F'd TX: The Saga
What happened, how it went down, how it ends.
November 9, 2022 was an unexpected day in crypto. FTX, the second largest crypto exchange with $16 billion in customer deposits that was valued at $32 billion, became insolvent. From one day to the next it was over for the 30 year old crypto-king Sam Bankman-Fried, affectionately known as SBF, lauded as crypto’s version of the esteemed 20th century banker J.P. Morgan.
SBF’s personal $15 billion fortune was eviscerated in 24 hours. He now holds two records. The fastest and youngest multi-billionaire. The fastest billionaire wealth destruction. Another record likely awaits him; a criminal one.
FTX 1.2 million users deposited $16 billion. All of it is likely lost. The impact across the industry will be even larger.
On Friday, November 11, 2022, FTX filed for Chapter 11 bankruptcy.
The shock of what has and continues to unfold is unprecedented, even for an industry rife with scams.
Buckle up for the saga. It’s laced with fraud and deception. Its tentacles reach every corner of crypto and extend to Washington, DC.
What happened?
On November 2, 2022, CoinDesk reported the precarious nature of Alameda Research’s balance sheet. Alameda is a quant crypto trading fund launched in 2017 by SBF. He owns 90% of Alameda. He was its CEO until last year. It contributed to half of his net worth. In 2019, SBF launched FTX. The market was aware the two were intertwined but turned a blind eye. Recent events revealed just how enmeshed they were.
CoinDesk noted that Alameda had $14.6 billion of assets and $8 billion of liabilities for an equity value of $6 billion as of June 30, 2022. Nothing wrong with that…until you realize what the largest asset is: $6 billion of FTT tokens.
Holding that much FTT in assets is an issue for four reasons:
Intertwined relationship: Alameda balance sheet highlighted how intertwined it was with FTX. Its largest asset, FTT, is a token issued by FTX. FTX and Alameda are in bed together.
FTT is a made up asset: The FTT token is issued by FTX. Its “value” is access to reduced trading fees on FTX. FTX controls how much FTT is issued. FTX uses ⅓ of its trading revenues to “burn” (i.e. buys back) FTT. FTT harkens to Luna’s role in Terra’s collapse. (Read WTF LFG?…a crypto crash explained). It only has value because we “believe” it has value…until we don’t.
FTT is illiquid: Since the spring FTT’s daily trading has ranged from $5-40 million. There is no way Alameda could ever monetize $6 billion worth of FTT when so little of it trades.
Questionable equity value: Alameda’s $6b equity value is entirely made up of FTT token. If it wasn’t for the value of the FTT token, Alameda would be insolvent. Its liabilities would be larger than its assets.
Alameda’s FTT asset became a massive issue when CZ, the CEO and Founder of the largest crypto exchange Binance, tweeted on November 6 that Binance will dump its FTT holdings worth $529 million.
16 minutes later, Caroline Ellison, the CEO of Alameda came to the rescue.
SBF chimed in. He stated FTX has enough assets to cover all clients holdings, can process withdrawals and never invested client funds. He subsequently deleted this tweet; an omen of things to come in our saga.
CZ declined to sell his FTT to Alameda at $22. Instead, he’d sell into the market. CZ skipped declaring war. He just dropped a bomb.
Due to Alameda’s close relationship with FTX, FTX clients feared the worst. They stampeded to the exit, withdrawing their funds from FTX. Dump first and ask questions later. On chain activity showed FTX depositing assets as quickly as possible to keep up with a flood of client withdrawals. Once people clued into this, the floodgates opened.
By the morning of November 8, FTT collapsed to $15. The market called Caroline’s bluff. Alameda could not support the FTT price.
FTX halted withdrawals. It had received $6 billion of withdrawals in 72 hours. By the afternoon FTT dropped to $3 after this bombshell.
The unthinkable happened. In 48 hours FTX went from crypto darling to insolvent. FTX admitted it was insolvent by agreeing to a fire-sale to Binance. It could not meet customer withdrawals. It capitulated.
The emperor was dethroned. But client’s assets were still missing. Something was gravely wrong on FTX’s island paradise.
$266 billion of crypto market cap (25%) was wiped out in two days.
26 hours after announcing the deal, Binance pulled out.
How did this happen?
The foundation
The saga goes back to the foundation of Alameda and FTX. Alameda was formed first in 2017. It had ample highly profitable crypto arbitrage trades. It lacked capital and proper trade execution. FTX solved both problems.
Founded in 2019, FTX rapidly became one of the best crypto exchanges. Its product and execution was unmatched. It was “built by traders for traders.” Technology is part of the equation for a successful exchange. Liquidity is the other. An exchange needs a lot of capital that trades with a high frequency. Alameda provided that.
