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FTX Crash: Why Crypto's 'Lender Of Last Resort' Is Seeking A Helping Hand

Crypto exchange FTX is struggling with a major liquidity crisis. What brought it here?

<div class="paragraphs"><p>Representations of cryptocurrencies Bitcoin, Ethereum, DogeCoin, Ripple, Litecoin. (Source: Reuters/Dado Ruvic/Illustration/File Photo)</p></div>
Representations of cryptocurrencies Bitcoin, Ethereum, DogeCoin, Ripple, Litecoin. (Source: Reuters/Dado Ruvic/Illustration/File Photo)

Late last night the troubled crypto exchange FTX announced that it was allowing some withdrawals for its users in the Bahamas, after having blocked withdrawals completely just days ago. The move was prompted by directions from FTX's Bahamian regulators, the exchange said in an announcement on Twitter.

"The amounts withdrawn comprise a small fraction of the assets we currently hold on hand and we are actively working on additional routes to enable withdrawals for the rest of our userbase. We are also actively investigating what we can and should do across the world," FTX said on its Twitter handle.

A couple of hours before that, FTX said that it had entered into a swap agreement with Justin Sun's blockchain network Tron to allow about $13 million worth withdrawals through a 1:1 swap to external wallets.

FTX founder Sam Bankman-Fried had also put out a series of tweets apologising and taking responsibility for how the entire saga at the crypto exchange was unfolding.

Bankman-Fried also said that he would "give anything" he has to raise liquidity for the exchange. The series of tweets came in a day after FTX's rescue deal with Changpeng Zhao's Binance fell apart.

All that's gone wrong at FTX stems from one fundamental problem: the exchange leveraged overpriced assets to borrow money it could not repay.

To understand more, let's delve into the events over the last few days.

What Happened?

FTX was till recently the second largest crypto exchange in the world, right behind Binance. Bankman-Fried's exchange has since dropped to the 32nd position, according to latest data available on Coinmarketcap, which owned by Binance.

Founded in the Bahamas by Bankman-Fried and Gary Wang in May 2019, FTX had grown to a point where it was supporting other ailing exchanges with emergency liquidity, in the form of a lender of last resort. The exchange itself took shape after Bankman-Fried's proprietary trading firm Alameda Research rose to glory.

While the two companies were always suspected to have overlaps, it was never proven.

The dream run came to end last week when Coindesk reported that much of Alameda Research's $14.6-billion assets were held in the form of FTT, which is FTX's own token. In comparison, the prop trading firm had loans worth $7.4 billion on its liabilities. This immediately sparked liquidity concerns.

The concerns were further multiplied after Zhao of Binance announced on Nov. 6 that he was exiting any and all FTT holdings, citing "recent revelations". In July 2021, FTX bought back Binance's equity stake in the exchange, paying $2.1 billion in cash and tokens.

An early investor in FTX, Zhao had been a close ally of Bankman-Fried. However, the relationship between them soured after they took diverging paths on regulation of the crypto industry. While Bankman-Fried became the face of crypto regulations with his U..S Congress testimonies, Zhao's Binance was facing probes from agencies.

Once Zhao announced his intention to sell his holdings, FTX started to see heavy withdrawals from users, estimated to be around $5 billion on Sunday. These withdrawals exposed that FTX did not have the liquidity it claimed to have before.

Bankman-Fried did try to assuage the traders claiming that the rumours were "unfounded" on his Twitter handle. But it soon came to light that FTX just did not have the liquidity it so desperately needed.

By Nov. 8, FTX announced that it was in discussions with Binance for a rescue plan.

Zhao later confirmed that they had signed a non-binding letter of intent and that due diligence was starting soon.

But within hours, Zhao started putting out cryptic tweets—without tagging FTX—warning crypto exchanges to ideally never borrow and to never use tokens they create as collateral for borrowing. He also warned that exchanges must maintain large capital reserves at all times.

By Thursday, Binance publicaly announced its exit from the transaction, stating that reports of customer funds being allegedly mishandled at FTX and alleged U.S. agency investigations had led to the decision.

What Next?

While there have been claims that FTX dipped into funds deposited by traders to buy its own coin and prop up demand, nobody involved has confirmed this yet.

In his tweet thread, Bankman-Fried blamed an internal labelling error for the lack of liquidity available for delivery. While he initially believed that FTX had zero leverage and 24 times daily average withdrawals in the form of liquidity, he had later come to realise that the exchange had 1.7 times leverage, with liquidity worth only 0.8 times Sunday's withdrawals.

For now, Bankman-Fried's Alameda Research has stopped all trading activities. The co-founder has also offered to step down if the need arises. He has also said that after the Binance debacle, FTX was in talks with other investors to support the exchange. No deals have come up yet.

Whether FTX survives this storm will only become clear in the next few days. But as things stand, Binance rules the roost when it comes to the global crypto trading volumes.