The Collapse of FTX
A recount of the past week and what I think comes after this
When I first started writing this article a week ago it was a pretty tame story about two titans fighting it out on Twitter. What none of us expected was it to bring down the entire industry with it and cause mass grief and pain. The events of the past week have made a lot of things “click” in my head personally and have put a lot of things in perspective. I’m going to write a few parts to this since there’s too much to write about in just one piece.
Beginnings
Binance got started in 2017 in the midst of the last bull market through an ICO to launch their crypto exchange. Two years later, they invested in an upcoming startup called FTX. Started by former traders, FTX was meant to target the pro-derivatives trader segment of the market.
Over the past few years though, FTX started to present itself as a threat to Binance on two fronts
Taking marketshare away from Binance’s retail segment
Trying to lock Binance out of the US through some regulatory shenanigans
Fast forward to a last week things started off with “rumours” of another exchange being insolvent. We then had information about FTX/Alameda’s balance sheet containing mainly illiquid assets such as FTT, SRM, OXY and more.
Most of these rumours were written off as baseless. No way could FTX and SBF be caught out everyone thought. All the connections with DC, Sequioa backing, tons of press, a legitimate exchange — it really was unimaginable that this was even a possibility. Many industry insiders put the chances of something wrong with FTX as less than 1%.
However, it did raise a question… If FTX/Alameda’s balance sheet was compromised mainly of illiquid assets, what would happen if the price of those illiquid assets was to go down?
In case you aren’t aware, a classic play that the SBF crew made in the bull market was something along the lines of:
Create some new token that was meant to be the next thing
Make the supply very large
Only release a very small portion of the supply to the public
Use the total fully diluted valuation to acquire real cash via secondary sales with long term lock ups or through loans
Deploy free money to DeFi yield farms and make $$
In case the above feels a bit too hypothetical, lets break it down with a more easier to understand example.
Suppose I create a new company called “FBS Limited”
I then create 1,000,000 shares of it
I then decide to take my company public but only releasing 100 shares to the public at $1
Now technically at this stage, you could argue that the entire company is worth $1m. But is it really? Could you actually sell 1 million shares to investors for $1? Probably not. But it doesn’t matter. I can now use a rational argument to say that “look because these 100 shares are priced at $1, I can price all the other shares at $1 for accounting purposes”. Now, because I can do the above I have a super-power — the ability to make non-existent money, real.
So now I go to investors and I say, I’d like to get a loan against my 500,000 shares please. They’re worth $1 each but I’ll be generous and only borrow $250,000 against this.
Provided I have a somewhat okay reputation and the thing kind of makes sense, they’ll say sure. Here’s $250k, just make sure to repay me 10% per annum.
You say “cool”, because all this money is virtually free and you know where to get 40%+
You arb the difference and make bank
Now what’s even more crazy is that some investors decided to buy some of this imaginary money. But what happens if they sell it you may ask? Well, what if they couldn’t sell for a very long time…
That’s exactly what happened.
So by this point the market had caught onto the fact that FTX might be on wobbly foundations. Now if there’s one player in the market to act swiftly and boldly — it’s CZ. I wrote an article about him a few weeks ago that perfectly exemplifies his thinking patterns:
Just like before, CZ thought that fate had presented him another opportunity to present and exercise his power. So he did it. Little did even he know the wrath he was about to unleash…
Shot #1
The importance of this tweet can’t be understated looking back. It was this message that caused the cascading failure of what we know today as FTX’s collapse.
As soon as the tweet came out, what did the market try to do? Well of course, sell their FTT before Binance could dump on them and become exit liquidity. Classic crypto. I was following things pretty closely to see where things would lead. Surprisingly, the price of FTX went down to only $22 and was aggressively being maintained there. If you look at the volume on the chart below you can clearly tell given all the sell pressure, there was some buyer who really didn’t want the price to go below $22 (until it did).
