In less than a week, a 30-year-old businessman once hailed as a modern-day JP Morgan has watched his digital empire, including billions in his own fortune, evaporate in a death spiral that has shaken the foundations of the trillion-dollar crypto industry.
On Thursday, Sam Bankman-Fried issued a mea culpa: “I nailed it,” he wrote in a lengthy Twitter thread, apologizing to investors and customers of FTX, the exchange he founded in 2019.
Failures are not uncommon in the murky, largely unregulated world of crypto, but FTX is not your average crypto startup. Its near-collapse this week represents a potential tipping point for an industry that many critics say has been taken for granted for far too long.
So what happened to FTX and why is the entire crypto space freaking out? There are still many uncertainties, but here’s what we know.
Last week, crypto news site CoinDesk published an article based on a leaked financial document from Bankman-Fried’s hedge fund, Alameda Research.
The report suggested that Alameda’s business rested on shaky financial ground. Specifically, that most of its assets are held in FTT, a digital token that was minted by Alameda’s sister company, FTX. This was a red flag for investors as the companies were, at least on paper, separate. However, Alameda’s disproportionate possession of the token suggests that the two were much more closely related.
On Sunday, the CEO of Binance, FTX’s much larger competitor, said his company is liquidating $580 million worth of FTX holdings. This sparked a firestorm of draws that FTX didn’t have the cash to facilitate.
By Monday, concerns about Alameda and FTX had seeped into the broader crypto market. But Bankman-Fried was defiant, tweeting that FTX and its assets were “fine.” Along with Binance CEO Changpeng Zhao, whose tweet had fueled the flow of FTX deposits.
There was clearly bad blood between the two, which is why it shocked the industry when the pair announced a tentative deal on Tuesday for Binance to rescue FTX.
“This afternoon, FTX requested our assistance,” Zhao wrote that afternoon, noting that there was a “significant liquidity crunch” at the company and that Binance would need to conduct corporate due diligence before proceeding with any deal.
Almost immediately after taking a look under the hood, however, Binance began to back down.
Meanwhile, Bankman-Fried’s personal fortune also declined. According to the Bloomberg Billionaire Index, Bankman-Fried’s net worth fell 94% in one day, from more than $15 billion to just under $1 billion — the index’s biggest one-day loss ever. (His net worth estimate was based on the assumption that Binance would eventually bail out FTX, where much of Bankman-Fried’s personal assets are kept. Which means his net worth may decrease further.)
On Wednesday, cryptocurrencies continued to fall as investor concern over the FTX bailout spread. Bitcoin and ether, the two most popular tokens, both hit their lowest levels in the last two years.
The selloff intensified following media reports that Binance was leaning toward pulling out of the deal. Sure enough, on Wednesday afternoon, Zhao tweeted a withering assessment of FTX’s woes:
“Initially, our hope was to be able to support FTX customers in providing liquidity, but the issues are beyond our control or ability to assist.”
It also referred to allegations of “mishandling of funds” and investigations by US regulators.
Binance was out. FTX’s best shot at a lifeline was gone.
The full extent of FTX’s financial problems is not yet known, but multiple reports say the company is facing an $8 billion deficit. Without a quick injection of equity capital, Bankman-Fried reportedly told investors Thursday, the company was facing bankruptcy.
Since the Binance deal collapsed, Bankman-Fried has been scrambling to raise capital. On Thursday, he tweeted that there were “certain players” the company was in discussions with.
“We are spending the week doing everything we can to increase liquidity,” he wrote in his apology thread. “Every penny” of that, plus the rest of the security, will go toward making users integrated, followed by investors and workers.”
Despite its reputation as a reliable, low-risk investment gateway, FTX’s business appears to have been built on a complex, highly risky type of leveraged trading.
Customers deposited their money to participate in crypto transactions. However, it appears that FTX took billions of dollars of that money and loaned it to its subsidiary, Alameda, to fund those high-risk bets, according to the Wall Street Journal.
Bloomberg columnist Matt Levine put it differently: “FTX took their customers’ money and traded it for a bunch of magic beans, and now the beans are worthless.”
At the end of the day, FTX experienced the crypto equivalent of a classic bank run. Customers wanted their money and FTX didn’t have it.
In traditional financing, customer funds are protected by the Federal Deposit Insurance Corporation, which insures the deposits. However, the FDIC does not insure stocks or cryptocurrencies, leaving the fate of FTX customers and investors in doubt.
One of those investors was the Ontario Teachers’ Pension Plan, which said it invested $95 million in both FTX International and its U.S. entity “to gain small-scale exposure to an emerging area of financial technology.” In a statement on Thursday, the scheme noted that any loss on its investment would have a “limited impact” as it represents less than 0.05% of its total net assets.
On Thursday, Bankman-Fried said Alameda Research will end trading while FTX focuses on extraordinary fundraising.
But since Binance, the industry’s largest exchange, has shied away from bailing out its rival, FTX may have few options.
Bankman-Fried told staff in a memo obtained by The New York Times that FTX had been in talks with crypto entrepreneur Justin Sun, who tweeted that he was working to “work out a solution” with FTX.
Meanwhile, US authorities, including the US Department of Justice and the Securities and Exchange Commission, are investigating FTX’s activities, according to Bloomberg.
