MC Explains | What is the FTX-Binance fiasco that's hammering Bitcoin?

Bitcoin, the digital asset that was touted to replace fiat currency in the future, has lost almost three-fourths of its peak value in the past year and is at the lowest level in two years.

The price erosion of the world’s leading cryptocurrency started last year but things have gone from bad to worse over the past few days with a leading exchange on the brink of collapse.

FTX, the crypto exchange that allowed derivatives trading in cryptocurrencies, has been forced to seek a bailout amid an unprecedented liquidity crisis. If it collapses—and the chances are high now—many traders will lose money.

What is FTX?

Founded by billionaire Sam Bankman-Fried, the FTX is a cryptocurrency exchange whose unique selling point was derivatives trading in cryptocurrencies. The exchange offers products including futures, options, volatility products and leveraged tokens. It claimed to be “built by traders, for traders”.

The exchange, founded in 2019, became popular quickly. It also attracted investments from private equity and institutional investors including Sequoia and SoftBank. The startup was valued at $32 billion in January.

Before starting FTX, Bankman-Fried had founded named Alameda Research, a trading firm.

Also read: The collapse of FTX — Is this crypto's Lehman moment?

So, what went wrong?

Everything you can think of.

Things started unravelling after reports showed that a significant portion of Alameda Research’s $14.6 billion assets were FTTs, a token issued by the FTX that can be used on the exchange. Although there was nothing wrong with FTT, having most of your "assets" in the form of tokens that your sister company can issue whenever it wants is a sign of bad corporate conduct.

This was followed by the mass sale of FTT owned by Binance, the largest cryptocurrency exchange in the world and a rival of FTX. Binance was an early investor in the FTX.

Binance CEO Changpeng Zhao said due to recent revelations, the company decided to liquidate any remaining FTT on its books. This was on November 7.

And then, all hell broke loose.

Also read: Cryptocurrencies slump again amid fallout from FTX sale

Wait, why?

When large shareholders dump stocks, the price falls. This is even more true when liquidity is low. A similar thing happened with FTT. Since Binance decided to dump FTT, a token in which trading volumes were usually low – prices started plummeting.

This was even before Binance started selling the FTT it owned as other traders wanted to get out as soon as possible. Binance halted the sale of FTT tokens on November 9.

Also, a bank run started on the FTX as some doubted the stability of the exchange. This led to a “liquidity crisis” – jargon for not having enough funds to pay back traders and depositors.

Oh, okay. Please continue.

Now, Bankman-Fried and the FTX needed a bailout amid an insolvency crisis. And, like a white knight, Binance appeared and announced the acquisition of the FTX in order to save the company. It sent a letter of intent to the FTX on November 8.

However, even before the ink on the letter dried, Binance took a U-turn and said it was backing out of the deal “as a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations.”

This sounds suspicious. Was this orchestrated by Binance?

Some people on social media suspected this. However, the Binance CEO denied it in a tweet. He said: “We did not masterplan this or anything related to it.”

What was that investigation?

Bloomberg reported that US regulators were investigating whether the FTX mishandled customer funds, and they’re looking into the firm’s relationships with other parts of Bankman-Fried’s crypto empire.

With these developments, the value of FTT dropped to less than $3 now from $22 a week ago. Bankman-Fried’s billionaire status is at risk. Sequoia has marked its investment in FTX as zero.

But why is bitcoin falling?

The crypto ecosystem is still not fully developed and any negative news impacts the entire market. The FTX was a large exchange and its collapse will lead to the end of a small part of the ecosystem.

Moreover, this fiasco comes after the Terra ecosystem collapse, the Celsius insolvency and the Three Arrows Capital blow-up on top of numerous instances of hacking that keep cropping up. As traders lose money, trust gets eroded and assets get devalued.

This has led to selling in cryptocurrencies, including Bitcoin, which has fallen below $16,000.

What now?

Things are still unravelling. The FTX has not filed for insolvency yet. If another company comes up to buy it, there is a slim chance that things may get better. The emergence of crisis after crisis in the cryptocurrency ecosystem has also led to a demand for increased crypto regulation. Even the Binance CEO acknowledged this in a tweet.

“Binance has backed out of the deal to acquire the FTX, which is driving investors away from riskier assets,” said Shivam Thakral, CEO of BuyUcoin. “Feedback from retail/institutional investors on withdrawals of their funds from the FTX will play a crucial role for the market’s recovery in the coming weeks.”

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