It wasn’t too long before we had a rather surprising move, Caroline (CEO of FTX) tweeting out that they’d buy out Binance’s FTT stack for $22 OTC. If this was a game of poker, this was a forced hand that FTX had to play. They only had two options:
Do nothing and try to absorb all the sell pressure to prevent price from breaking $22
Attempt to appear cool and give confidence to the market you can buy out Binance’s stack at $22.
While the intent made sense, the mistake was giving out the price itself publicly imo. Once people figured out $22 was the magic peg price that could not be broken, people had to break it. It was at this time we started seeing the first cracks in the empire start to form: $1.2b in withdraws:
In hindsight, those who go out were extremely lucky and fortune. From here things were about to get a lot worse. The $22 price of FTT broke and I remember thinking “something’s about to blow up”. It wasn’t until the next morning when I woke up that they had indeed blown up spectacularly:
Shot #2
FTX is insolvent and Binance might purchase FTX. Quite the headline to wake up to, but at least end users have a shot of getting a good chunk of their money back per dollar if the deal goes through. Strangely enough Su an Do decide to come on UpOnly TV on this particular day. It’s almost as if the bad behaviour of SBF washes off their terrible behaviour. Crypto really does your head in. At this point everyone is hoping that CZ can be the saviour to this very ugly situation.
However, later on in the day we have Brian Armstrong come on an interview basically stating that Coinbase wouldn’t touch FTX with a 10 foot pole. He also cites the things that he knows everyone else will eventually find out. Not a great vote of confidence.
Markets start to panic more urgently now given there could be a real possibility that all customer deposits on FTX may be worth $0. Withdrawals are still open although the window of escape for those stuck is closing very narrowly. Finally the flood gates open when CZ confirms that Binance will not be buying out FTX given the hole is too large for even them to fill out. We still don’t know the exact amount but estimates range from anywhere between $5b - $10b.
The question that’s now plaguing everyone is how the hell do you actually even lose that much money. We know SBF had some cool toys and expensive properties but the most you can blow on that stuff is a few hundred million. How do you lose a few billion with no clear explanation? But also where the hell does all this money come from? Was there a possibility that customer deposits were actually being lent out/used elsewhere. We’ll find out soon.
Shot #3
By this point the story is starting to take some weird turns. What started off as a rivalry between CZ and SBF is now uncovering a lot more than anyone would have anticipated.
How much money does FTX have versus how much does it owe lenders and users?
Where did all that money go in the first place and who loses?
How did things get to the scale that they are right now?
These are all great questions that unfortunately we still don’t have the complete answers to. However it does make you really question how someone can lie at such a large scale to so many people. The number of lies that have unravelled in the past few days is more than anyone could have thought. For example, SBF openly Tweeted that FTX.US was insulated from the mess of everything happening only to declare it bankrupt the next day. Bahamanian resident withdrawals being prioritised due to law enforcement only for the government to deny any such claims.
It’s all so tiresome, really.
However, what scares me isn’t this event in isolation but the amount of contagion around it that is going to unfold. For example a few themes that I already see emerging as a result of this mess:
CEXs Questioned: Every exchange being questioned on whether it is solvent or not. Proof of Reserves are being demanded in a way they never have.
DeFi Reborn: People’s respect and desire for DeFi services after this. CeFi blow ups have cost the industry too much. What’s DeFi’s future now that CeFi has shown it’s clear incompetence?
Regulatory limbo: What happens to Gary and the SEC’s close ties with SBF? Do the new regulations get passed on or do things get properly investigated?
Crypto adoption: the public’s trust in crypto has reached an all time low. Does this delay us to the next bull market longer than we think?
Contagion: which other firms are affected but haven’t come out of the shadows yet? Only time will tell.
Ponzinomics: I think we’re finally reaching a point where the danger of ponzinomics is clear. Will the industry keep supporting ponzis moving forward or will it grow up?
I don’t have any clear answers to these questions but I am excited to try to answer them in the coming weeks and months as the dust settles.
I hope ya’ll are safe out there and staying well during these turbulent times. I’m still here for the long term and am incredibly bullish on crypto now that a lot of the trash is being cleared out.