Binance’s decision to purchase the FTX crypto exchange eventually put an end to the uncertainty that shrouded it for the last two days. Although the move shocked the space, it eventually brought to light the challenges that the FTX crypto exchange would have been facing for a while. Binance CEO Changpeng Zhao (aka CZ) has now taken to Twitter to give sage advice to crypto companies, shedding light on FTX’s challenges.
Hole In The Sheet
Before CZ’s tweet about Binance’s plans to sell off its FTT token holdings, no one had guessed that the FTX crypto exchange had any sort of challenges. Now, in hindsight, it does look like the exchange’s relationship with Alameda Research contributed in large part to its woes, and some unsafe business practices would eventually put it in the ground.
In the tweet, CZ talks about two lessons that crypto companies should learn from the FTX fiasco. The first one was the fact that FTX was using its own native token, FTT Token, as collateral. According to the Binance CEO, this should be a no-no for any crypto business as it puts them at a disadvantage when it comes to paying off those loans.
The next lesson was to completely avoid debt. Understandably, a lot of businesses need debt to operate and provide capital but CZ said crypto companies should not do this. He also added that they should not use their capital “efficiently” and should instead opt for large reserves.
FTT falls from $19 to $4.5 | Source: FTTUSD on TradingView.com
The Binance CEO had previously alluded to this in a previous tweet where he compared banks to crypto exchanges. While banks are known to run on fractional reserves, ie only holding a small portion of customer deposits, CZ said crypto exchanges should never adopt this model. Rather, there should always be ample reserves of user funds.
All crypto exchanges should do merkle-tree proof-of-reserves.
Banks run on fractional reserves.
Crypto exchanges should not.@Binance will start to do proof-of-reserves soon. Full transparency.
— CZ 🔶 Binance (@cz_binance) November 8, 2022
FTX Made Mistakes
CZ’s tweets are indicators of what really went wrong with the FTX crypto exchange. While his tweet and Binance’s move to dump its FTT holdings may have triggered the eventual bank run, FTX was liable for having user funds available for withdrawals, and in the end, it could not fulfill these obligations to its customers.
By the second day, there had been a reported $6 billion worth of withdrawals carried out on FTX and the exchange had to halt withdrawals at one point, as it was unable to fulfill them. This eventually showed a hole in its balances rumored to run into multiple billions.
Binance’s acquisition of FTX still hangs in the balance as it is subject to approvals from the necessary parties. However, there are rumors that the exchange might eventually back out of the deal if the hole proves to be deeper than anticipated.
FTT’s price has taken a beating on the back of the exchange’s troubles. It is currently trading below $5 at the time of this writing and is down more than 80% in the last two days.
Featured image from Ledger Insights, chart from TradingView.com