What happened to FTX.com?

FTX Trading Limited was founded in 2017, incorporated in Antigua and Barbuda, and headquartered in the Bahamas. The founders were Samuel Bankman-Fried (‘Bankman-Fried), who became CEO of the company, and Gary Wang, chief technology officer. The privately held entity operated a major cryptocurrency derivatives exchange and trading platform, FTX.com. It claimed to have over 1.2 million registered users in early 2021.

The collapse of FTX occurred over ten days in November 2022. On 02 November 2022, the crypto news site CoinDesk revealed that Alameda Research, the quant trading firm also operated by Bankman-Fried, held a $5 billion position in FTT, the native token of FTX. The report disclosed that FTX had lent Alameda over $10 billion in funds, including making customer deposits. It seemed to make meeting the scale of withdrawal demands impossible. Consequently, concerns were raised throughout the cryptocurrency industry about Bankman-Fried’s companies’ undisclosed leverage and solvency.

On 06 November 2022, Binance, the world’s largest cryptocurrency exchange announced that it would sell all its FTT tokens—approximately 23 million FTT tokens worth $529 million. Binance CEO Chanpeng Zhao maintained that the decision to liquidate the exchange’s FTT tokens was based on risk management. The decision was made following the collapse of the Terra (Luna) crypto token earlier in 2022.

The FTX Liquidity Crisis and the Binance Deal

The following day, FTX began to experience a liquidity crisis. Bankman-Fried tried to reassure FTX investors that its assets were secure. However, the investors demanded $6 billion in withdrawals in the days following the CoinDesk article. Bankman-Fried sought additional funding from venture capitalists before turning to competitor Binance. In two days, the value of FTT fell by more than 80%. On 08 November 2022, Binance announced that it had reached a non-binding agreement to buy FTX’s non-U.S business for an undisclosed sum, essentially bailing out Bankman-Fried.

However, the promise of Bankman-Fried’s rescue was short-lived, as Binance pulled out of the deal the following day. Binance announced that it would cancel the FTX transaction after corporate due diligence sparked concerns about the mishandling of customer funds, among other issues.

FTX Assets Frozen and FTX Files for Bankruptcy

The Bahamas securities regulator froze the assets of FTX Digital Markets, FTX’s Bahamian subsidiary, on 10 November 2022. It did this after reports that Bankman-Fried was looking for up to $8 billion in capital to bail out the exchange. The California Department of Financial Protection and Innovation announced on the same day that it had launched an investigation into FTX.

The same day, Bankman-Fried apologized for the liquidity crisis. He admitted on Twitter that FTX’s non-US exchange did not have enough funds to meet customer demand. He claimed that “poor internal labeling” led to FTX overestimating leverage and liquidity. In the same Twitter thread, he stated that Alameda would cease trading. However, the following day on 11 November 2022, he stepped down as CEO of FTX. He was replaced by court-appointed FTX CEO John Ray. Ray had previously led the energy trading firm Enron through bankruptcy proceedings. Soon after, FTX filed for Chapter 11 bankruptcy protection, revealing that approximately 130 other affiliated companies were also involved in the proceedings. According to the bankruptcy filings, FTX had assets in the $10 billion to $50 billion range and liabilities in the $10 billion to $50 billion range.

The Impact of the FTX Collapse

FTX was seen by many as a stabilizing force in the cryptocurrency industry. It had previously backed cryptocurrency lender BlockFi Inc. with a $400 million credit facility. FTX  was trusted as it was known to be the market’s “most regulated” exchange. When FTX declared bankruptcy, 130 affiliated entities followed suit. They include Genesis Trading, which has lost access to $175 million in funds held on the FTX platform. These frozen funds have had a significant impact on customers or business partners and are generating waves of collapse in a market that is still too young to be resilient to such shocks.

The demise of FTX eliminates a significant investment pool for blockchain startups in the US and globally. Alameda Research, FTX, and FTX Ventures all made significant investments. FTX Ventures was founded in January 2022 and has already participated in 47 funding rounds, including leading a $300 million series B round for Mysten Labs Inc. As with Alameda Research, a large portion of the volume of investments went to early-stage vendors, and the entity supported startups in the Web3 and blockchain sectors. The fall in the value of major cryptocurrencies following the crisis suggests that the run on FTX may prolong a “crypto winter”. In addition to these immediate consequences, the demise of FTX may result in longer-term shifts in how distributed ledger technology evolves.

That said, Blockchain ecosystems are a breeding ground for new business models. The appreciation of tokenized assets associated with vendors’ offerings is a notable trend, and this commercial model has kept many blockchain products and services free. The long-term viability of such frameworks now appears in jeopardy. It remains to be seen whether this will cause blockchain tooling projects to shift to alternative financing models, such as using freemium pricing strategies or becoming more reliant on subscriptions or enterprise clients. Blockchain vendors who already have paying customers or are actively pursuing enterprise clients will likely be in a better position, especially those who rely solely on interest in their cryptocurrencies. This challenge may be less severe for vendors with tokens that have a clear utility value — used to power applications or vote on the direction of a project, for example — than for projects that rely on funding from users looking to speculate on asset valuations.

Bankman-Fried was a prominent figure in regulatory discussions and was a major donor in the U.S. midterms. The crash occurred at a critical point in cryptocurrency legislation. The EU hopes to have its Markets in Crypto Assets regulation in place by 2024. The Digital Commodities Consumer Protection Act is still being debated in the United States. It is difficult to imagine that upcoming regulations will not significantly impact on cryptocurrency services and increase levels of oversight. Stronger regulations will be viewed positively by enterprise-focused blockchain vendors. By improving the quality of assets and services “on chain,” the technology’s wider reputation is likely to improve. Businesses may be able to reduce the risk of participating in public blockchain ecosystems. A hardening regulatory environment prompted by FTX’s collapse may improve the space’s legitimacy. However, it may also close off some novel use cases, reduce pools of prospective on-chain customers, or significantly condense the vendor space.

We work closely with many clients in the blockchain sector and those within cryptocurrencies. It is a fast-paced sector and one which continues to evolve. There are risks but also many opportunities with this technology.   It is very important that any businesses in the blockchain space keep a firm eye on upcoming regulatory changes and work closely with lawyers specialising in this sector.

In the meantime, if you can’t wait, you can contact us directly for impartial advice by visiting our website https://www.acitylawfirm.com/ or emailing [email protected] 

Karen Holden is the Managing Director & Founder of A City Law Firm who practise both commercial law and litigation, having been admitted to the roll in 2005. If you require further advice or assistance, please do not hesitate to contact [email protected] 

A City Law Firm Limited is a leading entrepreneurial law firm in the city of London, with a dynamic and diverse team of lawyers. It was awarded most innovative law firm, London 2016 and Business Law firm 2017. They specialise in start-up business law, the tech industry, IP and investment.