Following the collapse of FTX last week (W/C 7th November), we thought it would be best to give everyone a rundown of events that led to this unnerving situation, what this could mean for crypto holders alike and the lesson we can learn from this unfortunate event. Let’s get started, shall we!

To kickstart this article, we thought it would be best to give everyone an overview of FTX, Alameda Research and, of course the FTT token.

SBF & FTX

The son of two Stanford law professors, Founder and CEO Sam Bankman-Fried (SBF) studied physics at MIT and traded ETFs at a firm before pivoting his investment strategies towards crypto trading in late 2017.

After much success as a day trader, SBF launched FTX in 2019. FTX was a leading centralised crypto exchange and brokerage with an exceptional trading platform. According to Forbes, investors valued FTX and its US division i.e. FTX US at a combined value of $40 billion.

FTX grew in popularity as it allowed traders to deposit fiat or crypto, and then borrow against them. As long as you had sufficient margin, you could borrow spot tokens simply by spending beyond your account’s balance.

For example, if you had a total of $10 as collateral and bought Bitcoin worth $50 in the spot BTC/USD orderbook, your total balance would then be $50 BTC; -$40 USD in your account and nothing more. You would be borrowing an additional $40, which would have come from your peers on the platform who have decided to lend out their $. Similarly FTX allowed users to lend their assets. If you had BTC that you were looking to hold long term, you could decide to lend it on FTX to gain yield from your holding.

The platform’s risk management was also so advanced that the sale of collateral when margin was breached was an automatic feature - there was no need to call up customers asking for cash to cover.

Alameda Research

Founded by SBF and named after his hometown of Alameda, California, Alameda Researchwas an investment firm founded prior to the launch of FTX. Alameda was a quantitative trading firm and crypto hedge fund that provided liquidity in cryptocurrency and digital assets markets. As a fund, it strictly managed investments of employees and a limited number of early backers. Prior to his role as CEO of FTX, SBF was the proud CEO of Alameda Research.

The most important point to note about Alameda Research is the fact that it was a major client of FTX.

FTT

FTT was used natively for crypto traders on FTX. It was the utility token of FTX and played a role in the rewards system of the exchange. FTT granted holders a discount on trading fees and the buy-and-burn mechanism.

FTX allowed holders to borrow up to 95% of the value of their FTT holdings. FTX used some of its trading profits to buy back FTT in the open market and ‘burnt’ them to reduce trading volume, thus increasing value the more trading profits FTX generated.

The token traded outside FTX on platforms including Alameda andBinance too.

The slow-burning crisis

The crypto market has undoubtedly faced a trying year. Several titans in the space folded earlier this year as plunging token prices sucked liquidity out of the market.

The wipeout of terraUSD (UST) and Luna brought down the most respected crypto hedge funds, Three Arrows Capital (3AC) and crypto brokers and lenders such as Voyager Digital and Celsius that had significant exposure to 3AC fell right along these burning firms.

The fundamental issue with this is the fact that everyone was borrowing from one another, which works out well when the price of crypto coins increases, not the other way around. By the summer of this year, the prices of crypto giants Bitcoin (BTC) and Ether (ETH) had fallen by more than half in value for the year.

Like other investment and trading firms in the space, Alameda Research allegedly incurred a significant loss in their portfolio amidst the bear market earlier this year. Amid the wave of bankruptcies, Alameda lenders asked for their money back but were surprised to learn that the fund did not have it as assets were illiquid. It is said that Alameda had parked money in failing digital asset firms.

Following recent discovery, to meet its debt obligations, FTX borrowed from customer deposits in the exchange to quietly bail out Alameda. Reuters reported that the borrowing was approximately $10 billion, in which $1 to $2 billion of that emergency fund is unaccounted for at the moment.

Evidently, the acclaimed firewall that was meant to separate the two entities was non-existent…which brings us to present.

House of Cards

On the 2nd of November 2022, CoinDesk reporter Ian Allison published a damning report that disclosed Alameda Research held several billion dollars worth of FTT.

The report stated that approximately $5.8 billion out of $14.6 billion of assets on Alameda Research’s balance sheet (based on then-current valuations) were linked to FTT, the single largest token holding in its reserve. The report revealed that Alameda had about $3.66 billion in unlocked FTT and $292 million of locked FTT with the remaining of $2.16 billion in FTT collateral.

This public finding suggested that Alameda and FTX were far from nominally separate entities, leaving Alameda severely exposed to the volatility of FTT. Furthermore, the report also disclosed that Alameda allegedly had most of its assets in illiquid altcoins.

The disclosed revelations prompted fear that the relationship between Alameda and FTX was but a house of cards. Given the shared ownership, the fall in value of FTT would damage both Alameda and FTX...and that is exactly what happened.

The disclosure of allegations led Binance Chief Executive Officer (CEO) Changpeng ‘CZ’ Zhao to tweet on 6th November, Sunday that the exchange will be selling all of its FTT holdings (approx. $500 million) because of said revelations that had come to light.

Shortly after Zhao’s announcement, Caroline Ellison, CEO of Alameda Research tweeted that they would buy his FTT tokens for $22 each.

