Contagion may follow: A battle between crypto titans has turned into an acquisition Contagion may follow: A battle between crypto titans has turned into an acquisition Contagion may follow: A battle between crypto titans has turned into an acquisition

Contagion may follow: A battle between crypto titans has turned into an acquisition

Mads Eberhardt

Cryptocurrency Analyst

Summary:  After a weeklong dispute between crypto exchanges Binance and FTX, the former is set to acquire FTX, stating a significant liquidity crunch for FTX. This may fuel further contagion throughout the crypto market, as not only FTX but also Alameda Research - the highly linked trading firm to FTX - may be insolvent.

The history of FTX

To understand this development and the potential contagion of these events, it is crucial to understand the history of FTX. In 2017, Sam Bankman-Fried co-founds crypto trading firm Alameda Research. The firm seemingly enjoys quick success to become a great trading firm within crypto. Fast forward 2.5 years, Sam Bankman-Fried establishes the crypto exchange FTX in May 2019. The exchange is fundamentally a by-product of Alameda.

At launch, FTX issues its own token called FTX Token (FTT) to investors, promising to buy back and burn 50% of the supply based on the firm’s future revenue from mainly trading fees. This model was also pursued by Binance at the firm’s launch in 2017. As expected, Alameda is a substantial investor in FTX, but Binance also takes an equity stake in FTX in late 2019. Over the following years, FTX rose to be one of the largest crypto exchanges by volume and was everywhere to be found as a sponsor in various sports. In the meantime, Bankman-Fried becomes a media darling, promising to give away most of his billion fortune. In 2021, Binance sells its equity stake in FTX. To let go of its stake, Binance is both paid in cash and the FTT token, seemingly deciding to hold on to the latter. Yet, FTX continues tirelessly and raises money most recently in January at a valuation of $32bn.

Does Alameda solely keep its head over water due to the FTT token?

Having shed light on the history of FTX, we move on to the head-to-head between Binance and FTX. At the start of November, CoinDesk publishes a story on Alameda’s balance sheet. According to a document from June 30th, the story states that the trading firm holds $14.6bn worth of assets against around $8bn of liabilities. The article specifies that $5.82bn of its assets consists of FTT, of which $3.66bn is unlocked and $2.16bn is FTT collateral. If this is accurate, it implies that not only is the majority of Alameda’s net equity in FTT, but the firm also owns the majority of the FTT supply.  The latter – alongside the normally extremely thin liquidity of FTT – would make it rather impossible for Alameda to sell the tokens to fulfill its liabilities, which it may have obtained by pledging some of its FTT position as collateral.

On Sunday, Alameda CEO Caroline Ellison stated that the story by CoinDesk only declare a subset of the firm’s assets. According to Ellison, the firm has an additional $10bn plus in other assets. Moreover, she says that the firm has returned most of its loans since the summer. If this is the case, Alameda seems to be in a much better place financially than first declared by CoinDesk.

Based on the story from CoinDesk and presumably because of Alameda’s close ties to FTX, it appears that Binance wants to liquidate its FTT position. On Sunday the CEO of Binance, Changpeng Zhao (CZ), announces that Binance plans to sell its entire 23mn FTT position. In comparison, the fully diluted supply of FTT amounts to around 320mn tokens. At the time of his tweet, Binance’s 23mn FTT position was worth north of $500mn. CZ stated that the selling is planned to take place over the next following months “in a way that minimizes market impact”.

The announcement made FTT tumble further before stabilizing at a price of $23. At this price, Ellison once again returned to Twitter to offer CZ to acquire all of Binance’s FTT tokens with an OTC transaction, sayingif you're (CZ) looking to minimize the market impact on your FTT sales”. Without responding directly to Ellison, CZ responded in another thread that Binance will likely stay in the exchange-traded market to sell its FTT holding. The public proposal by Ellison fueled speculation that Alameda was in fact insolvent if it could not keep the price of FTT above a certain level.

In dollar terms, it would be favorable for Binance to have accepted the offer by Alameda for an OTC transaction. At present, FTT trades well below the offered OTC price of $23 with an even greater downside if Binance was to start selling its massive FTT position on the illiquid market. So, the question is whether CZ knew what was de facto going on behind the closed doors of Alameda and possibly FTX when declining the OTC offer.

From Alameda to FTX

With the clear tie between Alameda and FTX, fear started to spread that Alameda and potentially FTX were not able to comply with its short-term liabilities or worse, were insolvent. Since CoinDesk’s story on November 2nd, customers of FTX have withdrawn billions worth of crypto assets from FTX, ultimately fearing something similar to the collapse of Terra and the bankruptcy of Celsius and other lenders earlier this year.

As late as yesterday, Bankman-Fried stated that “a competitor is trying to go after us with false rumors” referring to CZ and clarifying that FTX has enough funds to cover all client holdings and that the company has over $1bn in excess cash.

Binance to acquire FTX

Yet, earlier today, FTX halted withdrawals for some blockchains, including Ethereum, without explanation. Following around 3 hours in silence, Bankman-Fried and CZ announced that they signed a letter of intent for Binance to acquire FTX. Bankman-Fried writes on Twitter: “This will clear out liquidity crunches; all assets will be covered 1:1. This is one of the main reasons we’ve asked Binance to come in. It may take a bit to settle etc. -- we apologize for that. But the important thing is that customers are protected.”

CZ writes: “This afternoon, FTX asked for our help. There is a significant liquidity crunch. To protect users, we signed a non-binding LOI (letter of intent), intending to fully acquire FTX and help cover the liquidity crunch… Binance has the discretion to pull out from the deal at any time.”

So, at present, it seems FTX faces a liquidity issue but may not be insolvent, as both Bankman-Fried and CZ expect customer funds to be covered at 1:1. It can also be the case that the price of the acquisition may be sufficient to cover a potential hole in FTX’s balance sheet. Please be aware that this may change.

The main question is how FTX ended here. Coinbase said in June that it does not lend out client funds unless the client specifically instructs them to and Kraken does semi-annual audited proof of reserves, so for normal exchanges such as Coinbase, Kraken, and what FTX was, it is not standard practice to lend out customer funds. We cannot be sure that FTX was lending out customer funds, as the firm could also have suffered a hack or something completely different. Nevertheless, its close relationship with Alameda gets the speculation going.

Speaking of Alameda, if its assets de facto mainly consists of the FTT token, this can cause contagion, simply because Alameda may have more liabilities than assets, as the FTT token may become worthless. This was similar to the collapse of Terra in May, effectively causing the collapse of the crypto hedge fund Three Arrows Capital and the bankruptcy of lenders Voyager and Celsius. Likewise, if the assets of FTX’s customers are not fully covered, it may cause additional contagion throughout the crypto market. In our view, traders and investors in the crypto market should act cautiously in the foreseeable future. This may not be the last impact Alameda and FTX will have on the market.


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