Explained: How FTX, the world’s second-largest crypto exchange, blew up

The beginning of FTX

Alameda Research is where the tale starts. Sam Bankman-Fried established Alameda in 2017 as a proprietary trading company that dabbled in cryptocurrencies. By purchasing and selling cryptocurrency, they made money. And they produced a lot of it.

Sam soon came to the conclusion that he wanted more. He had more than just trading cryptocurrency in mind. He wished to assist others in doing the same. So he built an exchange — FTX in 2019.

As the name suggests, an exchange makes trading cryptocurrencies easier. They’ll find a buyer if you want to sell something. They will locate a seller if you plan to make a purchase.

Additionally, FTX profited each time a transaction was completed. If customers wanted to place large bets, it also offered loans to them. Naturally, the exchange imposed interest on this.

So what changed in the exchange?

According to media reports, FTX almost failed because of a “liquidity” problem. It’s a polite way of saying, “Customers wanted their funds returned. Funds they’d set aside on the exchange in the hopes of buying and selling crypto in the future. And when FTX couldn’t give them their money back, all hell broke loose.”

But if an exchange is just acting as a middleman, then in theory it shouldn’t have any trouble returning the money, right? You serve as a liaison. You don’t take money from customers and spend it on your own, do you?

The speculation begins at this point. There are currently a few stories going around, but nobody is certain of the exact mechanics because something bad happened.

First theory: An ugly plan

FTX has always had enormous goals in mind, in addition to earning money from transaction costs and interest payments. Additionally, as soon as they established their exchange, they unveiled FTT, their own cryptocurrency token. And this coin appears to be at the root of this almost catastrophic event.

Any coin that is created out of nothing should by definition have no value unless it has some very specific use. To create this use case, FTX promised all FTT token holders preferential access to their trading platform (lower fees, free withdrawals, etc.), which gave it some credibility.

The token soon began to show promise. The cost started to rise gradually. The saying goes, “The line must go up.” And FTX (the trading company) started purchasing (burning) its token using a portion of its actual revenue, which helped to support its value even more (generated from transaction fees).

They were inflating demand by buying their own coin.

Alameda steps in at this point. Sam, the founder of FTX and Alameda, has been persuading people for almost three years that the two companies are independent of one another andnothing funny is happening in this situation.

But that isn’t true.

Alameda has long held a sizable number of FTT tokens. Nobody knew the exact sum. However, they were aware that they had paid a very low price for it. As a result, when the cost of FTT started to slowly rise, the value of Alameda’s assets also started to rise at the same time. They expanded their balance sheet.

And now for some additional information on balance sheets. The company can borrow more money if there are more assets. Additionally, if it is a prop trading firm, it can use that capital and try to earn even greater returns if it can borrow more money.

It appears that Alameda purchased FTT tokens at a discount. awaited the value to skyrocket. and started using these highly inflated FTT tokens as collateral for “real money” loans.

Who was offering “real money” against FTT collateral is unknown for sure. However, it is alleged that FTX provided at least some of the funding. that it made loans to Alameda using money from customers.

They were unable to support the withdrawals, which is why. They never had them to begin with. It’s true that this is the more speculative version, which is more provocative. However, some people think that’s what actually happened.

Second theory: Borrowers’ panic

A less sinister explanation is that FTX borrowed money from outside sources or used their own funds to fund customer trades. Additionally, they did not have enough money to cover all client holdings when customers suddenly demanded their deposits. a situation of ineffective risk management.

They had set aside a few billion dollars. But it wasn’t sufficient. There were more than a few customers who wanted to withdraw money. It was a horde that was frantically trying to withdraw their money from FTX in a panic.

 What gave way to the panic?

Nobody knew how many FTT tokens Alameda actually held so far, until 6 days ago when somebody leaked their balance sheet to CoinDesk — a crypto news media company.

They reported — “As of June 30, the company’s assets amounted to $14.6 billion. Its single biggest asset: $3.66 billion of “unlocked FTT.” The third-largest entry on the assets side of the accounting ledger? A $2.16 billion pile of “FTT collateral.

There are more FTX tokens among its $8 billion of liabilities: $292 million of “locked FTT.” (The liabilities are dominated by $7.4 billion of loans.)”

Alameda is reportedly required to pay their lender $8 billion. However, the majority of the assets are in FTT, whose value might fall sharply. Alameda and FTX would both be in serious trouble if its value did fall.

And indeed, that is what took place. People realised how fragile things were once they started hearing about this story. They could see how both businesses could easily capitulate. So they started taking their deposits out.

The straw that finally broke the camel’s back wasn’t this, though. This occurred a few days later when Sam Bankman-Fried’s last-ditch attempt to save FTX was shattered by a tweet from the founder of Binance.

What Binance had to do in all this?

Global cryptocurrency exchange Binance is run by Chinese-Canadian billionaire Changpeng Zhao, also known as CZ,Additionally, CZ and Sam were once friends. Just six months after Sam founded FTX, CZ acquired a sizable stake in the fledgling business. And what’s this? He won the wager. FTX’s recognition increased. It received significant funding from outside investors, and its value increased.

Sam, however, later bought out Binance’s ownership of the business in 2021. The reasons for the founders’ split were never disclosed in the media. Reports at the time, however, suggested that Sam may have feared regulatory action against Binance, which likely drove him to leave the organisation.

And despite the rumours, it was still an amicable separation. Binance made $2.1 billion from the deal. And FTX no longer had to worry about a competitor owning a part of its business. The only caveat here — It wasn’t an all-cash deal. Some of it was paid in FTT tokens. And CZ held on to those tokens.

Sam apparently started whispering nasty things about Binance — to US regulators. He even took a jibe at CZ — the CEO of Binance and questioned whether he’d be allowed to visit Washington DC.

This was a suicide move because CZ pounced on the damning reports about Alameda’s balance sheet as soon as they appeared in the media. Invoking recent worries, he declared he would sell all of his FTT tokens. The sparse investors who did own FTT were alarmed by this.

The price of FTT would plummet if he flooded the market with that much of it. Additionally, Alameda’s balance sheet would be immediately depleted if the price fell. If they had loaned out customer deposits to Alameda, they would suffer greatly, and the infection would quickly spread to FTX.

FTX is going down

$6 billion – withdrawn in 72 hours.

The story has yet another turn. CZ enters the room once more with the enthusiasm of the main character and declares his willingness to acquire FTX pending due diligence.

He now serves as the last resort lender. technically not a lender. He is, however, backing up the deal. telling everyone to keep their cool. He made it clear that he would pay them in full if they still intended to leave FTX completely.

What if the accusations are accurate, though? What if FTX mismanaged the transfer of customer money? Would he still carry out the transaction?

On Wednesday night, Binance announced on Twitter that it was backing out of the deal with FTX. It said, “As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations, we have decided that we will not pursue the potential acquisition of FTX. In the beginning, our hope was to be able to support FTX’s customers to provide liquidity, but the issues are beyond our control or ability to help.”

For FTX, which is in a bind and desperately needs money, this is a huge blow. Furthermore, Binance’s statement won’t allay any concerns about rival suitors. This is bad news for FTX customers.