What Really Happened To FTX? (A Deep Dive)
It’s been a crazy few days for FTX, after allegations that they are insolvent proved to be true when users withdrew $6 billion worth of funds from the platform.
Here’s a breakdown of all the events that led to this potential ‘black swan’ event.
FTX and Alameda Research’s ‘complicated’ relationship
Sam Bankman-Fried (SBF) is the key player in this entire saga, where his crypto empire is built on 2 main companies: FTX and Alameda Research.
SBF founded Alameda Research, a principal trading firm in 2017.
This firm mainly consists of traders who trade digital assets to make a profit.
According to an interview back in 2021, SBF reportedly owns about 90% of Alameda Research, even though he is not listed as a part of their team.
In 2019, SBF founded FTX, which initially started off as a cryptocurrency derivatives exchange. SBF roughly owns about 60% of the exchange, which received an $18 billion valuation in 2021.
Furthermore, there were talks of having another funding round which could increase its valuation to $32 billion this year.
The relationship between these 2 firms has been rather murky, especially since SBF used Alameda Research to provide liquidity to the exchange.
Having good liquidity is a key component of an exchange, where traders can trade digital assets without experiencing slippage or price volatility.
Poor liquidity on the exchange means that there isn’t enough supply of digital assets to be traded, and the price that you’re paying for these assets may be higher than their current market value.
With Alameda’s liquidity, FTX was able to attract traders to the platform, causing it to grow into one of the largest crypto exchanges in the world.
The FTT token is another piece of the puzzle
As FTX grew in popularity, an exchange token, FTT, was launched.
This is similar to how other centralised exchanges have their own utility token, including:
The FTT token’s main aim is to ‘provide value to FTX’s community and users’.
If you stake FTT on the FTX exchange, this will give you certain benefits, including:
- Fee rebates on the FTX exchange
- Weekly airdrops of the SRM token
- Free withdrawals via the ERC20 network
- Increased referral bonuses
By staking this FTT token on FTX, you are locking up these tokens, which will reduce its selling pressure.
Furthermore, FTX makes FTT deflationary by conducting weekly buybacks of the token.
This is somewhat similar to a stock buyback, where the company would use some of its profits to buy its stocks, and reduce the number of outstanding shares on the market.
In a similar fashion, FTX buys some of the FTT token and ‘burns’ them, which reduces its circulating supply.
In theory, provided that the demand for the FTT token remains constant, a decrease in supply will result in an increase in price.
FTX uses a portion of its revenue to perform these token buybacks, such as 33% of all fees generated from its trading platform.
Alameda’s balance sheet raised eyebrows
The first spark of this entire meltdown was this news article by CoinDesk, where they gained access to a ‘private document’ which contained Alameda’s balance sheet.
The majority of Alameda’s assets are in the FTT token. Out of the $14.6 billion worth of assets that Alameda owns, $3.66 billion (~25%) of it is in the form of ‘unlocked FTT’.
What’s more, out of Alameda’s $8 billion worth of liabilities, $292 million is in the form of “locked FTT”.
Currently, only 38% of all FTT tokens are in circulating supply, which has a max supply of 352 million tokens.
As such, the locked FTT that is being used as liabilities is essentially an illiquid asset, which Alameda is unable to sell off.
This suggests that the majority of Alameda’s holdings are in the form of the FTT token, and not an “independent asset like a fiat currency or another crypto”.
Twitter user @DU09BTC likened this to what happened with Celsius, a centralised lending platform that is now insolvent.
You can find out the 3 main lessons we can learn from the crash of Celsius and other centralised lending platforms here.
Alameda’s CEO, Caroline tried to quash rumours of their balance sheet,
but the rumours just kept swirling around that FTX could be insolvent.
You can read this article to find a detailed explanation of how the FTT token in Alameda’s portfolio could result in FTX being insolvent.
Binance gave a ‘vote of no confidence’
Amidst this chaos, a war between FTX and Binance, another top centralised exchange, was brewing.
CZ, CEO of Binance, was not happy that SBF was ‘lobbying against other industry players behind their backs’.
CZ announced that he will be liquidating all of Binance’s FTT holdings over the next few months to minimise the impact on the market.
What’s more, he mentioned that this was post-exit risk management, after learning lessons from the entire LUNA debacle, where the exchange did not sell any of their LUNA holdings.
