The swift collapse of the cryptocurrency exchange FTX sent more shockwaves through the crypto world on Thursday, with authorities now investigating the firm for potential securities violations and analysts bracing for a further downturn in crypto prices.
FTX had agreed this week to sell itself to its bigger rival Binance after experiencing the cryptocurrency equivalent of a bank run. Customers fled the exchange after becoming concerned about whether FTX had sufficient capital.
A person familiar with the matter said that the Department of Justice and the Securities and Exchange Commission (SEC) were examining FTX to determine whether any criminal activity or securities offenses were committed.
And on Thursday, Reuters reported that the Securities Commission of the Bahamas had frozen the assets of FTX Digital Markets, a subsidiary of the cryptocurrency exchange.
This week’s developments marked a shocking turn of events for FTX CEO and founder Sam Bankman-Fried, who was hailed as something of a savior earlier this year when he helped shore up a number of cryptocurrency companies that ran into financial trouble.
The investigation into Bankman-Fried and FTX by those in the crypto world as well as securities regulators is centering on the possibility that the firm used customers’ deposits to fund bets at Bankman-Fried’s hedge fund, Alameda Research. In traditional markets, brokers are expected to separate client funds from other company assets. Violations can be punished by regulators.
Meanwhile, investors in popular digital currencies got some relief from the latest crypto crisis Thursday after days of selling. Bitcoin rose to $17,691 after dropping as low as $15,512 on Wednesday. Ethereum rose 12%. The gains came after a government report showing inflation had cooled a bit last month gave a lift to riskier assets.
The crypto world had hoped that Binance, the world’s largest crypto exchange, might be able to rescue FTX and its depositors. However, after Binance had a chance to look at the books of FTX, it became clear that the smaller exchange’s problems were too big to solve. Binance announced its withdrawal from the deal on Wednesday.
A person familiar with the dealings between FTX and Binance described the books as a “black hole” where it was impossible to differentiate between the assets and liabilities of FTX and those of Alameda Research. This person spoke on condition of anonymity because they weren’t authorized to speak publicly about the matter.
This person said Bankman-Fried had committed the “ultimate sin” by tapping into FTX’s custodial assets to fund Alameda Research.
In a further illustration of FTX’s financial straits, Bankman-Fried asked his investors on Wednesday for $8bn to cover withdrawal requests, according to the Wall Street Journal, citing unnamed sources.
In a series of tweets on Thursday, the FTX founder and CEO said that he did not have enough liquidity to cover withdrawals and that he was more leveraged than he had thought.
The latest crisis in the crypto industry prompted renewed calls for stricter regulation. The White House press secretary, Karine Jean-Pierre, said the FTX developments highlighted “why prudent regulation of cryptocurrencies is indeed needed. The White House, along with the relevant agencies, will again closely monitor the situation as it develops.”
The collapse of cryptocurrency’s third-largest exchange is likely to cause further disruption across the crypto world, analysts say, meaning Thursday’s rally could be temporary.
The unwinding of FTX, as well as its shock of confidence to the system, will cause crypto prices to fall even further leading to “a new cascade of margin calls”, said analysts at JP Morgan in a note to investors. This would be similar to the selloff that happened after the collapse of the stable coin Terra earlier this year, when prices continued to decline weeks after its failure.
“This deleveraging is likely to last for at least a few weeks unless a rescue for Alameda Research and FTX is agreed quickly,” JP Morgan analysts wrote.
The crypto industry is waiting to see what other companies are affected by the FTX collapse. The venture capital fund Sequoia Capital said on Thursday it was writing down its total investment of nearly $215m in FTX.