Last Friday, FTX, until then the fourth largest crypto-asset exchange platform in the world and still valued at 32 billion euros a few days earlier, went bankrupt. Its collapse has deeply weakened the cryptocurrency industry, due to the role it occupied in it. Market analysis published by the Kaiko Research team.
FTX, a cryptocurrency exchange, was supposedly based on a relatively low-risk business model, relying primarily on fees charged on transactions executed on it. It should have been able to access its customers’ deposits at any time. However, we now know that this was not the case, due to the recently exposed opaque financial relationships between FTX and its sister company – the investment and brokerage firm Alameda Research.
Several major steps precipitated the collapse of FTX:
On November 2, the specialized site CoinDesk revealed that Alameda Research’s balance sheet was made up mostly of FTT tokens issued by FTX (3.66 billion FTT and 2.16 billion “guaranteed FTT”, or used as collateral, for an asset of 14.6 billion). The token, whose utility is extremely limited, was also used by Alameda as collateral to borrow funds. The company’s assets were also made up of a significant portion of other illiquid or FTX-related tokens (SOL, SRM, MAPS, OXY, FIDA).
On November 6, the CEO of Binance, the largest crypto exchange, said that his company would sell its FTT holdings. As a reminder, Binance had invested in FTX shares at its inception and obtained a significant amount of tokens (estimated at around $2.1 billion worth of FTT and BUSD) following its exit from FTX in 2021. This announcement sparked massive withdrawals of funds from FTX customers (nearly $6 billion in just 72 hours).
On November 9, FTX suspended withdrawals and its CEO, Sam Bankman-Fried, announced a “strategic transaction” with competitor Binance to ensure that “customers are protected.” However, less than 48 hours later, Binance withdrew its buyout proposal, citing mismanagement of customer funds and investigations by US authorities.
On November 11, unable to overcome its liquidity issues, FTX and 134 associated companies – including its US arm FTX US and Alameda Research – declared bankruptcy. The American press revealed that the platform had lent more than half of its customers' deposits (between 8 and 10 billion dollars) to Alameda to finance risky operations.
A few hours later, the platform was the target of a massive hacking operation, with more than 600 million having been diverted from the wallets of FTX and FTX US. Many rumors quickly circulated about the possibility of an internal origin of these diversions.
The impact on crypto market liquidity will be significant:
Liquidity in crypto markets is mainly provided by a small number of companies, such as Wintermute, Amber Group, B2C2, Genesis, Cumberland and, until recently, Alameda. The disappearance of one of the largest market makers could therefore cause a significant drop in liquidity (the “Alameda Gap”). Losses suffered by other market makers, some of which (Amber Group, Wintermute and Genesis) have already confirmed having funds blocked in FTX, could contribute to these liquidity problems.
While a drop in liquidity is common during periods of volatility, the historical magnitude of the liquidity drop seen last week could raise concerns that the liquidity gap from Alameda’s collapse could be long-lasting.
The situation is particularly concerning in the much less liquid “altcoin” markets. Alameda had invested in dozens of projects and held millions of dollars of illiquid tokens for which it acted as a liquidity provider.
Crypto markets have decoupled from US stock markets:
The collapse of FTX had a significant impact on the crypto industry, with bitcoin and ether falling 21% and 23% respectively last week. The crypto market has thus decoupled from US stock markets, which ended the week sharply higher, benefiting from a slowdown in inflation. Thus, Bitcoin's correlation with the Nasdaq fell to its lowest level since November 2021, while its correlation with ETH reached its highest level in over a year.
Volatility risks in derivatives markets:
The fall in prices on the "spot" markets led to cascading liquidations, worth an estimated nearly 900 million on November 8 and 9, on the crypto derivatives markets. Investor confidence indicators such as the funding rate of perpetual futures contracts have deteriorated sharply. Investor risk perception has also been affected. Implied volatility, an indicator that reflects market participants' expectations of future movements in Bitcoin and Ethereum, doubled last week.
It is still difficult at this stage to assess the full consequences of the fall of FTX on the crypto industry before knowing how its main players have been impacted. Crypto lender Blockfi - benefiting from a funding facility with FTX US - announced that it would be forced to suspend withdrawals from its clients. Investment fund Galois Capital admitted that half of its funds were blocked on FTX. FTX investors, including SoftBank and Sequoia, have since reduced their stakes to zero, losing millions of dollars in value.
Everything suggests that the fall of FTX will have an accelerating effect on the regulation of the sector. Many centralized exchange platforms have already spontaneously published proof of their reserves (it should be noted, however, that these do not reveal the composition of the liabilities and depend on the good faith of the rapporteurs).