FTX exchange

In November, a major scandal erupted in the global crypto industry – the head of the third largest exchange, FTX, was convicted of extremely unreasonable financial manipulations. One of the youngest billionaires in the United States, Sam Bankman-Fried, disposed of clients' money at his own discretion, keeping them in the dark: as a result, his business collapsed, and exchange users had to say goodbye to their funds. This is not the first time that the crypto-currency industry has faced such a failure – pyramid schemes, and sometimes simply unsuccessful projects, have repeatedly pulled down the cost of bitcoin and other crypto assets, but the industry has always managed to recover. This time, experts doubt that the collapse of such a major player will pass without a trace for her: the head of FTX managed to single-handedly undermine the credibility of all crypto companies, and the market is seriously expecting a long chain of bankruptcies.

***

In early November, journalists from the CoinDesk portal published an article in which they analyzed the assets of the third largest crypto exchange FTX. According to a non-public document in their possession, 90 percent of the capital of the Alameda trading company, owned by the owner of the exchange, Sam Bankman-Fried, is in FTX-issued FTT tokens, which can be considered a security analogue. Such an impressive supply of tokens, equivalent to $5.8 billion in total, was extremely illiquid – the total value of all tokens in circulation was only 5 billion. An attempt to sell this block of assets would have collapsed the FTT quotes and, as a result, would have led to the bankruptcy of Alameda.

It would seem that the collapse of one of the companies of the owner of a large exchange does not lead to any losses for itself, except for reputational ones. However, after the release of the CoinDesk material, the crypto community decided to better understand the ties between the two companies of Sam Bankman-Fried – it turned out that the head of the FTX exchange provided his second company, Alameda, with emergency funding of $ 4 billion in FTT tokens. In fact, at some point, the billionaire risked “plugging a hole” in his company’s finances at the expense of the exchange’s clients. It became obvious that if Alameda went bankrupt, the money of FTX users would also evaporate.

The scandal naturally led to a stampede of customers from the FTX exchange – in 6 days from the date of publication of the CoinDesk article, users withdrew $ 6 billion from the site, and the FTT token has fallen in price by 80 percent since the beginning of the month. Bankman-Fried himself almost instantly lost his fortune: according to Bloomberg, by November 9, the businessman's net worth had decreased from $15.6 to $1 billion. In addition, the FTX crisis shook the entire crypto market – in two days (November 8-9), Bitcoin lost 20 percent of its value, and Ethereum almost 30 percent. At the low point, the price of Bitcoin fell below $16,000 for the first time in two years.

Backstory 

In October 2021, 29-year-old Sam Bankman-Fried became the youngest member of the Forbes 40th Richest Americans List. The fortune of one of the brightest stars of the crypto industry, known by the initials SBF, then amounted to $ 22.5 billion – and Sam managed to achieve this in just four years.

Coming from a family of law professors at Stanford University, Bankman-Freed showed his talents in the exact sciences at school, and then entered the Massachusetts Institute of Technology in the physics department. True, Sam spent little time reading textbooks – he was much more interested in computer games and meetings of the Epsilon Theta student fraternity.

At the university, the future billionaire and his friends became interested in the philosophical direction of utilitarianism, known as effective altruism. Supporters of the idea proposed by Princeton philosopher Peter Singer are convinced that altruism should be measurable and bring visible results. Bankman-Fried considered helping others and charity as his main goal, but as an effective altruist he was convinced that one should be extremely responsible for one's donations and think over one's actions so that they would bring the greatest possible benefit.

Sam quickly came to the conclusion that large sums of money were needed to effectively help, and therefore he abandoned his academic career and immediately after university went to make a fortune. To do this, he took a job as a trader in the New York company Jane Street, where he worked for three years, giving about half of his six-figure salary to charity.
At his trading firm, Bankman-Fried learned the ins and outs of arbitrage trading, in which a trader buys and resells assets to capitalize on price differences. Having discovered the crypto market for himself, Sam was amazed – if when trading ordinary shares, the profit could be several dollars, then the prices of digital tokens on different exchanges differed by tens of percent. “It looked too simple, something is wrong here,” the young trader thought at the time.

