The cryptocurrency market tumbled Tuesday after Binance and FTX, the world's two biggest crypto exchanges, agreed to merge to address what Binance called a "liquidity crunch."

Bitcoin tumbled 12.6% to $18,203, according to Coin Metrics. Earlier in the day, it fell to $17,300.80, its lowest level since November 2020. Ether dived 18.2% to $1,311.50, after falling as low as $1,228.89.

Those declines spread throughout the rest of the market, at one point even stealing steam from the stock market rally{

Crypto sell-off steals some steam from stock market rally

Stocks came off their highs as crypto fell hard after the two largest crypto exchanges agreed to merge to fix their latest "liquidity crunch."

Bitcoin was down more than 11% on Coin Metrics, after initially gaining on news Binance and FTX came to a merger agreement.

"It's clear the market got an upset stomach when this all came out," said Peter Boockvar, chief investment officer Bleakley Global Advisors.

Stocks recovered some of their earlier gains after dipping in afternoon trading. The Nasdaq was temporarily in negative territory.

"Crypto is just seeing another reiteration of accidents. This is so high profile. These were the two biggest crypto exchanges in the world, where one just in a matter of days sees a run on the bank and almost evaporates," said Boockvar.

— Patti Domm

FTX Token (FTT) Solana

In crypto equities, Coinbase slid 10.8%, and Robinhood, which also has a crypto trading business and in which Bankman-Fried has a 7.6% stake, lost 19%. Other crypto-related stocks, including crypto banks Silvergate and Signature and bitcoin miners Hut 8 and Riot Blockchain, also lost ground.

The moves came after Bankman-Fried announced on Twitter that Binance will buy FTX's non-U.S. business for an undisclosed sum. Binance CEO Changpeng Zhao confirmed the news minutes later.

The deal will affect only the non-U.S. businesses of FTX and Binance. The U.S. arms of each company, Binance US and FTX US, are unaffected, Bankman-Fried, also known as SBF, said in his tweets. The deal has not closed and the companies have more due diligence to complete, the CEOs said.

The crypto market slid as trading got underway as investors' worries about the solvency of FTX swirled following recent rumors about the exchange and its sister company, Alameda Research. The market briefly rebounded after the deal came together.

"There are a lot of mirrors to the Celsius and Three Arrows crisis that happened months ago and what you're seeing is investors having deja vu and fear leaking into the markets," said Conor Ryder, research analyst at Kaiko.

A rumor that sparked a 'bank run'

Investor confidence has been shaken after Zhao tweeted over the weekend that the company would sell its holdings of FTT. Binance is the largest crypto exchange in the world by trading volume and was an early backer of FTX. On Tuesday morning, FTX halted withdrawals from its platform, after spooked investors attempted to pull their funds en masse.

Zhao said in his tweet that Binance has about $2.1 billion combined in FTT and BUSD, the fiat-backed stablecoin issued by Binance and Paxos.

"Due to recent revelations that have came to light, we have decided to liquidate any remaining FTT on our books," Zhao said.

That referred to rumors about the solvency of FTX, the third-biggest crypto exchange in the world by trading volume. A CoinDesk report last week on the state of Alameda's finances showed a large portion of its balance sheet is concentrated in FTT, and some of its various activities are leveraged using FTT as collateral. Alameda has disputed that claim, saying FTT represents only part of its total balance sheet.

"The Alameda hedge fund is tied to FTX through a ton of FTT tokens, and the rumors started that if they are using all of these FTT tokens as collateral ... there are two issues," said Jeff Dorman, chief investment officer at Arca. "If the price of FTT goes way down, then Alameda could face margin calls and all kinds of pressure; two is if FTX is the lender to Alameda then everyone's going to be in trouble."

"What could have been just an isolated issue at Alameda became a bank run," he added. "Everybody started to pull their assets out of FTX, and there's this fear that FTX would be insolvent."

A 'black eye for trust'

Ryder said industry observers "generally" had confidence that FTX and its customers "would be fine" but that the panic was understandable. Before late Tuesday morning, Bankman-Fried had said little on the matter that would have calmed rattled investors.

"The problem is the opaque nature and the lack of transparency about FTX reserves, Alameda's reserves, the links between the two — no one really knows how intertwined the two are," Ryder said. "From that side of things, it mirrors Celsius issues a lot in that we have no transparency of funds, and FTX hasn't come out and reassured investors, so that's what we're seeing now leak into markets."

It's a good argument for more regulation of centralized entities, Ryder added, saying it's imperative for all centralized entities — be it hedge funds such as Three Arrows Capital or Alameda Research or centralized exchanges such as FTX and Binance that aren't publicly listed — to maintain a proof of reserves for the sake of investor protection.

Dorman echoed Ryder's sentiment, saying that while it may, at best, be a short-term liquidity issue for the market, it's "another black eye for trust."

"Do they put [the reserves] in a bank account? Do they use them to lend out?" Dorman said. "This is where the lack of transparency comes in: Something that probably isn't a problem and shouldn't be a problem becomes a short-term liquidity problem if FTX can't immediately process all withdrawals."