FTX: The Fall of an Empire
$14.6 billion evaporated overnight.
Disclaimer, NFA, all that legal stuff: All the information presented on this publication and its affiliates is strictly for educational purposes only. It should not be construed or taken as financial, legal, investment, or any other form of advice.
Hi folks 🙋🏻♂️,
I’ve been in crypto for almost 7 years. Yesterday was the second craziest day in my crypto career. The first one was in 2020 when I saw BitMEX’s BTC order book hit zero before BitMEX suddenly went into “maintenance” — Arthur pulled the plug and saved all of us. I had planned to write about Elon’s Twitter fiasco and how it might catalyze the rise of decentralized social media — but there’s no way I can write about that after what just happened. I really hope you readers are not impacted by this FTX debacle; and if you’re, know that things will always get better and the space will eventually bounce back. Stay strong.
FTX: The Fall of an Empire
Sam Bankman-Fried (SBF), the Co-Founder & CEO of FTX has been the poster child and media darling of the “western” cryptocurrencies landscape in the past few years. He’s seen as a brilliant, measured, and thoughtful individual. After all, how can you not see him as such? He’s a quantitative finance wizard who was working at Jane Street before starting his extremely profitable crypto trading firm, Alameda Research. Not long after winning big by arbitraging crypto price discrepancies between the Eastern and Western markets, SBF founded FTX, which then became a massively successful crypto exchange.
His brilliant understanding of the derivatives market propelled FTX into the limelight as the premiere platform for crypto traders around the world to speculate on crypto derivatives. Don’t get me wrong, derivatives in crypto already existed since the days of BitMEX, but FTX’s product was really good and took the crypto derivatives market to the next level. After achieving mainstream success with FTX, SBF was able to raise a significant amount of capital from notable investors around the world, the likes of Sequoia, and continued to expand his crypto empire. Not long after, come the Super Bowl ads, the athletes and stadium naming sponsorship, and other extravagant marketing initiatives to show that FTX is here to stay. SBF also then began courting policymakers, engaging with government officials in DC to help shape the future of crypto regulation in the US.
SBF had it all. A profitable business, a deca-billionaire status, athletes and celebrities endorsement, mainstream public awareness, and a promising regulatory engagement. But suddenly, in the span of 48 hours, everything crumbled down — FTX is having a liquidity crisis, most probably (or definitely) insolvent, and is in process of getting acquired by its rival, Binance.
In this piece, we break down what happened in the past 48–72 hours, what happened with FTX, and how did things go so badly so quickly.
Here are the quick takeaways:
- Rehypothecation, excessive leverage, and opaque reporting — crypto might be a relatively new asset class, but these are the same old problems.
- FTX (International entity) was most likely commingling funds with Alameda Research and got dragged down as a result.
- Binance *might* acquire FTX, but that’s pending due diligence, with many speculating that the deal will fall off because the hole in the balance sheet is too large ($6 billion+).
- There will be massive negative second-order effects on lenders and miners, including those who are regulated in the US.
- “Trust, don’t verify” will continue to be repeated as a talking point. This will hopefully usher in more on-chain solutions, but it will undoubtedly draw massive regulatory scrutiny in the near future.
What happened: FTX is rumored to be insolvent. The exchange halted user withdrawals and went MIA for approximately 12 hours before news broke out that Binance is going to acquire FTX. All this happened within a day after customers’ confidence in FTX waned because of Alameda Research’s balance sheet leak and a minor Twitter drama with Binance.
The Timeline:
- November 2, 2022 — CoinDesk broke a story leaking Alameda Research’s balance sheet.
- The number doesn’t look too good. Out of $14.6 billion reported, $5.8 billion were in FTT, FTX’s own exchange token. $2.1 billion of that $5.8 billion is reported as “FTT Collateral”.
- November 6, 2022 — Alameda’s CEO confirmed the balance sheet, stating that it has $10b+ of assets that aren’t reflected in the leak.
