In the Eye of the Storm - Crisis management playbook in Crypto's Lehman Brothers' event

Background

It all started in early November 2022 with a leaked balance sheet that revealed that the value of FTX CEO Sam Bankman-Fried’s trading company, Alameda Research, was bolstered heavily by a token created by its sister company, FTX, and not by independent assets such as fiat currency or other cryptocurrencies.1 The ensuing surge in withdrawals from FTX caused a liquidity crunch for the third-largest crypto exchange by trading volume, with US$6 billion of withdrawals made in just three days.2

The saga gained widespread attention after Binance’s CEO, Changpeng Zhao (CZ) initially revealed on Twitter that Binance had reached a non-binding deal with FTX “to fully acquire http://FTX.com and help cover the liquidity crunch.”3 Just one day later, Binance backed out of the deal following its due diligence. To add insult to injury, Binance disclosed on Twitter the existence of reports of “mishandled customer funds and alleged US agency investigations” and added that “the issues are beyond our control or ability to help”.4

Bankman-Fried is now forced to face the full brunt of a public fallout. Against hopes that Binance’s plan to bailout its fiercest rival would buy the crisis a little more time, Binance has decided to pull out just one day after announcing its plans. It remains to be seen what the impact of the fallout would be. There is also a real sense of contagion across the entire digital assets ecosystem, with many platforms finding themselves exposed. As Binance stated in its 10 November 2022 tweet, “we believe in time that outliers that misuse user funds will be weeded out by the free market.” Platforms are under increased scrutiny on whether they have sufficient liquidity with concerns of facing a “bank run” like that suffered by FTX, while questions are being asked on whether proper due diligence were done prior to committing to exposures to FTX. With more players in the digital assets space expected to be called out in time to come, there has never been a better time for those hoping to survive the crypto winter to ask, “so, what do you do in a crisis like this?”

5 steps in crisis management

The first 72 hours of any crisis is the most critical time period. Decisions which are made in this period could mean the difference between putting down the fires early versus having to contend with an irreversibly viral situation after the window closes.

  • The first step would invariably be to establish a crisis management committee. This would usually include someone with executive powers, a CFO, a lawyer, Ops, and a PR Head.
  • The second step would be to define clear objectives. Many problems cannot be solved within 72 hours. The objective may therefore not be to resolve a crisis, but to contain it.
  • The third step would be to fact-find, and to build a consistent narrative including statements around the facts which are in line with the corporation’s core values.
  • The fourth step would be to identify and prioritize key stakeholders and deploy a strategy to ensure there is consistent messaging all round, both within the organisation and externally, to manage all stakeholders’ expectations.
  • Lastly, the organisation in crisis should prepare to implement emergency countermeasures to enforce its narrative, where necessary.

Not a done deal

The mandarin word for crisis is 危机, which is an amalgamation of 2 distinct words and concepts. The first word refers to risks. The second refers to opportunity. Just as an agreement to agree is not enforceable, there is no absolute guarantee that Binance would not later return to the negotiations table. The Elon-Twitter saga itself had many turnarounds. From the collapse of Terraform Labs (LUNA), Celsius and Three Arrows, to the sale of Huobi to the founder of Tron, and now this, the digital assets market is suffering from growing pains as the natural processes of evolution and market forces redefine the landscape of those who survive and those who do not.

This is a sign of the ecosystem cleaning itself out, as a natural consequence of the limits of self-regulation. Any consolidation while at first glance could be seen as contrary to the spirit of decentralization, could actually pave the way for greater mass adoption, and become the framework for more robust decentralization to take place.

Whatever happens to FTX, one thing is clear. This crisis will set a new market practice where major exchanges would publish proof of reserves to demonstrate that their customers’ assets are backed (such as a Merkle Tree proof where hash on the blockchain could not be reversed).

A major issue at play and arguably the underlying factor that triggered the collapse is the valuation of FTT. We have already seen tokens become worthless overnight, revealed to be the true naked kings of their own realm (protocol). In the same fashion, FTT fell by approximately 80% in a day. There are now too many lessons on the importance of understanding the fundamentals of a token instead of relying on the perceived trading value in the market.

In a tweet, Bankman-Fried suggested that Binance would be FTX.com’s “first, and last, investors”.5 Realistically, while FTX may not want to deal unless the price is right, it may not have a choice as the crisis develops. Binance on the other hand, would have to consider what the future of FTT and FTX projects hold and whether these projects would cannibalize with what Binance already has to offer, on top of considering what responsibility it would have to take if any, for liability claims from investors against FTT arising from the collapse and its customers with suspended accounts and frozen withdrawals.

Get in touch with us

We have an active practice in working with clients on cryptoassets disputes including disputes arising out of the digital assets and blockchain space. In addition, Shaun Leong FCIArb has substantial experience in helping clients develop and implement effective crisis management strategies. Please get in touch if you would like us to share our expertise or to understand in further detail any of the points covered in this piece.

[1] https://www.coindesk.com/business/2022/11/02/divisions-in-sam-bankman-frieds-crypto-empire-blur-on-his-trading-titan-alamedas-balance-sheet/
[2] https://www.bbc.com/news/business-63577783
[3] https://twitter.com/cz_binance/status/1590013613586411520
[4] https://twitter.com/binance/status/1590449161069268992
[5] https://twitter.com/SBF_FTX/status/1590012124864348160?ref_src=twsrc%5Etfw%7Ctwcamp%5Etweetembed%7Ctwterm%5E1590012124864348160%7Ctwgr%5E4524e0cf993e0b8cb7e1377c829c405252d4f23d%7Ctwcon%5Es1_&ref_url=https%3A%2F%2Fwww.straitstimes.com%2Fbusiness%2Fftx-ceo-looking-at-all-options-as-binance-deal-collapses

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