The fall of FTX and its impact on the crypto market

A cryptocurrency trading platform, FTX was theoretically based on a relatively low-risk business model, relying mainly on fees applied to transactions carried out on it. Thus, it should have had access to its customers’ deposits at all times. However, we now know it it wasn’t like thatdue to the murky financial relationships recently brought to light between FTX and its sister company – investment and brokerage firm Alameda Research.

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What were the causes of FTX’s decline?

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Several major steps accelerated FTX’s decline:

  • On November 2, the specialized site CoinDesk has detected that Alameda Research’s balance sheet consisted primarily of FTT tokens issued by FTX (3.66 billion FTT and 2.16 billion “guaranteed FTT”, ie used as collateral, for $14.6 billion in assets). The token, whose utility is extremely limited, has also been used by Alameda as collateral to obtain loans. The company’s assets also consisted of a large 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 will sell its FTT holdings. As a reminder, Binance had invested in FTX shares when it was created and received a significant amount of tokens (valued at around $2.1 billion FTT and BUSD) after its exit from FTX equity in 2021. This announcement prompted a massive withdrawal of funds from FTX clients (almost 6 billion in just 72 hours).
  • On November 9, FTX suspended withdrawals and its CEO, Sam Bankman-Fried, proclamation a “strategic transaction” with its competitor Binance aimed at ensuring that “customers are protected”. However, less than 48 hours later, Binance withdrew its takeover proposal citing mismanagement of customer funds and investigations by US authorities.
  • On November 11, unable to overcome liquidity problems, FTX along with 134 related companies – including its US arm FTX US and Alameda Research – filed for bankruptcy. American press detected that the platform had lent more than half of its customers’ deposits (between $8 and $10 billion) 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 diverted from FTX and FTX US wallets. Many rumors soon circulated about the possibility of an internal origin of these deviations.

The impact on crypto market liquidity will be significant.

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Liquidity in crypto markets is primarily provided by a select number of companies, such as Wintermute, Amber Group, B2C2, Genesis, Cumberland and, until recently, Alameda. Therefore, the disappearance of one of the largest market makers can cause a significant drop in liquidity (“Alameda Gap”). Losses suffered by other market makers, some of whom (Amber Group, Wintermute and Genesis) have already confirmed that they have funds locked up in FTX, may contribute to increasing these liquidity problems.

While a drop in liquidity is common during periods of volatility, the historic size of the drop in liquidity seen last week may raise concerns that the liquidity gap associated with the Alameda collapse may be long-lasting.

The situation looks particularly worrisome in the much less liquid altcoin markets. Alameda had invested in dozens of projects and held millions of dollars in illiquid tokens for which it acted as a liquidity provider.

Crypto markets have decoupled from US stock markets.

The fall of FTX had a significant impact on the crypto industry, with bitcoin and ether falling 21% and 23% respectively last week. Thus, the crypto market decoupled from the US stock markets, which ended the week significantly 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 more than a year.

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Volatility risks in derivatives markets.

Falling prices in the spot markets led to cascading liquidations, worth about 900 million on November 8 and 9, in the crypto derivatives markets. Indicators of investor sentiment such as continuous funding rate futures have deteriorated significantly. Investors’ perception of risk was also affected. Implied volatility, an indicator that reflects market participants’ expectations of future moves in Bitcoin and Ethereum, doubled last week.

infestation

It is still difficult at this stage to assess the full ramifications of the FTX crash on the crypto industry before knowing how its major players have been affected. Crypto lender Blockfi – with a funding structure from FTX US – has announced that it will be forced to suspend withdrawals from its customers. Investment fund Galois Capital has admitted that half of its funds are locked in FTX. FTX investors, including SoftBank and Sequoia, have 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 exchanges have already spontaneously published proof of their reserves (note however that these do not reveal the composition of liabilities and depend on the good faith of the reporters).

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