- November 6, 2022 — Binance’s CEO publicly stated that Binance will liquidate its massive FTT holdings as part of its exit from FTX equity. They’ll be doing this because of “recent revelations”.
- November 6, 2022 — Alameda’s CEO offered to minimize the open market impact by buying all of Binance’s FTT at $22.
- November 7, 2022 — Binance’s CEO declined the $22 OTC offer and will stay in the free market.
- November 8, 2022 — FTT went below $22 and FTX paused all user withdrawals.
- November 8, 2022 — Semafor reported that SBF was talking to billionaires to raise emergency capital, with not much luck.
- November 8 EOD — Binance to acquire FTX. Pending due diligence. Binance can back off at any moment.
You might be asking: “all this doesn’t make sense”. For all that I care, FTT can go to zero and FTX should still be solvent. You’re right. That should have been the case. That will be the case for most other exchanges.
Crypto market participants have always known about FTX and Alameda Research’s relationship. After all, they’re owned by the same person. However, no one really had any idea about the extent of their dealings.
The answers: FTX and Alameda Research were commingling funds, which include users’ funds, via the FTT token. In short, Alameda utilizes FTT as collateral on FTX to borrow other assets such as USD-backed stablecoin from FTX’s customer deposits.
Once again, the crypto industry is suffering from the same old problems. An endogenous collateral system, opaque reporting, rehypothecation of assets, and excessive leverage.
Speculation Corner
Let us wear our tin foil hats briefly. Everything under this section is rumor and speculation, as well as hypotheses that I’ve heard from industry participants regarding what happened.
SBF and FTX had been lobbying US policymakers for a new bill called DCCPA, I wrote about it last week. It was speculated that the bill will more or less kill decentralized DeFi applications, benefitting FTX and other US-based exchanges in the process. There was also a rumor that FTX had been talking smack about Binance in DC — whether this is true or not, I wouldn’t be surprised if FTX has been laddering against Binance in DC, a strategic move where one company highlights the weakness of others.
Binance, obviously, doesn’t like this. They’ve been the opposite poster child of FTX. They were the target of investigative pieces from journalists as well as regulators around the world. CZ and Binance had practically been on a world tour in the past few years to rally regulators and former policymakers to their side. It must’ve cost Binance a substantial amount of capital lobbying retired policymakers as their “advisors”.
Somehow, Binance might have caught wind of the situation at FTX and Alameda Research and decided to catalyze further panic by dumping FTT on the open market. Although Binance has denied this. And also, we shouldn’t blame Binance for what happened. If FTX had really been commingling users’ funds with Alameda Research in a savvy way via FTT collateralization, it might have been… criminal. If FTX is kosher, no matter what happens to FTT, it shouldn’t be enough to make the entire exchange insolvent.
For now, we have a new god-king in crypto: Changpeng Zhao.
You don’t want to be the main character. Actually, let me be more specific. In crypto, we’ve seen times and times again those who acquire wealth and fame too quickly let it get the best of them. When everything seems to be working extremely well, ask yourself; do I have enough people around me that will say “no, dude, that’s stupid and dangerous, don’t do that”. If you don’t have these people around you, it won’t take long for you to walk into an extremely obvious land mine. In this case, SBF had an extremely profitable empire printing a stupid amount of money every year, but he was still able to mess it all up. And oh, if somebody claims to be an effective altruist, maybe try to dig deeper and see if there’s anything off — I’d rather trust a person that blatantly says they want to get rich.
Musing
Sometimes, I try to take stock of the fact that I’ve been in the space for almost 6 years; made a good income; build skillsets, and networked along the way, but haven’t really “made it”. If the last sentence sounds like copium, trust your instinct. I used to beat myself up knowing that there are people who got into NFT in 2021, hit the jackpot, and made mid-8 figures in 6 months. The truth is, I don’t know how I would become if that happened to me. Too many young people got destroyed by becoming too wealthy too quickly without experiencing setbacks and having the necessary experience to manage large-scale operations. By operations, I don’t only mean your organization or capital, but also your life.
Until next time,
Marco M.
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