FTX was scrambling to plug the hole in their sinking ship, but ended up filing for Chapter 11 bankruptcy. The Binance Letter of Intent (“LOI”) was contingent on a Due Diligence (“DD”) process that fell through within a 36 hours period. What does this mean for the wider crypto ecosystem, and who could be next?

This article examines the events in the lead-up to yet another crypto corporate blunder and assesses the possible impacts, specifically the contagion, on the crypto and NFT ecosystem.

Article Outline

• Background and Timeline

  • Alameda Research

  • FTX

  • Binance

• The Aftermath

• Exchange Benchmark

• Contagion Concerns

• Actions to Mitigate Contagion Impact

• Closing Remarks (TL;DR)

Background and Timeline

It’s important to set out the background for FTX, Alameda Research, and Binance for context around the events leading up to the FTX collapse and potential impact for the wider crypto ecosystem.

Binance was formed out of the ICO boom in 2017, becoming the behemoth it is today. It made several strategic decisions that propelled itself ahead of Coinbase in product offerings and service. FTX was arguably becoming the Binance challenger, recently overtaking Coinbase on daily trading volume.

Let’s look at the three entities in this scenario: FTX, Alameda, and Binance.

Alameda Research

• October 2017: Prior to FTX, SBF traded international ETFs at Jane Street Capital, a proprietary trading firm, then founded Alameda Research (quantitative trading firm).

• Alameda was a quantitative trading firm specializing in crypto. Its strategies were high-risk and included arbitrage, market making, yield farming, and trading volatility.

FTX

FTX was the second largest exchange by volume, gaining market share at a fast rate behind Binance. A key event timeline overlaid onto the FTX Token (FTT) chart has been illustrated below:

Binance

Binance held a significant stake in FTX from December 2019 until July 2021, where it divested its operations in return for a significant amount of FTX token (FTT). The fact it still held the FTT is important, as it became the straw that broke the camel's back.

Binance is acquiring significant stakes in communication platforms (Forbes and Twitter) and expanding its offerings within the crypto sector, using network effects to catapult its trajectory. By investing in communication platforms, Binance could find its marketing efforts receiving preferential treatment.

Timeline of Events

• December 2019: Binance invests an undisclosed amount in FTX, buying its FTT token as part of the structuring.

• July 2021: Binance divests FTX equity, receiving roughly $2.1 billion USD equivalent in cash (BUSD and FTT).

• May 2022: The Terra Luna collapse caused a stream of events that cascaded through the crypto ecosystem, causing the collapse of Celsius, 3AC and Voyager Digital.

• August 2022: SBF (with FTX) was described as the knight in shining armor, with plenty of liquid cash to acquire ailing centralized crypto lenders. It became apparent that these opaque corporate entities were mismanaging funds to their own demise.

• Alameda was impacted by the Luna fiasco, but was able to stay solvent in the short term through deals with sister company FTX, these deals supposedly involved lending customers funds with FTT as collateral.

• August 2022: Sam Trabucco from Alameda Research steps down as co-CEO. The market starts to question the reasons for the resignation.

• October 2022:  The new draft of the Digital Commodities Consumer Protection Act (DCCPA) was circulated.

  • SBF was involved in lobbying the contents of the bill, including how centralized entities (like FTX, Binance and Coinbase) would interact with Defi.

  • The bill wasunpopular with the Defi community. Some of the terms were deemed to be more favorable to FTX over other centralized exchanges like Binance.

• November 2022: The announcement by CZ was clearly the catalyst that drove the FTT token to slide. While the CoinDesk announcement around the Alameda balance sheet was the ignition, the FTT price was relatively unscathed until CZ’s 7m followers caught wind and connected the dots to the whale alert (a day prior).

• November 8: Acquisition LOI Announcement. The series of events that lead up to the Letter Of Intent (“LOI”) were sudden, stemming from a leaked document to Coin Desk regarding the Alameda Research Balance sheet.

The financial position of FTX did not meet the requirements for Binance to follow through with the acquisition. This caused a lot of speculation in the market around the reasons for Binance to walk away in such a short time period.

News broke around intermingled funds between client deposits and the more risky trading arm of the business. Unusual transactions between FTX and Alameda were under the spotlight with questions around the FTT token being overvalued.

