The digital crypto exchange FTX had reached a level of recognition thanks to Super Bowl ads, celebrity promotion, positive media coverage and industry support that included popular investors. They had favorable reports as a success story in an emerging industry, making it to Forbes Blockchain 50 2022. With a net worth of $32 Billion at their height, FTX was becoming one of the largest crypto exchanges following Binance and Coinbase.
In 2022 it looked like FTX was standing tall while many crypto fintech companies (e.g. Terra, Celsius, Voyager, etc.) had gone under amidst an economic downturn. Indicators like rising inflation, soaring gas prices, high interest rates, Ukraine/Russia conflict and the effects of COVID lockdowns played havoc on the global economy. The crypto industry was hit hard, leading fintech companies involved in the space to file for bankruptcy. Little did most people expect that FTX would be next in line.
A Brief Background
If you have been around crypto for a long time, it would seem that FTX is solid. They had a digital exchange and a trading partner called Alameda Research. That would make it seem like they have plenty of liquidity and assets to overcome the storm. They are also active in social media and marketing, with partnerships made with celebrities and influencers to promote their brand. With their growing revenues they began spending, having put $135 Million for a naming rights deal with the Miami Arena (home of the NBA team Miami Heat).
There are other stories about how FTX spent their money (which includes political donations), but it surely seemed like they were not about to run out. The founder, Sam Bankman-Fried, has even reached fame as the face of the company.
While the brunt of rekt crypto investors was being taken out on companies like Terraform Labs of the now infamous Terra Luna and UST token collapse, FTX appeared to be the reasonable one in the room. FTX was doing something else behind the scenes, based on reports. It is alleged that customer assets in custody were being used in risky crypto trading through Alameda Research. There was a co-mingling of funds between the two entities, and this also complicates auditing.
Since the crypto market was on a downtrend, many of those investments were tanking by the middle of 2022. Prior to this, several fintechs in the crypto industry had just filed for bankruptcy and prior to that the downfall of an emerging DeFi protocol and token. It seemed like FTX was doing just fine, even offering to save troubled Voyager.
We are not going to discuss how it all unfolded, but more on the consequences of the FTX collapse.
The Red Flag Is Raised
The red flag was raised by Binance CEO Chang Peng "CZ" Zhao around November 6, 2022. CZ announced that after "recent revelations", the world's largest crypto exchange Binance would be liquidating their remaining FTX tokens or FTT, worth $500 Million. He even sent the message from Twitter, which had a reach to millions of people. This was a part of the catalyst to the FTX collapse, as holders began to dump the token.
The problem here was that CZ came upon a leaked report of FTX finances that appears to have revealed that the FTX token was tied to the company's assets. There were rumors circulating that FTX was also insolvent, so they would not be able to back the token's value. There was a large number of the tokens being sent to Alameda Research, and it appears that FTX was using their own tokens as collateral for investing. Unfortunately there was really nothing backing up the token's value.
A "bank run" or dump would follow after that CZ tweet. There was a hole in the FTX balance sheet, and now the crypto world would once again be in the midst of a black swan event. This would only bring more fear into the market and a new level of distrust from people who thought that FTX was legitimate in their business. Contagion would spread in the market as it affected other firms in the crypto industry. This was another failed company in crypto and furthers skepticism among regulators and financial institutions of the overall industry.
The Collapse
It was natural that FUD would spread across the market, and people would start massive sell offs that would collapse the value of FTT. Faced with a liquidity crisis, the exchange did not have short term funds to honor the token's value. The damage was done and the exchange had taken a nosedive. On November 11, 2022 FTX filed for Chapter 11 bankruptcy.
FTT had a value of $85.02 per token at its All Time High back on September 9, 2021. It has since fallen by 97% of that value (April 19, 2023). Prior to the collapse, FTT had market open value of $22.14 on November 8, 2022. At the end of the day, which was after the collapse, the closing value was $5.5189 (per CMC Historical Data).
The Lessons Learned
These two important lessons are more for those who plan to launch a token project, but everyone can learn something from them. Let us start with the first lesson:
1. Do not use your own token as collateral
That means do not put your native token as collateral for taking out loans or investing. This is because token value is market driven, based on demand. If your token is doing fine, there should be no problem. However, when the token value starts plummeting it affects the collateral value put into a financial instrument. That means it can tank the overall value put into an investment, which can lead to liquidations. Putting tokens that you minted as collateral is like printing money out of thin air.
With FTT, it was meant to be a utility token for the FTX ecosystem. Users are incentivized for holding it and for using services provided by the exchange. This lowered fees for transactions when trading, and the more FTT a user holds the bigger the discounts. Over time, the FTT marketcap grew and that made it attractive to investors to hold.
It was not a good move to use FTT as collateral. Even though it had a high value per token, like holding a stock in a Fortune 500 company, in crypto the markets are not so stable. When holders begin dumping, the token's value will decline. This makes it less valuable as a collateral, and this loss in value will not be able to hold investments made.
Showing a Proof-of-Reserves (PoR) is probably a good way to show holders about the solvency of the token. This is not always required but is a step in the right direction.
The next lesson is for those thinking about taking on debt to fund a crypto project.
2. Avoid using capital efficiently, use it wisely
It was discovered from reports that FTX owed money to a long list of creditors. That probably explains why they had this facade of being financially stable, when in fact that was the opposite. Money was flowing into FTX, but they were not using it wisely.
When you have funds to play with in the case of FTX, you can put it into earning possibilities in the form of DeFi protocols like Curve. You can choose to be efficient, which is to maximize the amount available to earn the most possible returns. However, this is quite risky since you can lose everything. When you put those funds into cryptocurrency that start tanking, things can quickly take a turn for the worst.
It would seem like capital resources were not used wisely. If you are going to put funds into high risk ventures, make sure that you also have reserves in case something goes wrong. In this case, FTX could not turn to any source of liquidity to cover their debts worth $3.1 Billion. It could be because the assumption was that FTT could be used to pay creditors, but when that failed then it all fell apart.
It is best to make sure that any debt is put into good use to help earn revenues to help pay off the amount owed. Instead, it appeared that FTX was using the money that way, but got involved in some bad decisions . More details are emerging about this case, so this is not yet the official account of what happened.
Synopsis
For future token projects, the lessons learned are clear. Avoid taking on too much debt, and if you do make sure that the funds are used wisely. Using your own native token as collateral is not a good idea unless there is value to back it up. It may not even be possible to collateralize a native token, but a company like FTX had some clout in the industry so FTT was accepted. Unless your token is equivalent to gold or even Bitcoin, using it to get access to capital is quite risky.
Disclaimer: This is an opinion. All information provided is taken from published sources. This is for education purposes only, not for financial advice. Please do your own research always.
