The Rise and Fall of a Crypto White Knight

In what is being marked as Crypto’s Lehman moment, on November 11 FTX – formerly one of the world’s largest cryptocurrency exchanges– filed for bankruptcy protection. Once valued at approximately $32 billion in early 2022, FTX is collapsing towards $0 after a potential lifeboat acquisition by rival Binance fell through on November 9. This massive hit has further rattled the battered crypto space, already riddled with large market selloffs, multiple bankruptcies, and large-scale theft via hacks this year. While FTX’s bankruptcy is not the first in the Crypto space (e.g., Celsius Network and Voyager Digital), it is certainly the largest and has the potential to make massive shockwaves well beyond the confines of the Crypto world.

What is FTX?

FTX is a cryptocurrency exchange that enabled participants, both institutional and retail, to trade cryptocurrencies for other digital and traditional (e.g., U.S. Dollar) assets - and vice versa. Headquartered in the Bahamas and founded in 2018, prior to its fall this week FTX had been identified as the fourth largest crypto exchange based on daily volume. In August 2022, CNBC reported that FTX generated approximately $1 billion in revenue and more than $250 million in operating income in 2021.

Since 2019, the company raised approximately $1.73 billion in venture capital funding. In its January 2022 series, the firm raised $400 million bringing its post money valuation to $32 billion. The firm garnered widespread attention from many high-profile investors. The firm had investments from some of the world’s largest and most respective venture capital investors such as Sequoia Capital, Tiger Global Management, and Ontario Teachers’ Pension Plan, amongst others. Even FTX’s competitors, Coinbase Ventures and Binance Labs invested in the firm at one point.

FTX also had ties to many celebrities. Tom Brady and Gisele Bündchen were Angel investors and brand ambassadors for FTX. In addition, Stephen Curry, David Ortiz, Naomi Osaka and Shaquille O’Neal, amongst others, had brand ambassador deals with FTX and NFL’s 2021 No. 1 draft pick, Trevor Lawrence signed a multi-year sponsorship deal with FTX in April 2021. It remains unclear how much wealth these individuals stand to lose as FTX crumbles. FTX’s ties to the entertainment world extend beyond individuals. The Miami Heat Basketball team signed a $135 million deal to rename their arena the “FTX Arena.”  Additionally, FTX announced in 2021 that it reached a deal with Major League Baseball to become the official cryptocurrency exchange of the MLB, with umpires wearing FTX logos on their uniforms as part of the agreement. Even Cal Memorial Stadium, associated with University of California-Berkeley, was renamed FTX Field.

The Rise of a Crypto White Knight

FTX garnered a history of being “a respected industry player, ”having helped bail out several key troubled firms in the Crypto space. In 2021, following a hack on a Japanese crypto exchange, FTX provided $120 million debt financing to Liquid Group Inc (which it later acquired). Later, in mid-2022, when the Crypto world was rattled by large market selloffs following the collapse of Luna and Terra USD FTX was quick to step in to try and bolster the troubled industry. FTX and its co-founder and CEO Sam Bankman-Fried provided significant credit lines (e.g., $250 million to BlockFi Inc – a Crypto lending platform) to help stem contagion risks in the space. Mr. Bankman-Fried posted on Twitter that “[we] take our duty seriously to protect the digital asset ecosystem and its customers,” and in a later NPR interview stated they had a responsibility to consider stepping in to help stem contagions and help the industry thrive “even if it is at a loss to [themselves].”

FTX and Mr. Bankman-Fried became somewhat of a White Knight in the space. A Senior Analyst at Messari, a Crypto-data firm, said that “some would compare the move to Warren Buffet providing support to Goldman Sachs Group Inc. in 2008.” In an interview regarding FTX and the crypto liquidation crisis, Anthony Scaramucci – founder of SkyBridge Capital – stated “Sam Bankman-Fried is the new John Pierpont Morgan – he is bailing out cryptocurrency markets the way the original J.P. Morgan did after the crisis of 1907.” It should be noted that FTX later bought a 30% stake in Scaramucci’s SkyBridge Capital in September 2022.

