What FTX’s downfall means for crypto

Nov 9, 2022

Binance playing chess while FTX plays checkers

Note: This article was originally published on November 9th, 2022. The situation is evolving quickly and since writing this Binance has walked away from its deal to acquire FTX.com. In an effort to avoid bankruptcy, Sam Bankman-Fried and FTX.com are still looking for financing to save the distressed crypto exchange.

On Tuesday morning, the world’s largest crypto exchange Binance signed a letter of intent to acquire the second-largest crypto exchange and competitor, FTX. We believe this acquisition is akin to a bailout of FTX after the firm had to pause withdrawals due to a liquidity crunch.

Let’s dive into the events that led to the fall of FTX:

The backstory

CoinDesk first reported on November 2nd that Alameda Research, a proprietary trading firm co-founded by FTX’s Sam Bankman-Fried, had a large amount of its net equity tied up in FTX’s native exchange token, FTT, and other illiquid altcoins.
A few days later, Changpeng Zhao (CZ), CEO of Binance, announced on Twitter that Binance intended to liquidate all of their FTT holdings from their books, approximately $580m worth at the time.
In a day’s time, those comments started a wave of panic around the solvency of both FTX and Alameda Research. As a result, billions in assets and token values began to flow out of known FTX and Alameda addresses over the last week.
It is difficult to say with certainty, but FTX was likely working on a fractional reserve model, meaning that customer funds were lent to Alameda to generate yield. As the price fell, it was not prepared to meet withdrawals on a bank run triggered by CZ.
In order to honor these withdrawals, FTX needed assets that they loaned to Alameda.
However, as we have seen, Alameda Research did not have the liquidity to return the funds back to FTX. Thus, they started to liquidate liquid assets, including Ethereum and Solana, in an attempt to return funds to FTX to honor the withdrawal requests.
The efforts were futile as a bank run and panic were already in full effect. FTX struggled to meet a surge of withdrawal requests, and reports of them pausing withdrawals started to surface.
FTX needed to raise cash from external parties to meet these cash outflows fast. According to Semafor, in the hours before FTX secured rescue from Binance, it sought a bailout of more than $1 billion from third-party investors. By midday Tuesday, the hole appeared far more profound than initially anticipated – a liability closer to $5 billion to $6 billion.
Unable to find other financiers, Sam Bankman-Fried was forced to accept a bailout from rival Binance, who started the bank run panic in the first place. The deal would include Binance potentially fully acquiring FTX.com, conditional on due diligence. The market bounced back quickly following the announcements of plans to backstop contagion.

The takeaway

What happens from here remains to be seen, but we believe much of the damage is likely behind us. When major market players face trouble and struggle to meet their liabilities, the interconnectedness of crypto quickly leads to contagion. Volatility has been a consistent theme in 2022, with the industry learning the hard way that leverage can be extremely dangerous during a bear market.

We believe that transparency of balance sheets and further regulation in crypto markets will unlock further adoption, and unfortunate events like this may drive regulators to work a bit quicker.

What it means for you

Honestly, not too much. Crypto prices declined yesterday as the contagion hit crypto prices at large. We’re in this for the long haul and are working through a prolonged downturn.

We remain defensively positioned, with over 60% of the strategy invested in Bitcoin. Our muted altcoin exposure and strategic cash reserve led to a less dramatic decline Tuesday versus the Bitwise 10 Index.

We’ll continue to monitor the downstream impact from the fallout of FTX and Alameda Research, but we don’t anticipate making any near-term changes catalyzed by this event. Tides can change quickly, and we believe this speaks to the importance of active management in this growing asset class.

We hope this provides some clarity to an evolving situation, and please let us know if you have any additional questions.

Onwards,
Titan team