The price action that followed was catastrophic for the ailing crypto exchange as both the FTX and Alameda valuations fell to peppercorn consideration of $1, suggesting the corporate balance sheets were in a net deficit.

It’s apparent that FTX and Alameda are in financial ruin—the announcement that they have filed for Chapter 11 bankruptcy having proved speculation true—but the fallout could be even worse.

The rest of this article highlights the concerns around contagion and provides some actions that can be taken to mitigate exposure, and in turn losses.

The Aftermath

FTX Token Valuation

FTT is currently trading at $2.60. An 88% reduction in the token price, from $22 just before the panic selling set in.

A post mortem indicates that Alameda is suspected to have been in trouble since Q2 2022. A significant amount ($4.2 billion) of FTT was sent to Alameda to plug its balance sheet which was caused by the Terra Luna collapse in May 2022.

Were FTX and Alameda simply the next dominoes to topple in the contagion chain from earlier this year? The acquisition cost was just $1 peppercorn consideration given their net deficit (the gaping hole in its balance sheet). However, since the acquisition discussions, FTX has filed for Chapter 11 bankruptcy - the venture was clearly too far gone for a white knight to acquire.

SBF Net Worth

The Bloomberg billionaires index estimated that SBF is worth $991 million, down from $16 billion yesterday. However rumors are that this is even lower now that the situation has slid further into disarray.

Crypto Market Turmoil

The market went into free fall as FTX withdrawals were frozen, with minimal communication from FTX on the situation. This created a death spiral as more deposit holders sought to withdraw their funds.

The announcement was made and there was a relief rally before a Darth-maul candle for the entire crypto market.

24 hours after the event, we can see there is red across the board, with 15% wiped off the total crypto market cap, which sits at $845 billion.

The Alt coins have bled the most, particularly FTT and SOL given the FTX bankruptcy and significant recent SOL unlocks dumped on the market. BTC and BNB showing relative strength compared to the rest of the crypto market, as crypto investors take refuge in Satoshi and CZ’s assets.

The cascading effects of fungible token liquidations on the open market, the proceeds of which were required to cover the bad debt ripple effects from the FTX fallout. Companies are moving funds to safer assets and liquidating their holdings in preparation for additional dominos to fall.

The NFT market performed no better with WETH offers at their highest rate in recent times:

Exchange Comparison

From the above, it’s apparent that there’s a bloodbath for the wider crypto market, but how will the bankruptcy impact the crypto exchange landscape (assuming it goes ahead)?

Prior to the recent events Binance was, and continues to be, the largest crypto currency exchange by market capitalization and volume.

Volume

As per Bitquery, crypto exchange volume has been drying up with a 26% decrease in the month of October alone. Binance continues to dominate the existing market share with circa 55% market share of volume.

Binance had close to 10x volume of its former second place rival, FTX. Coinbase is a tight third with similar levels of daily volume at a tenth of Binance pre acquisition.

Market Capitalization

As of Nov 11, 2022 the Binance market cap is $45.9 billion.

Prior to the Binance acquisition, Coinbase and FTX had market capitalizations of $14.0 billion and $2.3 billion, respectively. Now after the aforementioned crypto crash post FTX collapse these market caps are down, along with the exchange volume.

There are many other exchanges and centralized crypto lenders that are significantly smaller than Binance and Coinbase. These entities are not as well capitalized so are less likely to weather the fallout as easily. There are a number of factors to look out for after a financial institution, of this size, crashes.

The knock on effects can be catastrophic:

• Customers unable to redeem their deposits

• Creditors unable to obtain their funds.

• Shareholders writing off their invested equity.

Let’s take a look at some known issues and potential actions to mitigate the impact of the contagion.

Contagion Concerns

We can start by looking at the FTX investors and creditors to examine the immediate effects of the company collapse. We are aware of some venture capital and hedge funds having meaningful assets on FTX, meaning less capital to deploy into the ecosystem.

There will be ripples of contagion spreading for months as additional entities run out of liquidity, become insolvent and hit financial turmoil.

Here are some of the known impacts, already:

1) Genesis

The fund has $175 of assets locked on FTX. However they have since managed to obtain a raise of $140m after the collapse.