In September 2022, FTX was identified as “an industry backstop, bailing out distressed lenders,” Mr. Bankman-Fried noted that FTX’s success came as “a result of stashing cash on hand, keeping overhead low, avoiding crypto lending and an ability to sign deals quickly as a private company.” He further noted that, in the long run, it would not be “good for anyone if [the crypto industry has] real pain and real blowouts.” In an ironic twist, FTX’s recent actions are creating both real pain and a real blowout to the crypto space and beyond.

The Fall of a Crypto White Knight

FTX is accused of using customer deposits to extend loans to its affiliated trading firm, Alameda Research, which used the funds on risky bets. In statements released in the last week, Mr. Bankman-Fried estimated that Alameda Research owes FTX roughly $10 billion, representing more than half of FTX’s customer deposits. Following rumors of liquidity issues at FTX, on November 6 the exchange was hit with approximately $5 billion worth of withdrawal requests, formally forcing FTX into a liquidity crisis as the company and its CEO scrambled for emergency investments. For a moment on November 8, it appeared rival Binance would acquire the firm, however Binance officially walked away November 9 stating FTX’s issues were “beyond [its]control or ability to help.” By Friday, November 11, FTX filed for Bankruptcy. The firm is in need of billions of dollars. It was reported that FTX held only $900 million in liquid assets against $9 billion of liabilities leading into the November 11 bankruptcy filing.

The ongoing fallout has already hit crypto markets, with prominent currencies like Bitcoin (BTC) and Ether (ETH) experiencing wild volatility and approximately $200 billion of crypto market value wiped from the markets. However, the collapse will likely have substantial ramifications for victims well beyond the crypto space. There are already several investigations underway regarding FTX. Authorities in the Bahamas have launched a criminal probe, the U.S. Justice Department is looking into details surrounding recent events, and the U.S. Securities and Exchange Commission is determining whether certain securities rules have been violated.

As mentioned earlier, the firm raised more than $1.7 billion in funding from investors. These investors, which include several well-known financial institutions are already beginning to write off their investments in FTX. On November 9, Sequoia Capital -one of the most successful venture capital firms – marked down the value of its ~$210 million stake in FTX to $0. While the stake accounted for a minor percentage of Sequoia’s capital, FTX had likely been one of its largest unrealized gains with FTX’s valuation recorded as $18 billion when Sequoia first invested in July 2021. Other major blue-chip backers of FTX included BlackRock, SoftBank, and Singapore’s sovereign wealth fund. Beyond investors, FTX also had partnerships with other companies. For example, in October 2022 Visa and FTX announced a partnership to roll out crypto Visa debit cards that were linked to the holder’s FTX account.

The fallout even potentially involves sovereign nations. There are rumors circulating that El Salvador, which became the first country in the world to use Bitcoin (BTC) as a legal tender, held some of its currency on FTX. While there are sources that indicate these rumors are false, regardless of where El Salvador’s BTC reserves are held, the collapse of FTX already has had a profound impact on the value of El Salvador’s BTC. Bloomberg estimates that the country, which holds 2,381 BTC, has experienced a 60% drop in the value of its BTC holdings since purchase. While these losses are unrealized as El Salvador claims to have not sold any of its holdings, the volatility in the cryptocurrency markets will continue to weigh heavy on the value of the country’s reserves.

Potential for Catastrophic Shockwaves

The collapse of FTX is ongoing, and the final damage remains to be seen, but more Crypto industry bankruptcies are expected. Due to its prominence in the industry as well as its partnerships, the ramifications of FTX’s fall will likely be widespread and will extend far beyond the Crypto space. Once touted as one of Crypto’s White Knights, FTX and its newly resigned CEO are now being labeled as “another nail in the Crypto coffin.” This event once again highlights the extreme risks associated with digital asset investments. Crypto investments typically have less transparency compared to traditional investment assets and there is significantly less regulation on digital assets and cryptocurrencies. While times of heightened distress often create opportunities for savvy investors, recent events highlight the importance of enhanced due diligence with an emphasis on both risk and return. At this point in evolution of investable digital assets, investors should consider their ability to withstand a complete loss of investment, which we believe is paramount to pursuing investments in the space.

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Kelsey Syvrud, PhD