FTX’s insolvency has been the big crypto news making the rounds over the last week. Announced recently as one of the top 5 Centralized Exchanges (CEX) in 2022, FTX’s glory days seem to be a thing of the past.

It all began from a CoinDesk report that claimed Alameda Research, a Trading Firm linked to Sam Bankman-Fried (FTX’s CEO), had a majority of its assets in FTX’s exchange token (FTT).

Ordinarily, nothing is wrong with Alameda holding FTT tokens; however, Alameda’s balance sheet being dominated by FTT tokens and not another crypto or fiat suggested that most of Alameda’s equity was false, as Sam Bankman-Fried (SBF) simply transfers assets to and from both companies.

This revelation sparked conversations in the industry, as it suggested fraud, or at best, some sort of manipulation to suggest an extremely inflated company valuation for investors in Alameda and FTX, and the first major action was taken by Binance’s CEO, Changpeng Zhao, who announced that his exchange would liquidate all FTT tokens left on its books.

This appeared to be the major trigger in the domino effect that led to the downfall of FTX, as it has since become incapable of functioning and looks dead. A popular opinion from many investors and market participants is that Binance CEO, CZ, spread FUD into the market by announcing his decision to liquidate $2.1 billion FTT tokens, which caused a ripple effect in the market. SBF confirmed that on Sunday, 6^th November, when CZ published the tweet, FTX had roughly $5bn worth of crypto asset withdrawals.

Although, in CZ’s defense, some people say that he just wanted to avoid another “LUNA” scenario that cost him $1.6 billion.

One of the biggest losing parties in all of these are FTT bagholders, who saw the worth of their holdings plummet as the token lost around 93% of its value, from $22 per token to $1.5. Hence, many questions arise about the level of security involved in exchange tokens.

What Are Exchange Tokens?

Exchange tokens are a type of utility tokens that are created and managed by an exchange for several perks to make the Exchange thrive while serving as an investment incentive. Some of these perks include: discounts on trading fees, buy-back and burn events, governance votes (for Decentralized Exchanges), etc.

Examples of Exchange tokens include Binance Coin (BNB), Kucoin Token (KCS), Huobi Token, Cake (PancakeSwap), UNI (Uniswap), etc.

In the case of Binance and Kucoin, which have a blockchain in addition to the Exchange platform, the token isn’t only a utility token but a blockchain token to pay gas fees on the network.

Is it Safe To Invest In Exchange Tokens?

There is no absolutely “safe” investment, whether in traditional finance or the crypto world. However, with a well-established crypto exchange, it is largely expected that continual success and usage will maintain the value of its token, which was the case with FTT as it grew to become one of the most valuable exchange tokens in the market.

However, given the launch model of CEX tokens, they are at greater risk than DEX tokens.

Investment by Influential Market Players

Most CEX tokens are launched via an Initial Coin Offering (ICO), which allows investments from several parties in Bitcoin, Ethereum, or other cryptocurrencies, before rewarding the investor with the token.

FTX also launched FTT via an ICO, where its competitor, Binance, invested heavily and had 23 million FTT tokens (around 7% of its entire supply); other investors also include Coinbase, Alameda Research, Pantera Capital, etc.

When the news broke out, and Binance, a big bagholder of FTT tokens, announced that it would liquidate its position amid speculations of FTX’s insolvency, it shook the entire market, and FTT’s value tanked.

DEX tokens have an edge against the risk of this kind of capitulation because, unlike CEX tokens, most DEXs don’t launch via ICOs or pre-seed funding that allows a large quantity of the equity tokens to be held by a single party; hence, they employ a fair launch method.

More importantly, Funds held in a DEX token’s treasury aren’t managed by one person; hence, a single person can’t manipulate funds, as SBF allegedly did.

Counterparty Risk

Generally, Exchange tokens (CEX or DEX) have the burden of proving that they truly have an asset reserve. Indeed, token movement can be monitored via the blockchain; however, when attention isn’t paid, shady things could be done by people with access, especially in a CEX (as SBF allegedly moved several billions between the FTX and Alameda Research via a secret backdoor).

As a result, many are calling for a new Proof-of-Reserve protocol that takes regular snapshots of the asset reserves the exchange has to back their tokens; hence, users can tell in advance if these exchanges have their assets at hand and aren’t at risk of insolvency.

Final Takeaway

The failure of several crypto projects due to lapses in judgment by major decision-makers has shown that there is no foolproof investment in cryptocurrency. Hence, it is important to deeply research a coin, its history, and its purpose before committing money to them. More importantly, diversify your investments so you don’t get caught up in no man’s land.

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