Overview

The bankruptcy of FTX, a Bahamas-based cryptocurrency exchange, began in November 2022. The collapse of FTX, caused by a spike in customer withdrawals that exposed an $8 billion hole in FTX's accounts, served as the impetus for its bankruptcy. Prior to its collapse, FTX was the third-largest cryptocurrency exchange by volume and had over one million users.

On 2 November 2022, CoinDesk published an article stating that Alameda Research, a trading firm affiliated with FTX and owned by FTX chief executive Sam Bankman-Fried, held a significant amount of FTX's exchange token, FTT. The article triggered a spike in withdrawals from FTX, but eventually, customers became unable to retrieve the money they had deposited in the exchange. On 11 November, FTX, Alameda Research, and over 100 affiliated entities filed for bankruptcy. Bankman-Fried resigned as FTX CEO and was replaced by John J. Ray III.

The collapse of FTX has had a wide impact on cryptocurrency markets, with comparisons made to the Enron scandal and Madoff investment scandal, and was described by federal prosecutors as "one of the biggest financial frauds in American history". Following the bankruptcy, the Securities Commission of the Bahamas froze the assets of one of FTX's subsidiaries. Bankman-Fried's net worth, estimated at $16 billion prior to the collapse, was reported as having been wiped out, and several institutional investors of FTX wrote off their investment stakes in the company.

Some $473 million in funds were later taken from FTX in an "unauthorized transaction". The collapse of FTX resulted in a ripple effect across cryptocurrency markets, with the price of Bitcoin falling to its lowest level in two years.

Background

Sam Bankman-Fried cofounded Alameda Research, a cryptocurrency trading firm, in 2017. In 2019, Bankman-Fried had the idea of starting a cryptocurrency exchange to help bring in revenue to fund Alameda's activities and founded FTX. Bankman-Fried was the CEO of both companies until he formally stepped down from his position at Alameda in October 2021, promoting traders Caroline Ellison and Sam Trabucco to co-CEOs. Ellison was reported to have a romantic involvement with Bankman-Fried. As of August 2021, Bankman-Fried still owned 90% of Alameda.

The close relationship and potential conflicts of interest between Alameda and FTX drew scrutiny from the rest of the cryptocurrency industry. Alameda was once the largest trader on FTX, bringing liquidity to the exchange. Between 1 June 2022 and 22 July 2022, Alameda's known wallets were the largest stablecoin depositors and sources of liquidity to all of FTX's known wallet addresses, accounting for 10% of Tether transfers and 30% of USD Coin transfers on the exchange. According to John J. Ray III, Alameda had a "secret exemption" from FTX's auto-liquidation protocol.

Alameda Research suffered a series of losses in May and June 2022, which anonymous sources told the Wall Street Journal resulted in FTX lending the trading firm more than half of its customer funds, a decision that the sources said FTX CEO Sam Bankman-Fried described as a "poor judgment call". This was explicitly forbidden by FTX's terms of service. On 12 November 2022, the Wall Street Journal reported that anonymous sources had said that Alameda CEO Caroline Ellison said that she, Bankman-Fried, Gary Wang, and Nishad Singh were aware of that decision.

The same was reported in the New York Times on 14 November 2022. FTX used software to conceal the misuse of customer funds.

CoinDesk article

Following months of arguments and disagreements between Changpeng Zhao, the CEO of Binance, and Bankman-Fried, tensions between the two had intensified days before the crisis. Zhao's firm Binance had obtained $2.1 billion in Binance USD and FTT coins in 2021, following a deal in which FTX bought back an equity stake held by Binance in FTX, and in early November 2022, it had 23 million FTT tokens, worth about $529 million at the time.

On 2 November, Ian Allison of CoinDesk reported that 40% of Alameda Research's $14.6 billion in assets was FTT token, whether unlocked (their biggest asset), locked or collateral (their third biggest asset).

Binance divestment and proposed acquisition

On 7 November 2022, Zhao announced that Binance had intended to sell its holdings in FTT. Ellison also extended an Alameda offer to Zhao to buy Binance's FTT at $22, which led to speculation that Alameda had loans that would be liquidated if FTT's price fell below that level.

The sale of Binance's holdings in FTT, compounded with the low trading volume of FTT and the enmity between Zhao and Bankman-Fried, resulted in the price of the token plummeting. Binance had received FTT from FTX in 2021 during a transaction in which FTX bought back Binance's equity stake in FTX. Zhao cited "recent revelations that came to light" as the motivation for selling FTT. Bloomberg and TechCrunch reported that any sale by Binance would likely have an outsized impact on FTT's price, given the token's low trading volume.

The announcement by Zhao of the pending sale and disputes between Zhao and Bankman-Fried on Twitter led to a decline in the price of FTT and other cryptocurrencies, resulting in $6 billion of customer withdrawals from FTX. FTX became unable to meet the demand for further withdrawals, and on 8 November, Bankman-Fried and Zhao jointly announced Binance had entered into a nonbinding agreement to purchase FTX to ensure that customers could recover their assets in a timely manner. The deal did not include the sale of FTX.US.

Zhao announced on Twitter that the company would complete due diligence soon, adding that all crypto exchanges should avoid using tokens as collateral. He also wrote that he expected FTT to be "highly volatile in the coming days as things develop". On the day of that announcement, FTT lost 80 percent of its value.

Binance acquisition dropped

On 9 November, Bloomberg called the acquisition of FTX by Binance "unlikely" due to the poor state of FTX's finances. Bloomberg also reported that the United States Securities and Exchange Commission and Commodity Futures Trading Commission were investigating the nature of FTX's connections to Bankman-Fried's other holdings and its handling of client funds. Later that day, The Wall Street Journal reported that Binance would not move forward with the deal to acquire FTX.

Binance cited FTX's reported mishandling of customer funds and pending investigations of FTX as the reasons for not pursuing the deal. Patrick Hillman, who was at the time Binance's Chief Strategy Officer at the time, said in CNBC interview that they were unable to determine FTX's assets and liabilities. Bankman-Fried said in a Slack message that FTX had learned through the press about Binance's concerns and decision.