In cryptocurrency trading, Bankman-Fried saw the best chance to earn and give away a lot of money. Enlisting the support of several fellow practitioners of effective altruism – including childhood friends Gary Wan and Nishad Singh, and Caroline Ellison of Jane Street – Sam decided to start his own token trading firm. According to university tradition, they gathered in a common house in Berkeley and devoted themselves to earning money.

Friends called their company Alameda Research to create the appearance that they are engaged in market analytics and not attract the attention of regulators. The idea of ​​Bankman-Fried was crowned with a resounding success – the firm soon reached a daily profit from cryptocurrency arbitrage of $ 1.5 million.

Having immersed himself in the industry, Sam noticed that professional traders who need to quickly make large transactions are uncomfortable working with modern crypto exchanges - they are all designed for small investors. Bankman-Fried decided to create a tool suitable for large players on his own –  in 2019 he took part of the profits of Alameda, as well as 8 million from small venture capital companies and launched the FTX exchange.

The target audience of the site were experienced investors trading derivatives – options on Bitcoin or futures on Ethereum. Sam managed to occupy a free niche in the market and two months after the birth of the exchange, the daily trading volume reached $ 300 million, and in 2020 the figure rose to a billion. Bankman-Fried said that in 2021, FTX received $1.1 billion in revenue and about $350 million in profit.

Rapid Collapse

In January 2022, FTX became the third largest crypto exchange in the world by market capitalization, with a valuation of $32 billion. However, already in November of this year, the resoundingly successful project turned into a pumpkin.

The collapse of FTX might not have been so lightning fast if not for the intervention of its main competitor, the world's largest exchange, Binance, led by Asia's richest man, Changpeng Zhao. When the CoinDesk portal reported Alameda's possession of a large illiquid stake of FTT tokens, which, in fact, are "shares" of the FTX exchange, the quotes of the digital coin went down.

In three days, the cost of FTT sank by almost 7% – not the most catastrophic decline in the history of the crypto market. However, on November 6, Changpeng Zhao entered the game – the head of Binance announced on his Twitter account that the exchange was going to get rid of the FTT package with a total value of about $ 580 million. In the next two days, FTT fell by another 8% – this was a signal to the entire crypto community that Bankman-Fried should no longer be trusted.

Changpeng Zhao denied accusations that he was deliberately "drowning" a competitor. “I didn’t think I would be the straw that broke the camel’s back,” the head of Binance said on his Twitter. In the crypto community, however, his tweet was considered a stab in the back of FTX.

Although Bankman-Fried assured exchange customers on Twitter that its “competitor is spreading false rumors” and “everything is fine with FTX and its assets,” users were quick to withdraw their funds from the exchange. It was then that the almost complete collapse of the FTT token happened – by 80% since the beginning of November. At the height of the panic, the exchange limited the amount of withdrawals, and on November 8, it completely banned withdrawals.

The history of the Bankman-Fried and Zhao rivalry goes back several years. The main reason for the confrontation is a radical divergence of views on the future of the crypto industry – the head of Binance has always advocated the maximum decentralization of digital finance and the absence of government control, while the creator of FTX considered it necessary to tighten industry regulation and actively cooperated with politicians.

Changpeng Zhao's participation in the FTX scandal was not limited to one tweet. When it became clear that without external support, the exchange would not cope with the crisis, Bankman-Fried began to seek funding, offering various investors to buy out a stake in the company. There were no people willing to become the owner of the sinking ship, and then Zhao came to the aid of FTX – on November 8, he announced that Binance was buying FTX. A more successful competitor promised to cover all of FTX's obligations to customers in order to prevent its bankruptcy.

Thus, Binance was going to get rid of a major competitor through its takeover. However, just one day later, a message appeared on her official Twitter account that, after a brief review of FTX's finances, the decision had been made to abandon her purchase. The need for money from the brainchild of Bankman-Fried was colossal – according to Bloomberg sources, the young businessman on a call with potential investors estimated the amount needed to avoid bankruptcy of FTX at $4-$8 billion. For Binance, such a deal would be unprofitable.

