FTX crash & burn: The what, why, how & moral of the story | Value Research The crypto exchange’s meteoric rise and fall is a tale to tell for the ages
Learning

FTX crash & burn: The what, why, how & moral of the story

The crypto exchange's meteoric rise and fall is a tale to tell for the ages

ftx-crash-burn-the-what-why-how-moral-of-the-story

For FTX, the world's second-most popular cryptocurrency exchange, things were swimmingly well.

From its founder, Sam Bankman-Fried, hailed as the "crypto Warren Buffett" to the company splashing eye-popping amounts on Super Bowl advertising to obtaining high-profile backing, FTX had everything going for it.

But in a short, sharp chain of events earlier this month, their bubble popped, imploding on our faces.

In a matter of few days, FTX declared bankruptcy, said it could not repay close to $3 billion to its creditors, flagged a hack worth $500 million of cryptocurrency and watched its founder's net worth tumbling 94 per cent in a single day!

A crash and burn that is being called the "crypto's Lehman Brothers" moment.

So, how did it come to this? Let's simplify the chain of events that has got everyone curious.

Short introduction about FTX
FTX is a cryptocurrency exchange. It is a platform that helps investors to buy and sell their cryptocurrencies, similar to how the Bombay Stock Exchange helps us trade company stocks.

How FTX became big
FTX was formed in 2019. In three short years, the company piggy-backed on the hype created around its then 27-year-old founder Sam Bankman-Fried and turned its charm offensive on politicians, celebrities and big and small corporations in the US and abroad.

Soon enough, the big bucks poured in. High-profile venture capitalists like Sequoia, Tiger Global and SoftBank pumped in almost $2 billion in the company.

The crash
This is where you need to be introduced to a trading company named Alameda Research.

Alameda Research?

This is another company Bankman-Fried found, and its role is crucial in this story of greed.

Alameda Research was a trading firm that bought Bitcoins and other cryptocurrencies from one exchange and sold it to another. The price difference was their profit.

As interest in cryptos zoomed, so was the company's growing need for more capital. (It needed more money to trade cryptocurrencies).

This was when Bankman-Fried came up with an ingenious idea. He set up FTX and minted a new token called FTT.

FTT?

FTT token allowed investors to buy and sell cryptocurrencies at a minimal processing fee.

As investors got attracted by the trading discount, they flocked to the crypto exchange, increasing the price of FTT.

This helped Alameda Research borrow more loans as they could offer higher-priced FTT tokens in return.

Their business plan was on track, until the overall crypto market saw a massive fall from its 2021 highs.

And when CoinDesk recently exposed that Alameda held a majority of FTT tokens, investors became aware that the company would only be able to repay its loans if the token price remained high.

The burn
Things took an even ugly turn. CZ, the Binance CEO, had earlier decided to step in and take over FTX. But after analysing the company's numbers, he made a sharp u-turn, tweeting that Binance would begin dumping $2.1 billion worth of FTT tokens held by them.

This was a brutal sucker punch, causing the token's price to fall even further.

The token crashed from around $23 to about $2.

And since Alameda was banking on the token prices to remain high in order to repay its loans, FTT's price crash doomed Alameda Research.

A leak of the company's balance sheet revealed it had $8 billion debt owed to FTX and did not have enough liquidity to repay the loan.

The fallout
This had a domino effect in the crypto world.

Investors started pulling out their money from other cryptocurrencies, including Bitcoin and Ethereum.

The cryptos FTX had been storing for users eventually ran out, forcing them to halt withdrawals. Investors were unable to take out their money!

The curious case of the hack
An official telegram from FTX stated the company had been compromised and urged users not to visit the FTX website because it could download Trojans. This further stonewalled investors from taking out their money.

There is a lot of conjecture that the hacker is actually an insider at FTX trying to move money elsewhere.

Then there are also reports of the CEO's private aircraft flying from the Bahamas to Argentina.

Not a good look for an exchange that's recently gone bust.

Lessons for us
What does all of this mean for the future of crypto? What conclusions can we draw from this? Of course, major coins like Bitcoin and Ethereum could recover as they have in the past, but this collapse is a cautionary tale.

Exchanges that should help us are actually deceiving us. Hence the need for robust regulations and exchanges to be backed by real money. Until then, such instances will keep happening.

This is why we'll use this as another opportunity to emphasise the need to invest safely.

Understanding the asset, having a long-term perspective, and resisting the urge to follow the crowd to make a quick "buck" is essential. It is your hard-earned money at the end of the day.

You don't want to invest in a company whose founder goes on Twitter to say that a few days after his bubble popped.

Suggested read: The crypto bloodbath


Recommended Stories

Other Categories