The Rise and Fall of FTX Custom Case Solution & Analysis

Evidence Brief: The Rise and Fall of FTX

Financial Metrics

• Peak Valuation: 32 billion USD as of January 2022.
• Funding Rounds: Total capital raised exceeded 1.8 billion USD from blue-chip investors including Sequoia Capital and Temasek.
• Internal Liabilities: An 8 billion USD hole in customer funds identified at the time of collapse.
• Collateral Composition: Significant portion of the balance sheet consisted of FTT, a token created by FTX, which lacked external market depth.
• Alameda Research Debt: Multi-billion USD line of credit extended from FTX to its sister trading firm using customer deposits as the source.

Operational Facts

• Corporate Structure: Composed of over 100 separate entities with no centralized accounting or human resources department.
• Governance: Absence of an independent board of directors. Key decisions were centralized among three to four individuals.
• Accounting Systems: Use of QuickBooks for a multi-billion USD global operation.
• Communication: Internal records and decision-making conducted on Signal with auto-delete functionality enabled.
• Geography: Headquartered in the Bahamas, operating outside the primary regulatory reach of the United States for the main exchange.

Stakeholder Positions

• Sam Bankman-Fried (CEO): Maintained total control over both FTX and Alameda Research despite claiming operational independence.
• Caroline Ellison (CEO of Alameda): Managed the trading arm that utilized FTX customer funds to cover speculative losses.
• Institutional Investors: Relied on the reputation of the founder and rapid growth metrics without conducting deep forensic audits.
• Retail Customers: Deposited assets under the assumption that funds were held 1:1 and not utilized for proprietary trading.

Information Gaps

• The exact date when customer fund commingling began remains unconfirmed by internal documents.
• Full extent of political donations and real estate purchases made using customer assets is not fully mapped in the case.
• The specific algorithmic triggers that caused the liquidation of Alameda positions are not disclosed.

Strategic Analysis

Core Strategic Question

How can a high-growth financial technology firm maintain hyper-scaling while ensuring fiduciary integrity and structural independence from sister entities?

Structural Analysis

• Agency Theory: The misalignment between the interests of the founder and the customers was absolute. Without a board to monitor the agent, the founder prioritized the survival of Alameda over the safety of FTX deposits.
• Value Chain: The integration of an exchange (FTX) and a market maker (Alameda) created a closed loop. This loop lacked the friction necessary to prevent the transfer of risk from the trading arm to the exchange arm.
• Regulatory Environment: Arbitrage of jurisdictions allowed the firm to avoid the strict capital requirements of traditional finance while mimicking the services of a bank.

Strategic Options

Option 1: Institutionalize Governance and Compliance

• Rationale: Transition from a founder-led startup to a regulated financial institution.
• Trade-offs: Slower decision-making and higher operational costs.
• Resource Requirements: Hire a Chief Financial Officer, establish an independent board, and engage a major accounting firm for quarterly audits.

Option 2: Mandatory Functional Decoupling

• Rationale: Create a legal and operational firewall between the exchange and Alameda Research.
• Trade-offs: Loss of the competitive advantage provided by having a dedicated, large-scale market maker.
• Resource Requirements: Divestiture of ownership interests to ensure no overlap in leadership or capital.

Preliminary Recommendation

The firm should have pursued Option 2. The commingling of functions is the root cause of the insolvency. Without a total separation of the exchange from the trading arm, no amount of governance would have prevented the eventual contagion of losses.

Implementation Roadmap

Critical Path

• Phase 1: Financial Stabilization (Days 1-15): Immediate appointment of a Chief Financial Officer and an independent Oversight Committee to verify the location and status of all customer assets.
• Phase 2: Entity Separation (Days 16-45): Legal dissolution of the shared credit facility between FTX and Alameda. All inter-company loans must be recalled or written off to clarify the balance sheet.
• Phase 3: External Validation (Days 46-90): Completion of a full audit by a reputable third-party firm. Public release of proof of reserves to restore market confidence.

Key Constraints

• Founder Control: The concentration of voting power in the hands of the CEO makes the implementation of an independent board difficult without a forced restructuring.
• Technical Debt: The lack of integrated accounting software across 100 entities makes the consolidation of financial data a high-risk manual process.

Risk-Adjusted Implementation Strategy

Success depends on the immediate removal of the inner circle from operational control. The plan assumes that enough liquidity remains to satisfy immediate withdrawals. If the 8 billion USD gap is already present, the only viable path is a structured bankruptcy to protect remaining assets. The contingency plan involves a pause on all withdrawals to prevent a total run while the audit is finalized.

Executive Review and BLUF

BLUF

FTX was not a victim of market volatility. It was a failure of corporate governance characterized by the illegal diversion of customer deposits to cover the losses of a sister company. The collapse was inevitable once the value of the FTT token, used as artificial collateral, faced a market correction. The recommendation is a total liquidation of the trading arm and the installation of professional management to preserve the exchange assets. Speed is the only priority to prevent total capital flight.

Dangerous Assumption

The analysis assumes that the FTT token had intrinsic value that could be liquidated in a crisis. In reality, the token was an illiquid asset that only held value as long as the exchange remained solvent, creating a circular dependency that ensured total collapse during a downturn.

Unaddressed Risks

• Contagion Risk: The collapse of FTX will likely trigger the failure of other lenders and exchanges that held FTT or had credit exposure to Alameda. Probability: High. Consequence: Systemic crypto market contraction.
• Regulatory Retaliation: The scale of the fraud will lead to aggressive legislative action that may make the current business model of the exchange illegal in major jurisdictions. Probability: High. Consequence: Long-term revenue decline.

Unconsidered Alternative

The team did not consider a preemptive merger with a larger, more stable competitor such as Binance during the early stages of the liquidity crisis. While this would have resulted in a total loss of founder equity, it might have preserved customer funds and the operational integrity of the platform.

VERDICT: APPROVED FOR LEADERSHIP REVIEW