Bankman-Fried himself suggested that the intention to buy FTX was a bluff on Zhao's part. 
On the same day that Binance refused to buy FTX, Bankman-Fried's manipulations with the money of the exchange's clients were revealed. The FTX exchange has provided Alameda with multi-billion dollar emergency funding, said Lucas Nuzzi, head of research at Coin Metrics, after examining open blockchain data. This publication marked the final demise of the young billionaire's business.

According to Reuters, in May and June, the firm suffered large losses due to several unsuccessful deals. In particular, Alameda provided a $500 million loan to the bankrupt Voyager Digital project. In addition, in the spring, many crypto funds suffered from the collapse of the third largest stablecoin Terra USD (UST) – the market then noted that Alameda was surprisingly resilient in the face of market chaos. In November, it turned out that the entire stability of the company was a sham – to save Alameda, Bankman-Freed decided to secretly use FTX funds, some of which were client deposits. As for the state of the businessman himself, after the publication of this data, Bloomberg called him "zeroed out."

"Sorry. I screwed up,” Bankman-Fried wrote on his Twitter on Nov. 10, and the next day FTX published an official press release stating that Sam had resigned as CEO, and the exchange itself had begun bankruptcy proceedings in accordance with Chapter 11 of the US Code. about bankruptcy.

This procedure involves the reorganization of the company to save business and allows it to continue to work until such time as the new managers do not develop a plan to resolve the crisis. For clients of the exchange, there is little good news – if they manage to return their funds, then only in a few years and only partially, said Ming Zhao, an expert at Point72 Ventures. FTX clients will be third in line for disbursement after senior lenders and platform staff, she said.

At the same time, the scandal continued to acquire new shocking details for the crypto community. For example, it turned out that the CEO of Alameda Research, once with $10 billion in assets, was 28-year-old Harry Potter fan Caroline Ellison, whose experience in finance was limited to a year and a half as a junior trader right out of college. Videos with the participation of the girl were widely distributed on Twitter, where she openly admits her lack of competence.

CoinDesk, citing sources close to the company, said both Bankman-Fried companies were run by a "bunch of kids" who cohabited in a house in the Bahamas. Many of them are former employees of the trading firm Jane Street, where Bankman-Freed's career began, and he met others at the Massachusetts Institute of Technology. “All of them are or were in a romantic relationship with each other,” the source told CoinDesk on condition of anonymity.

In addition, on the night of November 11-12, the FTX exchange was hacked – more than $600 million was stolen from the wallets of its clients. The official FTX support Telegram channel confirmed the hacker attack. “FTX got hacked. FTX applications are infected. Delete them. Do not go to the FTX website, otherwise you may catch a Trojan, ”the company representatives wrote.

Due to the attacker's inexperience, his identity was quickly revealed. In the course of manipulations with stolen money, the hacker used his wallet on the Kraken exchange, to create which you need to go through the Know Your Customer (KYC) procedure. Thus, the exchange had his personal data and recorded illegal actions. Although Kraken did not name the perpetrator, the crypto community believes that he is one of the employees of FTX, who, in the conditions of general panic, decided to use his access to private keys from the exchange wallets.

Finally, on November 14, it became known that Bankman-Fried secretly transferred not $4 billion, but as much as $10 billion from the accounts of clients from FTX to Alameda, of which more than a billion simply disappeared. The "effective altruist" acknowledged this in a meeting with other Alameda executives to determine the amount of external funding needed, Reuters sources said.

In November 2022, the trial began against Bankman-Fried, who denied the allegations and was released on $250 million bail. The New York prosecutor's office, which is investigating the businessman, accuses him of embezzling client funds. According to investigators, he committed "one of the largest financial crimes in American history." He was charged with eight counts, including conspiracy, money laundering and violation of political campaign finance. 

