What You Need to Know About Exchange Tokens After FTX’s FTT Meltdown

It was a shot heard around the crypto world.

On November 6, 2022, Changpeng “CZ” Zhao, CEO of the world’s largest cryptocurrency exchange Binance, announced that his company would liquidate shares in FTT, the native token of rival exchange FTX.

His announcement triggered a selloff in FTT, bringing five crypto exchanges to their knees. FTX experienced a bank run moment $5 billion in client funds he withdrew in one day and had no liquidity to cover it.

After FTX’s demise, the report revealed how much FTX and CEO Sam Bankman-Fried used hedge fund Alameda as collateral for FTT. These revelations have put exchange tokens under the microscope.

This Learn article will look at exchange tokens like FTT, what they are for and what risks they pose.

What is an exchange token?

An exchange token is native to a cryptocurrency exchange and created by the company that runs the exchange, often designated as a “utility token” because of its use in the exchange.

The most popular examples of exchange tokens are Binance’s BNB (the largest exchange token by market cap) and FTX’s FTT. Other centralized exchanges with their own tokens include KuCoin (KCS), Bitfinex (LEO), Crypto.com (CRO), OKX (OKB), and Huobi Global (HT).

How are exchange tokens used?

Crypto exchanges launch tokens for a variety of reasons, including as an incentive for customers to share the token, to cover transaction costs, to raise capital and liquidity, and in the case of exchanges governed by a DAO, as governance tokens.

In Binance’s case, “Along with BNB Chain ‘feeding’ transactions (similar to Ethereum’s gas), BNB also acts as a governance token,” says Binance. blog post explaining the token.

Binance says owning BNB gives investors the right to “hear your voice” and is required to participate in the governance of the BNB Chain’s decentralized chain.

At KuCoin, “Owners of KuCoin tokens get special discounts on trading fees and other related costs on the KuCoin exchange,” by KuCoin. he says in his explanation of the benefits of the KCS token.

KuCoin explained that the percentage of discounts an investor can receive is calculated based on the number of KCS tokens they hold.

In addition, KuCoin says KCS holders can use the exchange’s token to pay transaction fees.

Crypto.com’s CRO “gives its users access to exclusive rewards and discounts offered through its flagship credit card products,” according to Crypto.com. he writes. “As Crypto.com became an ecosystem of crypto solutions, CRO also added benefits such as lower trading fees, higher loan rewards and more.”

How do you buy exchange tokens?

As their name suggests, investors can purchase these tokens through the token’s parent exchange. In some cases, as with FTX’s FTT token, they can also be purchased on rival exchanges.

If the exchange does not have a fiat onramp, investors wishing to load exchange tokens will need to exchange their Bitcoin or Ethereum tokens. This process usually involves setting up an account and doing a Know Your Customer (KYC) check.

Depending on the exchange, some tokens are only available in certain regions. For example, FTT not available in the United States and other prohibited jurisdictions.

“If you are located, incorporated or otherwise established in the United States of America, or are a resident of the United States of America, you are not authorized to transact on the FTT,” the FTX.com website says.

What are the risks of exchange tokens?

The risk associated with cryptocurrency exchange tokens may seem murky at first.

In cases like FTX, where the industry found itself to be a powerful player with global influence, investing in FTT might be a good idea. That was until you consider how many tokens a rival cryptocurrency exchange had.

As mentioned above, Binance had a large number of FTT tokens: 23 million, worth about $529 million. Binance held all that FTT because it was an early investor in FTX in 2019, and when FTX cashed out Binance’s stake in July 2021, Binance paid in FTT.

When Binance announced that it would liquidate its entire position and the resulting liquidity crisis, the value of FTT sank by 85.6%.

This is known as another risk of investing in exchange tokens counterparty risk. In crypto, counterparty risk is mostly represented by a stable currency and the issuer backing the coin with a real-world asset. Cryptocurrency exchange tokens have a similar risk: what protects them?

That risk includes whether or not the exchange has the liquidity it needs to back its token, with the protection of any sort of reserve, as in the case of FTX, if liquidity suddenly dries up.

Because investors must exchange BTC or ETH to receive these exchange tokens, if the value or price of that token drops, there is no recourse to get back the exchanged BTC or ETH. It’s the same risk with token bets.

Staking tokens are locked in the network or exchange, and while it is shared, the investor cannot move or exchange these tokens. If the exchange suffers a collapse or cyber attack, the tokens will go with it.

Not all cryptocurrency exchange tokens are compatible with hardware wallets. Check the list of supported coins and tokens for the wallet you want to use.

A common refrain in the Bitcoin and cryptocurrency space is “not your keys, not your crypto.” But in cases like FTX and Terra’s LUNA, keeping your coins cold won’t help protect their value and will also take away any utility the exchange would bring.