Mayhem: The crypto world shaken to its core after a chaotic day (2024)

The foundations of the crypto world are wobbling after the world’s largest cryptocurrency exchange walked away from a rescue of the second-largest within 24 hours of saying it had struck a deal to acquire it.

Binance had tentatively agreed to buy FTX on Wednesday but pulled out after an exceptionally brief due diligence investigation. The haste with which it withdrew points to something other than the “liquidity crunch” that Binance had originally believed had caused an implosion in the value of FTX’s token, FTT.

“In the beginning, our hope was to be able to support FTX’s customers to provide liquidity but the issues are beyond our control or ability to help,” Binance said.

“As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations, we have decided we will not pursue the potential acquisition of FTX.com,” it said.

So, having looked under FTX’s hood, Binance so disliked what it saw that it ran as fast as it could from a transaction that was supposed to stabilise, not just FTX, but the sector. It is apparent from Binance’s statement that it believes FTX’s problems go well beyond a liquidity crunch – a “run” by investors – to issues of solvency.

Loading

The news worsened what was already a rout in the market for crypto assets.

Bitcoin traded below $US16,000 for the first time since the onset of the pandemic. Less than a year ago it was valued at close to $US70,000. It has now lost 23 per cent of its value in two days.

Ethereum has lost nearly 30 per cent of its value this week and its blockchain rival, Solana, which has ties with FTX and its founder, Sam Bankman-Fried, nearly 60 per cent.

FTT tokens were trading at more than $US24 before FTX’s woes became known – a year ago they were above $US62 – but have collapsed to just over $US2.

It was the sell-off of FTT after a crypto news site published what it said was a balance sheet of Bankman-Fried’s hedge fund, Alameda Research, that triggered the crisis within FTZ. That balance sheet showed that, of Alameda’s $US14.6 billion of assets, at least about $US6 billion was exposed to FTX, either through holdings of the tokens or as “FTT collateral.” It also had an exposure of more than $US1 billion to Solana.

With both the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) now reportedly investigating FTX and Alameda (along with a wider investigation of crypto exchanges) the causes of the group’s now-inevitable failure might eventually be detailed.

There was a clue, however, in a tweet by Binance’s chief executive and founder, Changpen Zhao (or CZ, as he is commonly known) on Wednesday.

The “Two Big Lessons,” he tweeted, were:

“1. Never use a token you created as collateral.

“2. Don’t borrow if you run a crypto business. Don’t use capital ‘efficiently.’ Have a large reserve.”

He said Binance had never used its token as collateral and never taken on debt.

FTT is what’s called a “utility” token, or one that provides incentives for users to hold and trade them by saving on trading fees and other benefits. They are effectively akin to a rewards or loyalty scheme.

FTX creates the tokens and, from time to time, uses its own balance sheet to buy some back. Essentially, it underwrites their value and, if it were inclined, could manipulate their price. Without the buybacks – which are dependent on FTX’s financial capacity – the tokens would be of modest, if any, value.

What CZ appears to be hinting at is that Alameda and/or FTX used FTT tokens that were on their balance sheets as collateral for loans.

When Alameda’s balance sheet was published Bankman-Fried claimed it showed only a small partial picture of his group’s finances. The insights, however, caused Binance to announce that it would sell the $US580 million of FTT tokens it received in a deal last year “due to recent revelations that came to light,”

When FTT’s price started dropping like a stone it did exactly what Binance and others thought the disclosure of the incestuous relationships between Alameda, FTX and FTT might do and sent FTT’s price into a savage downward spiral and ultimately winnowed out the foundations of Bankman-Fried’s entire group, an “empire” valued by a capital raising earlier this year at about $US32 billion.

It’s not yet known what the prospective losses for his group’s investors – whether holders of FTT tokens or the blue-chip investors in FTX – but there is speculation that they could range from $US6 billion to $US8 billion. Among those who have backed Bankman-Fried are BlackRock, Ontario teachers’ Pension Plan, SoftBank, Tiger Global, Sequoia and Singapore’s sovereign wealth fund, Temasek.

Loading

It also destabilised the wider crypto market, which has lost about $US280 billion, or 26 per cent, of its market capitalisation this week. A year ago the market was valued at about $US3 trillion. Now it is capitalised at only about $US790 billion.

In a note to Binance employees after abandoning the plan to acquire FTX, Zhao said Binance had not master planned the events and, until Bankman-Fried contacted him asking for help, he had “very little knowledge of the internal state of things” at FTX.

That may have been a response to suggestions, here and elsewhere, that Binance’s announcement that it would dump its FTT holdings had effectively and conveniently driven a major competitor into its arms. While it now isn’t going to bail FTX out, the implosion of ts major competitor ought, in normal circ*mstances, to benefit Binance.

These aren’t normal circ*mstances, as Zhao recognised.

“FTX going down,” he said, was not good for anyone in the industry and shouldn’t be seen as a win for Binance.

It is apparent from Binance’s statement that it believes FTX’s problems go well beyond a liquidity crunch – a “run” by investors – to issues of solvency.

“User confidence is severely shaken. Regulators will scrutinise exchanges even more. Licences around the globe will be even harder to get, And people now think we are the biggest and will attack us more,” he said.

He’s right on all counts. FTX was highly regarded – Bankman-Fried was a star of the crypto sector, with deep and broad connections with the political establishment in the US – and so its demise will, and is, shaking confidence in the entire sector, a sector already made brittle after the savage downturns in crypto asset values over the past year.

Loading

It will force legislators to do more to ensure the sector is better regulated. The turf war between the SEC and the CFTC – both want to be the lead regulator for cryptos – will have to be resolved but FTX, while very large and high-profile, is only the latest of a very long series of scandals and investor losses in the crypto sector.

It’s little wonder there are those who liken the sector to a giant Ponzi scheme.

If crypto assets are to play any role in finance in future, trust in the integrity of the promoters and entities has to be gained and that will only come with the assurances provided by regulators’ oversight and a lot more transparency into what the participants in the sector are doing.

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.