Uncovering FTX Bankruptcy: Reserves, SBF, Alameda & Binance

The spectacular downfall of one of the biggest exchanges unfolded like an action movie. It had everything: Sam Bankman-Fried’s fall from grace, wriggling with Alameda, Binance’s whipsaw, VC funds losing their stake, a hack that was an inside job, infinite market attention, federal investigation, and unprecedented calls for transparency via Proof of Reserves (PoR) Audit. Let’s review FTX’s bankruptcy in detail.

Cryptocurrency industry struggles for mainstream credibility

The major and most damaging implication of FTX’s saga is that the cryptocurrency industry once again falls out of favor with mainstream adoption. FTX pushed for exactly this type of credibility with enormous PR stunts, such as getting Miami Arena naming rights and running Super Bowl commercials. It turns out that sponsorships cannot beat integrity. The blow is especially devastating because insiders perceived FTX as one of the most stable exchanges in the unconstrained crypto industry. Sam Bankman-Fried (SBF), the CEO of FTX, had backing from Sequoia Capital and Lightspeed Venture Partners, two of the largest venture capital funds. Binance was one of the early investors in FTX. 

One can only wonder what sorts of dangers are hidden in less publicized companies. No reason to be overly optimistic. We have no data on assets, liabilities, and net cash positions. Under current circumstances, we are confident that 95% of CEXs are gambling with client deposits.

.@FTX_Official prompt takeover by @binance will just delay huge CEXs armageddon

We still don't know:
– CEXs assets
– CEXs liabilities to depositors
– CEXs own funds net cash positions

No doubt 95% of CEXs are gambling with client deposits#FTXCRASH #ftx #Alameda

— Dyma Budorin ?? (@buda_kyiv) November 8, 2022

What Happened to FTX?

FTX went from a $32-billion top-tier “blue chip” cryptocurrency exchange to being effectively dead. 

• The downfall started on 2 November when it became known that Alameda Research had too much FTT (FTX’s native token) on its balance, suggesting that Alameda and FTX formed an unhealthy bond that shouldn’t exist.
• Binance’s CZ accelerated the downward spiral on Sunday 6 November saying they would liquidate all the remaining FTT on their books.
• On Monday 7 November, Sam Bankman-Fried assured everyone, “FTX is fine. Assets are fine.” He later deleted the tweet.
• Binance teased a life-saving bailout but eventually pulled out of the deal.
• In 72 hours, investors withdrew $6 billion fearing the worst.
• On Friday 11 November, FTX filed for bankruptcy as users were storming the platform to withdraw their funds.
•  After a bankruptcy announcement, an insider tried to move $450 million from FTX hot wallets under the disguise of a hack.
• FTX couldn’t meet the demand and still owes around $8 billion to more than 100,000 creditors.
• The SEC and the U.S. Justice Department are now looking into signs of misconduct when FTX propped up Almeda.

The spectacular downfall happened in a matter of days, but the underlying causes took months in the making. There was just too little oversight. Why did FTX go bankrupt? What was the role of Almeda and Binance? Was it a hack or an inside job? Find out how exactly FTX came to nothing in our next article.

How the Market Reacted?

FTX’s doom may be a Lehman moment for crypto. The infamous 2008 Lehman Brothers collapse spilled over Wall Street and started a broad market failure. Will FTX set off something similar in the crypto market? Too soon to say, but the signs are worrisome.

Bitcoin and Ether plummeted. BTC fell to $16,300, the lowest price in a year. ETH did slightly better but still experienced a sharp drop. Shares of Coinbase exchange, a publicly traded company, dropped from $75 in late October to $45 on 9 November. Obviously, Alameda ended its trading business together with more than 100 affiliated corporate entities that filed for bankruptcy on the same day as FTX. The spillover is considerable. Genesis ended its lending obligations citing the loss of industry confidence. With this decision, Geminin couldn’t support its earning program.

Perhaps, the Solana ecosystem is the next big litmus test. Alameda held more than $1 billion in SOL (another token supported by SBF).

A Wake-Up Call For the Community

Public discussions about FTX’s case took over the world. Hacken’s CEO Dyma Budorin joined leading Web3 influencers on Twitter Spaces and CoinDeskTV in an effort to understand what happened, and find answers on what to do next. The consensus is that we cannot drop centralized crypto exchanges from the equation because they drive mass adoption. The only way forward is to have more transparency.

Transparency plan:
1. Proof of reserves for CEXs
2. Crypto funds and influencers' on-chain wallets are to be labeled
3. Global ledger of vesting schedules
4. Crypto projects to disclose their treasuries

— Dyma Budorin ?? (@buda_kyiv) November 12, 2022

Sam Bankman-Fried, the man himself, said in an interview that he had “expanded too fast and failed to see warning signs.” SBF publicly apologized on Twitter, “Hopefully this can bring some amount of transparency, trust, and governance.” Naturally, the next question is how to reach those things.

2) I'm really sorry, again, that we ended up here.

Hopefully things can find a way to recover. Hopefully this can bring some amount of transparency, trust, and governance to them.

Ultimately hopefully it can be better for customers.

— SBF (@SBF_FTX) November 11, 2022

Transparency: Proof of Reserves (PoR) Audit is long overdue

We are witnessing a grand overhaul in the world of cryptocurrency exchanges. To have any hope of long-term operations and mainstream adoption, exchanges must engage in unprecedented self-regulating measures where they disclose their reserves. 

.@FTX_Official collapse is like a childhood disease that the web3 industry needs to go through

We will become stronger if there is a push from the crypto community towards ALL CEXs, so they made Proof of Reserves audits

Keep asking CEXs to prove their solvency

— Dyma Budorin ?? (@buda_kyiv) November 12, 2022

Some call it “proof of funds,” we call it “proof of reserves.” In either case, the essence is the same: a credible auditor verifies on-chain funds against liabilities to assess collateralization. We already offer Proof of Reserves (PoR) Audits to crypto exchanges. Hacken has been preaching about transparency through disclosure since 2019. 

Our first researchers over Proof of Reserves are dated almost 4 years ago. Relevant as ever https://t.co/AV5Q1kuzMl

— Dyma Budorin ?? (@buda_kyiv) November 10, 2022

Today, major players are picking up the trend of full transparency. CZ announced, “All crypto exchanges should do Merkle-tree proof-of-reserves. Binance will start to do proof-of-reserves soon. Full transparency.” Our partner CoinGecko added Reserves Tab to the exchanges’ profile page. Nansen and DefiLlama now provide data on assets or reserves. Crypto exchanges are disclosing the data voluntarily, but this will be a new norm, “If they can’t show the client’s funds – they are frauds!”

All exchanges that will not be able pass proof of funds are crypto brokers

— Dyma Budorin ?? (@buda_kyiv) November 11, 2022

Push for Better Governance 

Transparency is not the only thing to gain trust. We also have governance. Good governance ensures sensible decision-making. A crucial point regarding governance is that FTX had zero outside investors on its board. This was something that SBF specifically called for. Sequoia Capital and Lightspeed Venture Partners (FTX’s largest VC funds) didn’t have any means to bind their investment to sound decision-making. SBF and a few more executives held all the power. The small circle surrounding SBF was literally isolated and cut off, as they all lived in the Bahamas. FTX’s downfall came as a surprise to most of its 300 employees, indicating poor communications inside the organization.

Gaining mass adoption is impossible without centralized crypto exchanges. They are the gateway into the world of cryptocurrency. The unprecedented push for transparency is a chance to make things right. Show your integrity and the market will trust you. Otherwise, your empire may fall overnight.