The Biggest Crash in Cryptocurrency History: Summarizing the FTX Contagion

Background

Recent events leading to the most significant cryptocurrency crash have led experts to look closely at the industry, the key players, and the regulations guiding them. 

In the eyes of many, cryptocurrency leads to corruption. It is perceived as a highly volatile form of gambling, the sole purpose of which is to make it easy for criminals to launder funds and mask illicit transactions. This narrative is perpetuated when significant market crashes occur, which result from the corruption of individuals who take advantage of privacy-enabling features for their own gains. 

Chief among these individuals is Sam Bankman-Fried (SBF), who was once hailed as the golden child of cryptocurrency and would bring realistic regulation to the space. SBF was the founder and CEO of both FTX and Alameda Research, and the debacle stemming from these firms led to the loss of $9 billion in customer assets.

This blog will examine what cryptocurrency is and what happened with FTX.

Cryptocurrency Contextualized

Cryptocurrency is an encrypted digital currency that utilizes cryptography to remain secure, which prevents third parties from viewing a user’s transaction history. Unlike fiat currency, cryptocurrency can be deflationary and prioritizes decentralization, user privacy, and anonymity. Fiat is printed endlessly by the Federal Reserve, the only organization to control the supply of USD; in contrast, no single individual or organization controls the supply distribution of a cryptocurrency like Bitcoin. 

Cryptocurrencies are hosted on a distributed ledger technology called blockchain, which records all transactions and ensures that they are valid and irreversible. Cryptocurrency allows users to transact directly with one another without oversight or interference from an intermediary or centralized authority like banks. Additionally, participation in cryptocurrency networks is permissionless, meaning anyone can buy and sell cryptocurrencies without needing identification, allowing them to remain anonymous in their affairs. 

What happened?

Key Players Involved

The events leading to the crash are complicated and start with the founder of FTX, Sam Bankman-Fried, and his involvement in other companies within the industry.

SBF founded Alameda Research in 2017, a quantitative trading firm that provided liquidity and funding to many other crypto projects. Two years later, in 2019, Sam Bankman-Freid founded the Bahamian headquartered, centralized cryptocurrency exchange, FTX. FTX had its own cryptocurrency token, FTT, which incentivized users to keep trading on the exchange. 

Now, exchanges are the busiest places in crypto regarding the number of active users; exchanges are hubs where hundreds of cryptocurrency tokens are bought and sold daily. At any given moment, tens of billions of dollars are circulating in trade volume on the top exchanges and billions more in stored value across user exchange accounts. 

A competitor of FTX, Binance is another centralized crypto exchange founded in 2017. Binance’s CEO, Chanpeng Zhao, aims for the exchange to be institutional. Sam Bankman-Fried and Changpeng Zhao had a long-standing feud that culminated in Binance dumping all of its held FTT tokens, flooding the market, and crashing the token’s price.

The Sketchiness of FTX Exposed

On November 2, 2022, the crypto publication CoinDesk, published findings concerning details about Alameda’s balance sheets. Of the $14.6 billion in assets held by Alameda Research at the time, FTX’s FTT token accounted for $5.82 billion, prompting questions about the FTX exchange’s leverage and solvency. 

Sam Bankman-Fried being the founder of both FTX and Alameda Research, and how most of Alameda’s asset holdings consisted of the centrally administered and controlled FTT token was already suspicious enough. However, the real controversy formed when it was realized that the maximum supply of the FTT token and its initial allocation breakdown made it impossible for Alameda to simultaneously hold as much FTT as it did while the circulating supply of the token remained the same.  

This led to speculation that SBF had been conducting fractional lending to take user FTT holdings directly from their accounts and use the funds to progress Alameda. Alameda, in turn, would then redistribute the stolen FTT to numerous crypto projects it had invested in that relied on the Alameda AMM protocol for liquidity. They were making the implications of this controversy extremely far-reaching within crypto markets. 

Token Crash

By virtue of the speculation that FTX was using customer assets to fund Alameda, Binance CEO Changpeng Zhao, tweeted on November 6, 2022, that he would be liquidating all the FTT held within Binance’s treasury reserves. 

Changpeng Zhao’s tweet expressing his intent to flood the market with Binance-held FTT tokens initiated a two-day bank run which crashed the token’s price as customers scrambled to withdraw their holdings from the FTX exchange. 

Insolvency

Within 48 hours, requested customer withdrawal amounts totalled nearly $6 billion, and on November 8, 2022, FTX paused all user withdrawals. This action did two things; firstly, it confirmed that the exchange had used customer assets to fund Alameda, and secondly, it exposed the insolvency of FTX because customers had nothing to withdraw. Their holdings had already been lent out, and FTX was too illiquid to pay them back.

Bahamian regulatory authorities stepped in on November 8 to seize the remainder of FTX assets and freeze all activity on the exchange; upwards of $9 billion in user assets had been lost.

Consequences

Sam Bankman-Fried was arrested in the Bahamas on December 12, 2022, after US prosecutors filed charges in an eight-count indictment against him and requested his extradition to the United States. In a press release issued by the US Attorney's Office on December 13, 2022, the Assistant Director in Charge of the New York Field Office of the FBI levied the following charges against SBF:

• Conspiracy to commit wire fraud
• Wire fraud
• Committing campaign finance violations
• Conspiracy to commit securities fraud
• Conspiracy to defraud the Federal Election Commission
• Conspiracy to commit commodities fraud
• Conspiracy to commit money laundering
• Conspiracy to commit securities fraud 

Sam Bankman-Fried made his $250 million bail on December 22 from a bond only nine days after his arrest; he didn’t have to pay a dime.

Sam Bankman-Fried appeared in New York for a court hearing on January 3, 2023, where he pleaded not guilty to all charges listed in the indictment brought against him. SBF was placed on house arrest following the hearing and, in the weeks since, has participated in a series of Twitter AMAs where he spoke openly—against the advice of his lawyers—about how the exchange's collapse was out of his control and that it had been the fault of corrupt FTX employees. 

Closing Thoughts 

The FTX contagion is still ongoing. It has resulted in billions of dollars in losses and the lowest lows this bear market has seen since the summer of 2021. Many crypto projects won’t survive; only time will tell who will make it out unscathed. The FTX scandal is a reminder to insure your assets, so you’re covered in case something like this happens again!