Naturally, panic rose within the market, investors began to lose confidence in FTX and thus, investors raced to pull money out of the exchange. According to SBF, the exchange had roughly $5 billion of withdrawals on the very same day.

Cry for help

As the value of FTT plunged in tandem with these mass withdrawals, SBF turned to investors to cover the multibillion-dollar hole from the money that had been used to bail out Alameda in the summer. SBF said that all investors declined this and in a move of desperation, he turned to his biggest rival, Binance i.e. Zhao.

Zhao publicly tweeted Binance’s decision to fully acquire FTX and help cover the liquidity crunch through a signed, non-binding Letter of Intent (LOI). Zhao also mentioned that they would conduct a full due diligence in the coming days...to only lead to the demise of FTX.

When it rains, it pours

As a result of corporate due diligence, Binance announced via Twitter its decision to back out of its plan to acquire FTX, leaving the exchange on the brink of collapse.

Following this tweet, Zhao took to Twitter to share his feelings on this too:

Chapter 11

The value of FTT continued to plummet as the FTX-Binance turmoil further spooked investors. Fast forward to 11th November, a statement released by FTX announced that the exchange, Alameda Research and approximately 130 affiliated companies under FTX Group filed for bankruptcy. The statement also disclosed that SBF would step down from his role and be replaced by John J. Ray III but would remain for any assistance required during the Chapter 11 proceedings.

At the peak of his wealth, Crypto’s white knight, SBF had a total net worth of $26 billion. With this tumultuous financial crisis, SBF took a massive personal financial hit himself with his entire remaining fortune of approximately $16 billion being completely wiped out.

What happens now?

Whilst the takedown of this crypto powerhouse does represent the latest unsavoury chapter in the industry’s regular battle against crises, historically, cryptocurrencies have rebounded to new heights following each adversity.

Post Mt. Gox

Let’s take a look at what happened to the market post-Mt. Gox.

Mt. Gox was Tokyo-based and once the largest crypto exchange by daily users and trade volume back in the early 2010s. Launched in 2010, Mt. Gox handled over 70% of all Bitcoin transactions globally by early 2014. Due to a fatal hack in February 2014 that wiped out the exchange by approximately 750,000 total customers' Bitcoins, the exchange filed for bankruptcy shortly after.

According to Nasdaq the pool of lost tokens was worth around $473 million and continued to fall in value as the Bitcoin market was contracting. If we fast forward to 2021, creditors managed to recoup 90% of the Bitcoin in which the value of those assets were now worth $9 billion; a 20-times gain.

Needless to say, crypto markets do have a history of rebounding. This was not only the case after Mt. Gox but also crypto’s first winter in 2011 as well as 2018.

It is also important to recognise that tragic hiccups aren’t unique to the crypto market. This happens in regular financial markets too. Let’s take a look at the 2008 crisis:

The fall of Lehman Brothers in 2008

Similarly, back in 2008, Lehman Brothers loaded its balance sheet with significant amounts of subprime mortgage debt. Unfortunately, due to the housing market collapse, the value of these securities plummeted overnight, causing a domino effect that penetrated through the global economy which eventually led to the worst financial crisis since the Great Depression.

Whilst far less significant than Lehman Brothers, FTX and Alameda have faced similar problems with regards to balance sheet and leverage. The traditional financial system failed in 2008 because of leverage and interconnectedness and similarly, FTX has been made fragile by both leverage and interconnectedness.

According to CNN, the crypto winter is poised to worsen as fears about the broader economic backdrop continue to erode the appetite for risky assets.

Binance’s Zhao shared at a conference in Indonesia on 11th November stating, “We’ve been set back a few years by this. Regulators rightfully will scrutinise this industry much, much harder, which is probably a good thing to be honest.”

Inarguably, plenty will continue to scrutinise and question the risk associated with the crypto space. However, it is important to recognise in the wake of the downfall of FTX, crypto traders are beginning to turn toward decentralised finance (DeFi) protocols over centralised ones…and rightfully so.

DeFi protocols

DeFi protocols such as dYdX, a decentralised exchange built on the Cosmos blockchain has seen an influx of users as high as 99%. The exchange has also reported that transactions have surged by 136%. The price of its governance token, DYDX has been up by __nearly 70%__in the last week (at the time of writing) too.

FTX showed the problems of centralised finance (CeFi) and further proved the need for DeFi. DeFi protocols are designed to preserve the benefits first introduced by Bitcoin and which are further demonstrated by Ethereum: transparency, self-sovereign, permissionless and censorship-resistant.

Thus, regulators undermining crypto markets should see through the facade of ESG (environmental, social and governance) advertisements in Times Square as well as black tie events and recognise that centralised players calling for DeFi regulation are looking for what works in their interest. Time and time again, DeFi has beat CeFi by a long shot.

Final Thoughts

It is important to recognise that the implosion of FTT is not unique to the crypto markets, but rather a reflection of flaws that come with financial markets and centralisation in general.

The collapse of FTX has proven not only the power that comes with DeFi but also the flaws that lie with implementing centralisation to this new innovative application of novel underlying technology.

We need not distance ourselves from the innovations of DeFi but instead, learn from the mistakes of centralised markets and refocus on a solution that serves businesses and consumers in the real world.

The future of DeFi remains bright - so LFG!