2) Wintermute

Wintermute has confirmed that it has funds remaining on FTX, although stated that the amount is within their risk tolerances.

3) Multicoin Capital

• The fund was able to withdraw 24% of its assets, 15.6% of the assets of the fund are still on FTX, unable to be withdrawn.

• The fund managed to liquidate its entire FTT position for $17.79 average price.

4) Amber Group

The fund has 10% of its trading group assets on the FTX exchange.

5) BlockFi

The centralized crypto lender, BlockFi, was in the dark until the Twitter announcement from FTX. It forced the lender to cease trading and it now falls under the Chapter 11 bankruptcy filing along with the rest of the FTX group.

6) Galaxy Digital

Galaxy Digital is reported by CoinDesk to have $76.8m exposure.

7) CoinShares

CoinShares is reported to have $30.3m exposure.

8) Liquid Meta

Liquid Meta is said to have $7.5m exposure of assets with FTX.

9) Silvergate

The crypto contagion has penetrated the equity market with Silvergate Capital’s stock plunging 23% on Tuesday.

10) Solana Unlock

There were multiple significant Solana unlocks. FTX and SBF were heavy investors in the SOL ecosystem. The timing of the unlock when many are dumping the layer 1 chain’s tokens is not great.

This indirect impact has caused the price of SOL to plummet from $37 on November 5, down 49% to $19 on November 11.

11) Canadian Pension Fund

The Ontario Teachers Pension Plan (OTPP) released a statement stating it has $95 million exposure to FTX. This is the third largest pension fund in Canada and will likely have knock on regulatory impacts as a consequence.

12) NFT Projects

There will be numerous NFT projects that have treasuries on centralized exchanges, including on FTX.

Many other projects could have secured Venture Capital funding from the likes of FTX Ventures, but not yet received it. The venture capital arm of crypto exchange FTX has invested in Bored Ape Yacht Club creator Yuga Labs, USDC stablecoin issuer Circle, layer 1 blockchains Near Protocol and Sui. The execution risk of these projects could increase if the capital needs to be clawed back.

Solana NFTs have been indirectly impacted given the heavy SOL exposure / backing that FTX / SBF provided to the ecosystem.

The above list of contagion will get longer. How can one mitigate the impact on your own portfolio and pre-empt future at risk entities? Let’s have a look at some actions that can be taken.

Actions to Mitigate Contagion Impact

Preservation of capital is key to profitable trading in the current market. Here's a list of points you need to watch out for:

1) Check your high yield baring assets.

High yield protocols/entities are at a higher risk of becoming the next domino in the contagion chain. If you can't explain where the yield is coming from, you are the yield. If the yield is high, then then the protocol/entity has taken on more risk to cover this. With higher risk comes a higher probability that their capital has diminished in this market.

2) Look at the investors and creditor balances of recent corporate failures.

It's likely that those entities that have filed for bankruptcy (Chapter 11, 13 etc) will take time to pay their liabilities back. Even so, these will be a fraction after legal fees. Below is FTX:

3) The blockchain is transparent - Use it.

• Look at your portfolio.

• Identify the biggest balances.

• Get hold of the entity's public wallet.

• Check its reserves.

• See if the liabilities are public. Are they solvent and liquid?

4) There's usually no smoke without fire.

If you hear a rumor, and it impacts your portfolio don't hesitate to investigate immediately. These things spread like wildfire, particularly in the crypto space.

5) Many CEX are undertaking Proof of Reserves.

Has your exchange disclosed its reserves and its wallets? Are there delays in getting this information? If you're feeling uneasy about an entity, DIG. If you don't get what you need, PULL THE PLUG.

6) Verify and Corroborate with Reliable Evidence.

A "trust me bro" tweet from the founder of an entity is NOT sufficient comfort to allow you to leave your funds with them.

This has been proven time and time again. We need to see corroborative evidence of these balances, particularly in light of the recent management attestations unraveling over social media.

Many centralized exchanges are completing Proof of Reserves. For instance Nansen is assisting many with proving their wallet balances on chain:

7) Intermingling of Client Funds is a Huge No.

If you get a whiff that an entity is commingling client funds with its trading activities, this is a huge red flag. TradFi banking requires the separation of retail and investment arms thanks to legislation from the Glass-Steagall Act of 1933. A century ago! Yet it still happens!

