Understanding crypto exchange tokens in light of FTX's collapse

Bespoke tokens have proven crucial to growing crypto exchanges, and — in the recent case of FTX — one may have been its downfall.

Driving the news: Yesterday, FTX announced that it had tentatively reached a deal with Binance, the world's largest crypto exchange, to be acquired as a way of protecting customers.

Context: The news shocked the crypto world. It's sort of like waking up one morning to learn Walgreens bought CVS — with no advance warning.

• FTX going south was not something that anyone expected. The company was fine, and then it had a $6 billion run on its reserves.

Crucial to the whole story was the exchange token that had driven loyalty for FTX, FTT.

• Neither FTX nor Binance have provided Axios with additional details on the events or the deal, despite repeated requests.

Catch up fast: Both Binance and FTX have exchange tokens. Binance's is called BNB (the fourth largest market cap of any cryptocurrency).

• One could argue that there are four kinds of tokens that have proven a market fit: Bitcoin, Ethereum's ether, stablecoins and exchange tokens.
• Exchange tokens work sort of like loyalty cards and sort of like equities.
• Exchange users with tokens get discounts on trades.

The killer feature of exchange tokens is their method of profit sharing. Exchanges use some portion of their trading fees and other income streams to buy tokens off the market and burn them (thus increasing scarcity, which should boost price).

• FTX put a third of its trading fees into buying and burning FTT.
• This should, in theory, drive up the value of the token for all remaining holders, assuming demand remains constant.
• In the weeds: American regulators are very likely to look askance at an exchange token, if they ever got their hands on one. Exchanges firewall them out of the U.S. (FTT included).

How it happened: Uncertainty began to kick in after CoinDesk got its hands on the balance sheet of Alameda Trading, the investment arm closely linked to FTX.

• That reporting revealed that, at the time of writing, $3.7 billion of the total $5.1 billion in FTT tokens in existence were on Alameda's balance sheet.
• Then the CEO of Binance announced he would sell significant amounts of FTT on the open market.
• FTX had halted withdrawals on Tuesday morning.

What they're saying: In a message to his employees that he also tweeted this morning, Binance CEO Changpeng Zhao wrote, "We did not master plan this or anything related to it."

Between the lines: Like all tokens spun up by crypto firms, the company behind it and its team members got distributions of the token. Its investors too.

• Alameda was in a position to buy up FTT early and accrue it over time. When Binance learned just how much it had, it appears the competitor saw a weakness.
• Aztec Network's Jon Wu breaks this down in a detailed Twitter thread, pointing out in particular that FTT was thinly traded on the open market. That made a sudden sale by Binance dangerous to its price.
• Whatever happened with FTT, it made some weird moves on chain between Alameda and FTX recently, as Coin Metrics's Lucas Nuzzi found.

The crux: It would be fine for Alameda to hold a lot of FTT, the danger is if it borrows against it. Particularly if it borrows against it from FTX.

• If in fact Alameda used FTT holdings as collateral to borrow other cryptocurrencies from FTX, that puts the exchange in danger.
• Even if Alameda bought all of Binance's FTT, such a massive sale would inevitably cause others to start unloading FTT as well. Eventually, it could have been too much for the firm.
• Once crypto traders saw FTT falling, they started getting out of the exchange.

Quick take: Tokens make it easy to get a day to day vibe check on the market's assessment of a given project, but those prices have real world value and when they turn fast enough, they have real world implications.