The Digital Assets Newsletter: FTX's Liquidity Crunch
The world's third largest exchange is on its knees following a major bank run, how did this happen?
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Event of the Week: The FTX Liquidity Crunch
In light of the events related to FTX that have transpired this week, we will dedicate this weeks newsletter to breaking down this event for you readers. This will consist of the following sections:
What is FTX, Alameda Research and FTT
What has Happened
Binance Steps In and Out
What Now?
What is FTX, Alameda Research and FTT
Alameda Research is a quantitative cryptocurrency trading firm and liquidity provider founded by MIT graduate Sam Bankman-Fried (SBF) in 2017. In 2018, Alameda Research and SBF founded FTX which grew to become the world’s third largest centralised cryptocurrency exchange, specialising in derivatives and leveraged products. During 2022, FTX had over a million users with the platform recording billions of daily trading volume thanks to it providing a variety of derivative products and tradable instruments such as:
Futures
Perpetual futures
Options
Tokenised assets
FTT is an ERC-20 token created by FTX. An ERC-20 token can be thought of as a cryptocurrency that doesn’t have its own blockchain and is instead issued on the Ethereum network. Thus, FTT operates as FTX’s exchange token which allows investors to trade it with many benefits such as lower fees and staking. As described by ByBit, “one-third of FTX's trading revenue is used to purchase and burn FTT supply, so as trading revenue increases, it creates intrinsic value and increases the market cap of the FTT token.” Sounds a bit weird right?
What Has Happened?
In summary, FTX has ended up in a major liquidity crunch (or bank run) that has put them in solvency risk. Although there is still a lot of uncertainties and theories regarding what has really happened, this is what is largely believed to have happened.
On November 2nd, Coindesk released a piece outlining major issues in Alameda Research’s balance sheet. According to private documents reviewed by them, an extremely large portion of Alameda’s balance sheet was FTT. Namely, as of June 30th, $5.8 billion out of the company’s $14.6 billion assets were in FTT or “FTT collateral.” This was problematic given FTT’s low liquidity relative to Alameda’s holdings with it being 2x-3x FTT’s circulating supply. This essentially means that if the company had to sell its holdings, there wouldn’t be enough buyers for it. Furthermore, Alameda Research was a debtor to a variety of institutions where it posted FTT as collateral. The article can be found here. Note that the key issue with FTX’s exchange token is its lack utility and intrinsic value. Binance’s BNB token operates on its own blockchain ecosystem and can be used for a wide range of applications and use cases unlike FTT who’s primary utility is as a medium of exchange and offering lower trading fees.
On November 6th, Changpeng Zhao (CZ), the co-founder and CEO of Binance, announced that Binance will liquidate its holdings in FTT in light of recent revelations.
This caused FTT tokens to tumble significantly. Furthermore, as a result of Alameda’s leaked balance sheet, a wave of users began withdrawing money out of FTX. With the combination of the fall of FTT, a lack of liquidity in the crypto markets and masses of withdrawals, FTX entered a liquidity crunch.
Binance Steps In and Out
On November 8th, CZ announced that Sam Bankman-Fried and FTX has contacted him for help in essentially bailing them out. Wherein a non-binding Letter of Intent was signed with the intention of Binance acquiring FTX following thorough due diligence.
On November 9th, less than 48 hours after due diligence proceedings began, Binance announced that it will back out the FTX deal citing issues that were beyond their control or ability to help. The company released a statement saying “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.com.” Sam Bankman-Fried tweeted out an apology thread explaining how he “fucked up.”
What Happens Now?
Information is still coming to light so there are still major uncertainties into what truly happened (so take this article with a grain of salt). Ultimately, there will be major ripple effects throughout the markets and potential regulatory backlash. As of now, fears of a financial contagion have swept through crypto markets with Bitcoin tumbling down to its lowest point since 2020 despite recovering quickly thereafter. This contagion fear is attributed to how interlinked FTX and Alameda Research is to the wider ecosystem given the amount of assets they have borrowed and their need to liquidate their holdings. For now, we can only recommend that you keep an eye on the events that will transpire.