According to the prosecutor's office, he resorted to political donations from both the Republican and Democratic parties of the United States to influence decisions made in Washington. If proven guilty, Bankman-Fried could face up to 115 years in prison. His former colleagues – the former head of Alameda Research (a company also owned by Bankman-Fried and involved in the fraudulent scheme) Carolyn Ellison and FTX co-founder Gary Wang – pleaded guilty to fraud and are helping the investigation.

During the court hearing on January 11, 2023, it became known that FTX received permission to sell four subsidiaries in order to pay off debt to creditors.
FTX has begun a strategic asset review process and is considering the sale of four subsidiaries, including operations in Europe and Japan, as well as two US companies  – brokerage technology and infrastructure provider Embed and crypto platform LedgerX. Delaware Bankruptcy Judge John Dorsey gave the green light to the sale.
The company has already received dozens of offers to buy and plans to hold auctions starting in February 2023. The Financial Times writes that more than a hundred potential buyers are interested in acquiring one or more FTX subsidiaries. The consulting firm Perella Weinberg Partners will help sell the assets.

In addition, FTX intends to reorganize or sell investment company FTX US and the main international exchange FTX.com, as well as non-strategic investments with a book value of $4.6 billion. In addition to selling affiliates and illiquid assets, FTX will stop sponsoring ($135 million) Miami Heat for 19 years and  video game League of Legends ($89 million) for seven years.

Sullivan & Cromwell employee, FTX attorney Andrew Dietderich, said in court that the cryptocurrency exchange discovered $5 billion in assets. These funds include cash, investment securities and liquid cryptocurrencies. He added that it does not include assets confiscated by the Bahamas Securities Commission, where the company was headquartered and the founder of the crypto exchange, Sam Bankman-Freed, lived. FTX's lawyer estimates that the value of the seized funds is only $170 million, while the Bahamian authorities put the figure at $3.5 billion. 

Dietderich clarified that the seized assets mainly consist of own and illiquid FTX FTT tokens, the value of which is volatile. Dietderich admitted that the restructuring team, led by John Ray, still cannot give the exact amount of client losses, as lawyers are still working to restore the records. Earlier, the US Commodity Futures Trading Commission estimated the shortage of client funds at more than $8 billion.

Confidence Crisis

The collapse of FTX provoked panic throughout the crypto market, as happens after scandals with any major player in this young industry. The sale affected not only the largest assets  – Bitcoin and Ethereum, but also smaller coins. For example, the Solana (SOL) token has halved since November 2, from $30 to $15. In addition to the general sentiment, its price was downgraded by the fact that a significant proportion of Alameda's assets were in SOL.

The decline in the crypto market was also reflected in the largest stablecoin Tether (USDT, a token pegged to the value of the dollar 1:1) with a capitalization of more than $68 billion. Although the company that launched the coin publicly disavowed ties to FTX or Alameda, on October 11, USDT quotes broke away from parity with the dollar and fell to 98 cents.

The bankruptcy of FTX is the industry's fourth major crisis in 2022, after Terra/Luna, Celsius, and Three Arrows Capital failed. Each of them turned into a one-time fall of almost all crypto assets. However, the scandal surrounding the third largest exchange, which had a reputation as one of the most reliable, is significant in that it undermined the credibility of all centralized crypto exchanges. This is evidenced by the massive withdrawal of funds by clients from several international services – from November 6 to November 13, users withdrew $3.7 billion in the form of bitcoins and $2.5 billion in the form of Ethereum from exchanges.

According to some members of the crypto community, the dominance of centralized exchanges makes the industry dependent on individuals and their approaches to doing business, which reduces its overall sustainability.

The FTX story is already being compared to the collapse of Lehman Brothers, which started the 2008 mortgage crisis in the US. Even the head of Binance, Changpeng Zhao, whom Sam Bankman-Fried himself congratulated on his “victory” and the elimination of a major competitor, said that it was unlikely that anyone would benefit from the collapse of FTX: in an internal note to employees, he wrote that the blow was dealt across the entire industry of decentralized finance, and now regulators around the world will only tighten the rules of the game for cryptocurrency companies.