Market behaviors around bankruptcy and frozen funds withdrawal: Trading stranded assets on FTX

Abstract

How do cryptocurrency markets react when an exchange allows trading but freezes withdrawals? This study examines the impact of liquidity funding shocks on the market liquidity of cryptocurrency markets and traders’ behavior. We examine this issue using a natural experiment in major cryptocurrencies when the FTX exchange, while about to file for bankruptcy, prohibited most investors from withdrawing assets held by the exchange while allowing trading to continue. By using proprietary tick-by-tick data, we test price divergence between FTX and Binance and perform t-tests on the difference in magnitude of liquidity measures between the pre- and post-withdrawal halt periods. We find that a substantial amount of trading on FTX occurred during this stranded asset period, even though liquidity deteriorated as the bid-ask spread and implicit transaction costs increased sharply. We further find traders engaging in a revealing flight to safety by moving their investments in stablecoin Tether or even exiting the market. These findings not only shed light on the resilience of cryptocurrency markets in the face of liquidity crises but also offer insights into the mechanisms traders employ to navigate such tumultuous periods.