FTX's Controversial Bankruptcy Highlights Structural Risks of the Crypto Industry

• Earlier this week, the world's second largest crypto exchange, FTX, filed for bankruptcy
• The news sent a clear risk-off message across the entire crypto industry
• The big question is what happens now with the other two giants in the industry: Binance and Coinbase 

The FTX bankruptcy continues to create controversy. Let's analyze step by step how it all happened and its consequences for the crypto industry. 

There are two main players in this crisis: Sam Bankman-Fried created FTX, the world's former second largest exchange, and Alameda, a hedge fund also founded by Bankman-Fried.

Alameda was going through financial difficulties, and Bankman-Fried used billions of dollars in customer funds from FTX, his other platform, all unnoticed by investors, employees, and auditors to cover for Alameda's risks.

How did he do it? By using the FTT token as collateral. However, when the token's price plummeted 75% in one day, the collateral became insufficient to cover the trades.

Why is this important? Because cryptocurrency trading platforms must have enough money to match what customers deposit. So, if several clients request to withdraw their crypto, that is, their money, the platform has no problem because it is covered. But this was not the case with FTX.

Thus, FTX underestimated the amount of liquidity it needed to have available for withdrawals.

And this situation came to the public's attention. Reports began to leak out about the critical state of FTX's accounts, and the link between the exchange and Alameda came to light. This caused a panic in the investment community, which requested withdrawals from FTX to about $6 billion.

FTX couldn't cope with the issue and filed for bankruptcy, which, in turn, caused a minor collapse in the crypto sector. At this point, Binance, the first crypto exchange, and FTX's rival, entered the scene, announcing it would come to FTX's rescue. But this lasted only a few hours until Binance CEO Changpeng Zhao claimed it was too risky and backed out, which delivered another blow to the crypto sector.

As a consequence, Bankman-Fried resigned as CEO of FTX, and Alameda Research will shut down operations.

In the end, FTX, valued at $32 billion just a few weeks ago, is now worth zero.

Ripple effect

The collapse of the Terra network last May took down several companies, including crypto platform Celsius and Chinese fund Three Arrows.

Now, following the FTX crash, two Asian exchanges announced that they were suspending withdrawals, Aax and BitCoke. For its part, the broker Genesis has also suspended crypto refunds to its customers.

And now we have learned that another exchange, BlockFi, may soon announce its bankruptcy due to its heavy exposure to FTX—i.e., it had many funds there. Furthermore, there is also talk of two other crypto companies holding funds in FTX, Sequoia Capital and BlockFi.

The big question is what happens now with the two giants in the industry, Binance and Coinbase Global (NASDAQ:COIN), and whether they will also be affected by this domino effect.

What is the problem with all this? 

In my opinion, a huge loss of investor confidence in the cryptocurrency sector, which is a very risky sector to begin with. But even more so now that we are getting a better picture of the industry's solvency difficulties.

We have seen that Bitcoin, to give an example of the largest crypto in the world, has gone from being worth $69,000 just one year ago to the current $16,000. And some analysts believe that we may have yet to hit bottom and could see $12,000 if this crisis continues.

Disclosure: The author owns Bitcoin.