Bitcoin, FTX and What Went Wrong

Following yesterday’s dramatic short squeeze in response to the announcement of the October Consumer Price Index, stocks were flat this morning. Prior to levelling out through lunchtime, the Dow, S&P, and Nasdaq Composite all experienced small gains.

Bulls continue to feel pleased about yesterday’s enormous surge, while the situation for cryptocurrency investors has gotten much worse. Yesterday, Bitcoin fell sharply in response to issues at FTX, a well-known worldwide cryptocurrency exchange, after the latter restricted withdrawals amid a hunt for liquidity. CEO Sam Bankman-Fried only had around 80% of the money needed to keep the platform going because he misjudged the amount of leverage FTX clients were utilizing with their accounts.

In a Twitter thread, Bankman-Fried acknowledged that the problem was caused by an internal mislabeling of FTX assets, for which he took responsibility and which gave the exchange’s leadership a false impression of its financial situation.

Following a botched rescue attempt by rival exchange Binance, the Twitter revelation helped calm concerns; but, after FTX filed for chapter 11 bankruptcy, Bitcoin ultimately fell once further. The original liquidity issue was caused by a massive withdrawal of FTX Token, FTX’s proprietary cryptocurrency.

But as the story went on, creditors grew to be a far bigger issue for the struggling exchange. In fact, the 23-page bankruptcy filing for FTX claims that there are over 100,000 creditors who are due between $10 and $50 billion.

Given that FTX’s existing assets are only in the $10 to $50 billion range, should the liquidation process not go well, many creditors risk losing all (or a significant portion) of their investment.

130 additional FTX-related business companies who voluntarily entered Chapter 11 proceedings are also impacted by the bankruptcy.

“The immediate relief of Chapter 11 is appropriate to provide the FTX Group the opportunity to assess its situation and develop a process to maximize recoveries for stakeholders,” said John J. Ray III, who replaced Bankman-Fried this morning as CEO.

“The FTX Group has valuable assets that can only be effectively administered in an organized, joint process. I want to ensure every employee, customer, creditor, contract party, stockholder, investor, governmental authority and other stakeholders that we are going to conduct this effort with diligence, thoroughness and transparency.”

Most likely, Ray is best known for his role in the bankruptcy of Enron. Ray was successful in obtaining assets from Enron worth about $1 billion that were later returned to creditors, which was regarded as a significant achievement at the time. Creditors of FTX are anticipating a similar result.

Despite this, Bitcoin fell below $17,000 once more today after dropping to around $15,800 yesterday. Investors are concerned that when they rush to sell or withdraw from other exchanges, the FTX breakdown may cause a “domino effect” of liquidity problems.

BlockFi, a well-known cryptocurrency lending company, stopped accepting withdrawals last night, sending a very pessimistic message in the process.

“We are shocked and dismayed by the news regarding FTX and Alameda,” BlockFi said on Twitter.

“Given the lack of clarity on the status of, FTX US and Alameda, we are not able to operate business as usual.”

If other significant crypto platforms adopt the same strategy, a flurry of margin calls and a winding down of leverage might follow. According to JPMorgan experts, Bitcoin won’t bottom out until it reaches $13,000, which may happen in a few weeks if additional exchanges fail.

Owners of FTX accounts ought to still be able to withdraw their money for the time being if they haven’t already. Despite the exchange’s warning to users that trading would be suspended in a few days, FTX withdrawals were still functional as of yesterday. As Ray creates a liquidation strategy, FTX may continue to run thanks to a chapter 11 bankruptcy.

Investors might want to hold off on purchasing the crypto dip until additional crypto leverage is unwound, or, to put it another way, until FTX’s bankruptcy is permanent. This is because more “dominos” (exchanges) could fail in the interim, driving Bitcoin considerably lower.