Chief Executive Officer of FTX Trading Limited Sam Bankman-Fried speaks during a House Committee on Financial Services
Jabin Botsford-The Washington Post/Getty Images
November 9, 2022 9:16 PM EST

Crypto experienced one of its worst days ever on Wednesday in the wake of the stunning collapse of the FTX exchange, a platform once hailed as one of crypto’s foremost success stories.

FTX faces potential bankruptcy after its competitor Binance reversed its decision to bail the exchange out from a cash shortage reported to be $8 billion. Binance wrote on Twitter that discoveries made during “corporate due diligence,” combined with newly-announced federal inquiries into the company—which was valued earlier this year at $32 billion—made the deal too risky.

Earlier this week, investors of FTX lost confidence in the exchange after Binance’s CEO, Changpeng Zhao, expressed skepticism about FTX’s financial stability and pulled $500 million worth of investments. A bank run ensued, and FTX found itself facing a major cash shortage, with no way to pay all of the users trying to withdraw all their money at once. So they sought help from Binance—the largest centralized crypto exchange—who agreed on Tuesday to bail them out.

On Wednesday, however, the deal fell apart. Now, many pessimistic crypto insiders are fearing the onset of a vicious downward spiral in crypto asset values that will damage individual investors and the entire industry for years to come.

Many are already comparing FTX’s crash to that of the Lehman Brothers in 2008, which helped precipitate a global financial crisis. Indeed, on Wednesday, as the deal to save FTX appeared to unravel, Bitcoin fell below $16,000 for the first time since November 2020, while Ethereum shed nearly a third of its value from Monday.

“I think it’ll be very bad: This is contagion to the maximum,” says John Lo, managing partner of digital assets at the investment firm Recharge Capital. “We’re going to see household crypto names, lenders and funds go down completely. It’s going to get messy and protracted.”

The fall of FTX

FTX’s rapid rise and calamitous collapse occurred under the leadership of Sam Bankman-Fried, who created the platform in 2019. Within three years, it was one of the fastest-rising currency exchanges in the world, with billions of dollars of crypto traded on the exchange daily. But earlier this month, the news outlet CoinDesk reported that FTX’s sister company, Alameda Research, held much of its reserves in a crypto token that FTX itself had created, FTT. If FTT were to drop, then the value of Alameda, a trading and investment juggernaut, would tank too.

FTX was unable to assuage concerns about the report, and on Nov. 6, Binance announced its intention to offload $500 million worth of FTT. This triggered a bank run in which FTX users who traded cryptocurrency on the platform scrambled to withdraw their funds. Due to this frantic pressure, FTX found itself unable to meet all of their withdrawals.

In order to pay their customers back, FTX agreed to be bought by Binance on Tuesday. (On its surface, the deal mirrored Bank of America’s buyout of Merrill Lynch during the 2008 financial crisis, which effectively rescued it from bankruptcy.) Bankman-Fried promised that customers would be able to recoup their balances in full.

Read More: The World’s Largest Crypto Exchange Is Buying a Major Competitor. Here’s Why That Matters

But after the agreement was announced, more and more reports began to circulate about major issues with FTX’s business dealings. Analysts alleged that FTX held far less funds in reserve than it claimed to, and that it co-mingled customer funds with those of Alameda Research—an incredibly risky practice given that the exchange is supposed to perpetually safeguard its customers’ funds.

Regulators immediately took notice. Both the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) launched investigations into whether FTX had mishandled customer funds, Bloomberg reported. Meanwhile, turmoil boiled over at the company, with most of FTX’s legal and compliance staff quitting Tuesday evening, Semafor reported.

On Wednesday afternoon, 29 hours after Binance’s CEO Changpeng Zhao announced the deal, Binance pulled the plug. “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,” Binance’s account tweeted.

Contagion

The crypto markets, which had dropped on Tuesday in anticipation of the Binance-FTX deal, sank again. The first victims were FTX users, who had put their faith in a company purported to be one of the most trusted parts of the crypto ecosystem. FTX halted withdrawals of both crypto and fiat currencies from the exchange, and many of the platform’s users began to doubt they would get their funds back at all. On Tuesday, Zane Tackett, the head of institutional sales at FTX, liked a tweet alleging that the company “gambled with client funds and lost… If you haven’t gotten your funds yet expect pennies on the dollar in bankruptcy court.”

FTX is now scrambling for funds. On Wednesday afternoon, the Wall Street Journal reported the exchange’s shortfall to be $8 billion. According to Bloomberg News, Bankman-Fried told investors that if the company did not receive a cash injection, it would likely file for bankruptcy.

And experts fear that if FTX is not propped up, the entire crypto downturn will become even steeper. FTX sits at the center of the crypto world, with many major venture capital funds—including BlackRock, Sequoia, and Temasek—heavily invested in its success. (Celebrities like Stephen Curry and Tom Brady had also invested in FTX.) Those entities now stand to incur major losses, which could affect funding across the crypto ecosystem. Several crypto companies have already declared bankruptcy this year, which in turn has left individual investors waiting to recover their funds.

At the same time, FTX and Alameda were key investors in the larger crypto ecosystem. For instance, they provided significant backing for the blockchain Solana’s $300 million ICO (initial coin offering) last year. On Wednesday, Solana fell 50%, with various parts of its ecosystem collapsing. It now appears a long way off from many of its users’ goal to unseat Ethereum as the most-used blockchain.

Meanwhile, several crypto-adjacent entities also felt spillover effects. Shares of the trading app maker, Robinhood dropped 13% on Wednesday, as Bankman-Fried owns more than a 7% stake in the company. And the bank Silvergate Capital, which offers crypto banking, likewise saw its stock fall deeply.

Many experts believe that these sorts of losses will compound on themselves—and efforts to integrate crypto with mainstream finance and culture will slow dramatically. “The long term legitimacy of crypto as an industry is in real danger for the first time,” wrote one user on Twitter.

And the fall of FTX and Bankman-Fried is likely to cause lasting damage far beyond falling crypto values. Bankman-Fried had positioned himself as the community’s affable do-gooding leader with a strict moral code. He hobnobbed regularly with regulators and politicians in an effort to convince them of crypto’s benefits. Now, a bipartisan bill that would place digital exchanges and brokerages under the light oversight of the Commodity Futures Trading Commission may be imperiled due to Bankman-Fried’s fierce advocacy of the measure.

Lo, at Recharge Capital, says regulators are now much more likely to come down with much harsher measures. “From a regulatory perspective, this really really winds back a lot of the goodwill that was built up in the past two-three years,” he says. “It shows that centralized finance and cryptocurrency definitely needs to be regulated to a certain degree.”

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