You can find out more about the whole LUNA-UST debacle in our breakdown here.
As CZ is one of the most influential figures in the crypto space, this move signalled that Binance was no longer confident in FTX.
This resulted in a mass exodus from the exchange, as users rushed to withdraw their funds from FTX.
Such a scenario is likened to a bank run, where fears of insolvency lead to large-scale withdrawals. In the worst-case scenario, the exchange will not have enough funds in its reserves to process all withdrawals.
Furthermore, this also led to a total collapse of the FTT token’s price, as its holders started to panic sell.
Since FTT was used as collateral for Alameda to take loans from other platforms, the crashing of this price could mean that Alameda’s positions would be liquidated.
One such platform was Nexo, which sold off all of the collateral provided by Alameda for its loan.
Withdrawals started slowing down on FTX
As more users started to withdraw funds, many of them experienced delays, where some took up to 24 hours before being processed.
FTX cited some reasons for these delays, including:
- Issues with the BTC withdrawal nodes
- Banks not being open to process stablecoin withdrawals
However, on-chain activity showed a mass inflow of funds from multiple wallets.
This included wallets linked to Alameda, and even other wallets linked to centralised exchanges like OKX, Bitfinex and Gate.io.
Most centralised exchanges will store users’ funds in both a hot and cold wallet.
A hot wallet is connected to the internet, which poses risks of users’ funds being hacked. Most CEXes will only leave a portion of users’ funds in this wallet to quickly process withdrawals.
In the event that the hot wallet gets hacked, the majority of their users’ funds won’t be compromised as they are not in this wallet.
Meanwhile, a cold wallet is much more secure as it is not connected to the internet. Most exchanges will use a cold wallet to store their users’ funds, due to its added security.
However, it will take a longer time to process withdrawals as the funds need to be transferred to the hot wallet first, before they can be withdrawn.
Based on the on-chain analysis, it seems that this is not the case for FTX.
It seems that users’ funds were actually in wallets that were owned by Alameda, and not in a cold wallet owned by FTX!
FTX was criticised for its lack of transparency of where their users’ funds really are, particularly since they are not coming from a single cold wallet.
What’s more, this seems to violate FTX’s own Terms of Service, which mentions that users’ assets are never used by FTX Trading.
SBF tried to allay fears by saying that all assets are safe, and also mentioning that FTX had an excess of > $1b in cash reserves.
However, on-chain activity painted another picture as FTX seemed to have halted withdrawals from their wallet.
This scenario was exactly what happened to other fallen crypto platforms, including Hodlnaut.
Binance lands the nail in the coffin
As users started to panic, Binance shocked the crypto world by signing a non-binding letter of intent (LOI) to acquire FTX.
Binance will acquire all assets owned by FTX, and provide enough liquidity (i.e. funds) for all requested withdrawals by users.
This was further confirmed by SBF, who bit the bullet and sought help from his ‘competitor’.
If the deal does go through, all withdrawals should be able to be processed. However, this LOI is non-binding, which means that Binance can pull out at any time.
Furthermore, this deal seems to raise alarm bells as Binance is acquiring one of its main competitors in the crypto space.
While there are many roadblocks, Binance could further stamp its authority in the crypto space with this acquisition.
UPDATE: Binance has announced that they are not going through with this acquisition, mainly due to the huge discrepancy between FTX’s assets and liabilities.
Final Thoughts
This is certainly a dark day for crypto, as one of the crypto giants has fallen.
However, it may actually be a blessing in disguise, as it shows you just how risky it is to leave your funds in a CEX.
The main idea behind cryptocurrencies was decentralisation, where it gives power back to the people.
When you are leaving your funds in a centralised exchange, it is possible that they can use your funds for other purposes.
While there are no confirmed reports of FTX utilising users’ funds, the lack of transparency on this matter is rather concerning.
The safest way to own your assets is by storing them in a non-custodial wallet.
Based on the saying ‘not your keys, not your crypto’, if you don’t own your private keys, your assets are never really yours!
If you’re new to this concept of non-custodial wallets and decentralised finance, do let us know what your questions are in the comments below, and we’ll guide you along.
And if you’re ready to make your first step into this world of DeFi, you can consider trying out our all-in-one platform here!
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