The past week has been one of the most eye-opening weeks in the history of the cryptocurrency industry, with one of the largest digital asset exchanges in the world filing for bankruptcy on Friday, November 11. How did this happen so quickly?

Here is a high-level overview of the fact pattern:

  • On Sunday, November 6, a significant holder of FTX’s native token, FTT, threatened to sell all of their FTT tokens, which created widespread panic, driving the price of FTT down significantly and leading customers to begin pulling their funds off of the FTX platform.
    • For context, on Sunday, FTX fulfilled approximately $5 billion in customer orders.
  • As a result, FTX was not able to meet customer demands since it did not have sufficient assets to fulfill customer liabilities.
  • Unable to fulfill all customer liabilities, FTX began searching for alternative options. The first was to engage in acquisition with the largest digital asset exchange, Binance, to acquire FTX and assume their liabilities ultimately. Binance agreed on Tuesday, November 8; however, less than 24 hours after initial due diligence, they decided against an acquisition.
  • Running out of options, FTX was forced to file for Chapter 11 bankruptcy.
  • According to the bankruptcy filing, FTX indicates they have more than 100,000 creditors with assets in the range of $10 – $50 billion as well as liabilities ranging from $10 – $50 billion. Along with FTX, over 130 other companies were directly impacted and filed for bankruptcy.

For reference, as of Sunday, November 6, FTX had a valuation of approx. $32 billion. This has essentially disappeared overnight, but how?

In short, FTX was using customer funds for investments and other lavish purchases via Alameda Research, the trading firm created by FTX CEO Sam Bankman-Fried. They would leverage FTX’s native token, FTT, as collateral and take user deposits of digital assets for their own use. Once the FTX token took a nose-dive of more than 75%, on Sunday, November 6, FTX began to face a massive liquidity crisis and was not able to sufficiently meet customer demands since they did not have the assets to match the corresponding liabilities leading to the various events notated above.

The full force of these events has yet to be discovered as more facts continue to come to light; however, the significance this has had and will continue to have on the digital asset community is by far the most important the industry has yet to face.

We will continue to update this as more details emerge.

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For more information on this topic, please contact a member of Withum’s Technology and Emerging Growth Services Team.