What led FTX and Alameda to file for Chapter 11 bankruptcy?
The events and allegations outlined below are suspected to have ultimately led to FTX and Alameda filing for bankruptcy on Nov. 11, 2022.
According to the SEC, FTX granted Alameda special privileges, including the ability to access an unlimited line of credit backed by FTX customer deposits. Over the years, Alameda drew down on this line of credit and borrowed billions from third-party crypto lending firms.
In May 2022, the price of digital assets fell. Alameda’s lenders demanded repayment on billions of dollars of loans. According to the SEC, Alameda was unable to fulfill its debt obligations, so Bankman-Fried instructed Alameda to draw on the line of credit from FTX to repay its third-party lenders.
Alameda was now in a position where it owed FTX billions of dollars with no immediate capacity to repay its debt. Nevertheless, the SEC stated that Bankman-Fried continued to draw down on the line of credit to increase his investments and provide loans to himself and his associates.
On Nov. 2, 2022, crypto news website CoinDesk reported that Alameda held billions in FTT tokens. According to the SEC, Alameda and FTX collectively held the majority of the FTT tokens and only a small portion were in circulation. The SEC stated that Bankman-Fried “misrepresented the risk profile of investing in FTX” for reasons including:
- FTX valued the FTT tokens held by Alameda at prices greater than their market value.
- Alameda pledged the overvalued FTT tokens as collateral against the funds it borrowed from FTX (i.e., the line of credit).
- Bankman-Fried failed to disclose to investors FTX’s exposure to Alameda (i.e., the collateral was largely illiquid).
If the value of the FTT tokens fell, Alameda's collateral would also be worth less. As a result, FTX would be confronted with a solvency crisis if it could not recoup its loans from Alameda to cover impending customer withdrawals. This posed a risk to both FTX platform users and FTX investors.
This is precisely what happened in the days that followed the revelation by CoinDesk.
Crypto asset trading platform Binance announced shortly after the release of the Coindesk article that it would liquidate its more than US$500 million investment in FTT tokens. After Binance’s announcement, other FTX customers began to make withdrawals. Around the same time, the value of the FTT token fell from $22 to under $5.
Unable to cover all the customer withdrawals, FTX and Alameda filed for bankruptcy on Nov. 11, 2022.