Can a crypto exchange go bankrupt?
Hello! Business Bytes is back with its weekly edition, and today we’re covering the collapse of FTX, a crypto-trading platform. Whether you’re a crypto enthusiast or a sceptic, this episode holds lessons for everyone with assets to invest.
Read Jatin Pawahanee’s explainer to find out.
What Happened to FTX?
An interesting series of events took place in the crypto world this week.
It all started with an article on Coindesk about Sam Bankman-Fried’s two main companies - FTX and Alameda Research. Bankman-Fried founded Alameda Research, a quantitative trading firm, in November 2017, to do crypto arbitrage and market-making trades - basically buy and sell crypto tokens for a profit. He then founded FTX in [year] to have a better exchange for Alameda to trade on. But he didn’t stop there. He also created a new cryptocurrency token, called an FTT. And this token derived most of its value because FTX promised token-holders a bunch of benefits such as lower fees, no-cost withdrawals, etc.
Coindesk reported that Alameda has a lot of FTT on its balance sheet. Alameda rested on a foundation that largely consisted of a coin that its sister’s company created. What concerned people in all of this was that if FTX loaned a bunch of customer assets and got back FTTs in return. So FTX ran a risk of destabilization if the price of FTT crashed.
This is the crypto equivalent of a bank run - if you are scared that your holdings (cash or in this case, crypto) will lose their value, you want to take them out of the bank (or the crypto exchange) as soon as possible. If a large enough number of people do this, it could cause a problem. So when a large number of FTX’s users tried to take out their funds, FTX could not provide them with their funds. This is essentially the “liquidity” issues that news reports keep talking about.
This is where Changpeng “CZ” Zhao, the founder of Binance Holdings Ltd, comes in. For context, Binance is the biggest crypto exchange in the world. CZ tweeted that Binance is planning to liquidate its FTT holdings:
He apparently did this because of the “recent revelations” that came to light. People began to think that this would tank the price of FTT and started to get out. They withdrew almost 430 million dollars worth of bitcoin, customer assets, in four days. The platform had more than 20,000 bitcoins going into Sunday and by Wednesday it was left with almost zero. Bankman-Fried then started to look around for a loan or bailout.
CZ, who had kind of started it all, then announced that Binance might acquire FTX. However, as of the time of writing this article, Binance seems to be out of the deal:
Bankman-Fried saw 94% of his wealth being wiped out due to this episode. This is the biggest one-day collapse ever among a billionaire tracked by Bloomberg.
Here’s an interesting newsletter we discovered this week.
Abundantia
If you like finance, history and economics (in the true interdisciplinary Ashokan fashion), you would absolutely love this newsletter. Every article starts with an obscure historical narrative that you would have never bothered to look up yourself - but it’s so interesting that you get hooked in immediately. And right when you start thanking fate that you don’t live in the barbaric world of knights and conquests anymore, the author reveals an amazing contemporary parallel - a bit of major financial or economic news that inspired the post. This is that one newsletter that makes you go Ah, so history does repeat itself.