The catastrophic collapse of crypto titans FTX and Alameda Research has rocked the cryptocurrency world over the past two weeks. The rumor that the pair had blurred the lines between user deposits and their investments soon became a cascade of events that sent shockwaves through the industry. Bitcoin and other cryptocurrencies were sent into a downward spiral after the implosion, earning November 2022 a place in the history books as one of the worst months in crypto’s history.
But what really caused the downfall of FTX, what was the impact and why is Bitcoin falling?
The last quarter of 2021 marked the beginning of what has since been a brutal downward trend for Bitcoin and crypto markets. Despite hitting an eye-popping US$69,000 almost a year ago, Bitcoin is down nearly 75% from its all-time high. The entire cryptocurrency market peaked at a total value of $3 trillion at around the same time in November last year, but has lost nearly $2.2 billion in value over the past year.
2022 proved to be a challenging year for investors worldwide, with both Russia’s invasion of Ukraine and massive fiscal stimulus by governments during Covid-19 lockdowns causing high inflation for countries worldwide. To reduce the inflation rate to acceptable levels, central banks increased interest rates, which negatively affected investment markets, such as stocks and crypto.
Since the start of the year, cryptocurrencies have generally trended downward in value, exposing vulnerabilities for some players in the industry. The Terra Luna crash in May caused significant fallout for the entire crypto space, wiping nearly $US60 billion from the crypto markets in a matter of days. Numerous companies were directly affected; notably Celsius, Voyager and 3 Arrows Capital filed for bankruptcy after the incident.
By October, the crypto markets were finally starting to shake off the dust from the Terra crash, and the space seemed to be moving in a positive direction. However, on November 2, 2022, CoinDesk ended the brief moment of calm by revealing that the giants FTX and Alameda Research had put themselves in a risky position. A cascade of events soon followed, creating mass hysteria in the world of crypto and causing the price of Bitcoin to tank as investors panicked and sold their assets to save whatever money they had left.
A little background: FTX implosion explained
Sam Bankman-Fried, more commonly known as SBF, is a crypto tycoon known for founding the stock exchange giant FTX and the quantitative trading firm, Alameda Research. CoinDesk revealed that while Alameda Research and FTX were thought to be separate companies, the balance sheets of these companies became intertwined. Alameda Research’s holdings were dominated by FTX’s token, denoted by the ticker symbol FTT.
Several days after this information surfaced, a rival exchange and investor in FTX, Binance, announced that they would sell all remaining FTT stakes, amounting to $US580 million. Naturally, the price of the FTT token dropped after the news. This price drop caused immediate panic among FTX users, and a ‘bank run’ on the exchange ensued. After only $US4.5 billion worth of crypto assets were removed from the FTX platform, withdrawals stopped being processed without warning.
This situation trapped $US10 billion of user funds on the exchange, potentially affecting millions of users. Fearing the worst, some affected crypto-investors began selling what assets they had left to get out of the market, causing a rapid drop in Bitcoin and cryptocurrencies across the board. Competing exchange Binance briefly stepped in and offered to buy out FTX and meet their obligations; however, after less than a day of due diligence, they announced the issues were beyond their control “ability to help”.
Following this, Chinese crypto-tycoon and founder of TRON, Justin Sun, offered to back any FTX deposits of TRON-based tokens. Seeing a way out, users immediately flocked to buy and withdraw the Sun-backed tokens, pushing up the price on the platform by nearly 50 times the original. Of course, when it was withdrawn, it meant that you had to take an immediate loss of up to 99%. Many FTX users decided that taking this loss was better than leaving assets on the exchange.
FTX has since filed for bankruptcy both in Australia and overseas, suffered an alleged hack for nearly $US1 billion in user funds, and is now under investigation by the Bahamian government for criminal misconduct. Quite the downfall indeed.
Impacts of the FTX merger
The collapse of SBF’s empire has widespread consequences for the crypto industry. FTX and Alameda Research were considered industry powerhouses and had investments or commitments in many companies in the space. Other companies affected by the FTX collapse have already begun to come forward, pausing user withdrawals from the platform while they assess the extent of the damage.
Apart from the direct impact of FTX’s dealings with other companies, there was also some mass hysteria and panic. Some crypto investors have almost lost faith in centralized platforms and exchanges, frantically withdrawing every penny they can from their accounts. Massive outflows from exchanges show the extent of this loss of confidence, with more than $US3.7 billion worth of Bitcoin removed from exchanges, along with billions of dollars in other currencies.
Some users may be so shaken by the disaster that they may decide to sell their assets and leave the crypto space altogether. The plunge in prices across many crypto-assets suggests that this could be a distinct possibility and could be one of the reasons why Bitcoin is falling. However, despite the negative impact of the past week, there are some positive takeaways.
A key takeaway will be the need for improved regulation for centralized crypto exchanges to ensure the proper management of users’ funds. SBF presented the case to regulators who suggested a light touch, favoring FTX and worst affecting competitors and decentralized financial applications.
Another critical realization for crypto investors is that centralized platforms are not necessarily the safest places to store crypto: those who chose to keep their crypto assets in their wallets were not affected by the events of the past week and still have access to their cryptocurrencies. Some may be so violated by FTX’s crash that they choose this storage method in the future. Anyway, watch this space.
This article is not an endorsement of any particular cryptocurrency, broker or exchange nor does it constitute a recommendation of cryptocurrency as an investment class.