8, when concern mounted over a possible liquidity crisis. On November 11, then CEO Sam Bankman-Fried stepped down as the company declared bankruptcy. How could this happen? And what will it mean for the future of bitcoin?
The trouble began for FTX on November 2, when new data came to light illustrating a disturbing relationship between Bankman-Fried’s two main companies: FTX the exchange and the Alameda Research trading firm. For Alameda, a claimed $14.6 billion in various assets turned out to mostly be stored in illiquid altcoins with more than $5.8 billion split between FTT and “FTT collateral.” FTT is the token issued by FTX and used for trades on the platform. On the FTX website, they claim that FTT is the “backbone of the growing FTX ecosystem.”
The company spent one-third of all exchange fees to purchase more of the currency. This creates a problem: Actually selling even $1 million worth of FTT would have a dramatic impact on its price and the total market cap of FTT is less than the amount that Alameda held on its books. In other words, the relationship between FTX and Alameda may have been rife with loans using these tokens as collateral. In the event of an actual crunch as was seen last week, users were unable to withdraw money from the platforms.
This situation itself was enough to make plenty of FTX users very nervous. Failures of exchanges mean that customers who theoretically “owned” large amounts of assets on these platforms simply lose them in the case of insolvency. One good bank run destroyed confidence in FTX as a platform and the devaluation of the FTT token also helped to crash both firms. Changpeng Zhao (aka “CZ”), co-founder and CEO of Binance, publicly announced Binance’s plans to gradually liquidate its entire holdings of FTT, leading to these exact events playing out.
On November 8, the next bombshell dropped: Binance sent a non-binding letter of intent to purchase FTX to ensure solvency and liquidity, albeit with the knowledge that Binance could back out of this deal at any point during the discovery period. Although the exact details of this document discovery aren’t yet known, CZ took to Twitter again to post two pieces of advice: “Never use a token you created as collateral,” and “Don’t borrow if you run a crypto business. Don’t use capital ‘efficiently.’ Have a large reserve.”
In two days’ time, FTX was finished. CZ compared this event to the 2008 financial crash as “probably an accurate analogy.” With one of the largest exchanges being demolished in the blink of an eye, it could spell trouble for other exchanges and the entire industry. Bitcoin’s valuation has already tumbled by several thousand dollars, as a generalized fear of being left with worthless tokens and altcoins sweeps users worldwide. Yet, despite comparisons to the 2008 crash which created Bitcoin, the greatest silver lining may be in the differences between Bitcoin and finance, specifically in regards to bailouts.
In the traditional stock market, cascading bank failures eventually led to the U.S. federal government bailing out the private banks, which more or less, landed on the backs of the American taxpayer. Bitcoin, however, is trustless, stateless and decentralized. When a firm is about to fail and none of the other firms want to bail it out, nobody else comes to the rescue of bad actors or companies with nefarious business practices. The industry will instead sustain a major blow with leverage being flushed out of the system and better businesses filling the void.
Bitcoin has survived a large amount of crashes and bear markets. This is what has given the community such enduring resilience. Nobody will come to save bitcoin except the Bitcoiners themselves. Periodic events like this are needed to shake off some of the excess. Where will the market bottom and for how long? When the community does rebuild and re-orient, how high will the next bull market go? Questions like this are impossible to answer, but there is more than enough reason to believe that Bitcoin and its ironclad fundamentals can survive and thrive despite this setback.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.