8) Is an entity/protocol holding a significant amount of its own token as collateral on its balance sheet?

The value is likely overstated. If they need liquidity quickly, then this could result in a dump in the price, particularly as news spreads

9) Not your keys, not your crypto.

Use a CEX as an on/off ramp. Only keep what you are willing to lose. You have counterparty risk by leaving it on exchange. If you don't trust your own key mgmt. then weigh the risks of a CEX vs. self custody.

10) Understand how the entity or protocol works.

Do they have a productive business with REAL revenues? Are they selling a product or service? If you don't understand the mechanics, you shouldn't be investing there. All it takes is one "bad actor" to rug.

11) Have notifications on reliable, efficient news sources.

You will be able to act on this news faster, potentially saving your portfolio. Track knowledgeable traders, and get alerts when large sums are being moved on chain. Information asymmetry is rife, so do your best to be on the side of the informed.

12) Don't just isolate your attention to the crypto market.

All financial markets are interconnected. Stay abreast of what's happening & think as to whether it impacts you. That foresight could save you your entire bag.

13) Keep an eye on regulation. FOMC updates, regulatory decisions.

Put these dates in your diary. Timing and outcomes have huge impacts on markets, particularly on those smaller, higher-leveraged entities.

14) Keep an eye on political conflicts.

Are any of your investments domiciled in these regions? If so, have they moved the corporate assets to a separate location? Do they have a reliable disaster recovery plan? If not, then the RISK has gone through the roof.

15) Do a comparison of a company or protocol's market value compared to its NAV.

Is it a lofty valuation? Tech stocks & crypto are guilty of this. Worst case: its assets can be carved up and sold, but if there are no tangible assets, then it's a higher risk.

Closing Remarks

TL;DR

• The interconnectivity of Binance holding FTT enabled CZ to call out the mismanagement of funds going on behind the scenes at FTX.

• Alameda and FTX were illegally commingling client funds with risky business trading activities.

• Alameda was kept temporarily afloat by FTX using its own FTT token as collateral for an intercompany loan; FTT plummeted after the CoinDesk announcement.

• The aftermath caused significant dumps in crypto prices, especially the FTT token, which fell 82%. Other heavily FTX-backed tokens like Solana also suffered badly as news broke.

• The NFT market saw its biggest number of WETH offers accepted on record.

• Binance remains the top exchange by far, with the lion's share of exchange volume. CZ comes across as a calm and collected leader, providing confidence over proof of reserves and responsive, transparent communication around the LOI to acquire FTX. It became clear that Binance pulling out of the deal was representative of the current financial distress FTX was in, with the chapter 11 bankruptcy following,

• Contagion concerns kick in with the following already heavily impacted:

  • Genesis ($175m) but managed a capital infusion of $140m.

  • Wintermute (Exposure, but “within our risk tolerance”).

  • Multicoin Capital (15.6% of the fund’s assets).

  • Amber Group (10% of the trading group’s assets).

  • BlockFi (Ceased trading and filed for bankruptcy).

  • Galaxy Digital ($76.8m exposure).

  • CoinShares ($30.3m exposure).

  • Liquid Meta ($7.5m exposure).

  • Silvergate (23% drop in listed share price).

  • Solana Unlock (49% dump in the price of SOL).

  • Ontario Teachers Pension Plan ($95m exposure to FTX).

• Actions to mitigate the impact include:

  • Centralized exchanges begin providing Proof of Reserves to alleviate deposit holder concerns.

  • Check high-yield investments; they’re riskiest and may be next.

  • Check your exposure to creditors and investors of FTX.

  • Check the reserves of your largest investments, on chain.

  • Check if the protocol/entity has any of its own token on its balance sheet, and determine (if possible) whether it’s being used as collateral.

  • Not your keys, not your crypto.

  • Understand the mechanics or model of whatever asset you invest in.

  • Set notifications for reliable news sources, and act quickly.

• Concerns over regulatory tightening following the FTX collapse. Could set the crypto sector back several years.

At OriginsNFT we leverage data-driven decision making, educational resources, and proprietary analytics to remain ahead of the curve with respect to blockchain tech and specifically NFTs. To find out more, please visit our website or Twitter.

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