The two went hand-in-glove. FTX went from obscurity to main player eclipsing Coinbase, which was founded 10 years earlier, in 3 years.
How did so much capital enter the FTX/Alameda machine so quickly?
The answer: FTT token
The FTT token was likely used to transfer assets between FTX and Alameda. The transfer mechanism works as follows. FTX created FTT tokens. Alameda buys FTT token. FTX pumps the value of FTT by controlling the issuance of FTT, ensuring it was thinly traded and uses 1/3 of FTX revenues to burn FTT. Alameda then posts FTT collateral to FTX in order to borrow real assets from FTX. The real assets borrowed were client deposits. Alameda makes a bunch of profitable trades. Alameda and FTX mutually benefit. Rinse and repeat.
Alameda and FTX appear at arms length. There are legal credit agreements between them. Alas, the asset pledged as collateral is fabricated. FTX breaches its terms of service and the law by using client funds for undisclosed purposes.
The damning part
The FTT token is the mechanism to facilitate the borrow and lending between FTX and Alameda. The mix of assets and liabilities on Alameda’ balance sheet suggests transfers could have happened. But it’s hard to prove FTX actually lent client funds to Alameda collateralized by FTT token. There are several indications it did.
1. FTX’s current position
FTX did not have capital to meet withdrawals. It blocked withdrawals. It’s unclear what happened to client funds. FTX filled for bankruptcy. Something is grievously wrong.
2. Binance bails
Binance pulled out of its rescue bid for FTX a mere 26 hours into their due diligence. They likely discovered an enormous pile of dirty laundry even their juggernaut couldn’t clean. Then CZ tweet this:
Using capital “efficiently” is cryptic. Is it a nod to FTX using client funds for Alameda trading book?
Whatever the meaning, it was so bad that those that looked jumped back.
3. Voyager and BlockFi bailouts
In the spring several CeFi platforms imploded from the Terra/Luna and 3AC collapse (Read CeFi Casualties). SBF, via FTX and Alameda, rescued Voyager and BlockFi. At the time, SBF’s actions highlighted the strength of his fortress. He was heralded as crypto’s savior. In retrospect, something else may have motivated saving these two entities.
Voyager disclosed in its public filings that it loaned Alameda $376 million. If Voyager collapsed, the loan would be called. From what we know of Alameda's June 30, 2022 balance sheet, it wasn’t liquid. Yet on June 22, 2022, Alameda provided a $200 million loan in the form of cash, USDC and bitcoin to Voyager. Where would these funds have come from?
BlockFi is not public. Less is known about it. Could Alameda have been a BlockFi debtor as well?
It makes sense that the SBF complex would cherry pick these two assets, among many, to save if they risked toppling FTX and Alameda. As soon as the FTT mechanism was compromised, Alameda and FTX were undermined. If Voyager or BlockFi called outstanding Alameda loans, a collapse was imminent. To prevent that, SBF’s enterprise was motivated to save them.
4. Peculiar on chain activity
There is a peculiar set of transactions by FTX and Alameda in September discovered by Lucas Nuzzi. The transactions suggest a $4 billion loan from FTX to Alameda. On September 28, 2022 an enormous amount of FTT was moved on chain. Alameda received $4 billion worth of FTT tokens. Alameda then sent the entire amount to FTX.
It was by far the largest daily move of FTT in the token's existence and one of the largest ERC20 daily moves recorded at Coin Metrics.
Why did that happen?
A potential reason is the following. The sequence of events created $4 billion of assets on Alameda’s balance sheet in the form of FTT tokens. Those tokens were then sent to FTX as collateral securing a $4 billion loan.
Alameda may have needed $4 billion emergency funding, because, like 3AC and others, it imploded. FTX came to the rescue.
On chain investigation does not show cash moving from FTX to Alameda. It’s unlikely such a transfer would happen on chain. If this theory is true, it is highly likely FTX’s sources of funds was its customer deposits. Where else would it have gotten $4 billion of cash from?
5. FTX defections
Sam Trabucco, CEO of Alameda, stepped down on August 24, 2022. On September 27, 2022 - the day before the monster peculiar on chain activity - Brett Harrison, CEO of FTX US stepped down.
Rumors spread this week that FTX's entire legal team quit.
6. Anonymous FTX insiders
Reuters sourced two FTX insiders stating FTX transferred customer funds to Alameda. WSJ claimed that up to $10 billion of customer funds may have been used for risky bets.
The colossal mistake
FTT is the lynchpin of SBF’s enterprise. Then why on earth did SBF give $529 million worth of FTT to Binance?
Binance acquired a 20% stake in FTX for $100 million six months after FTX launched. FTX grew at a lightning pace. It became a competitor to Binance. The relationship between the two soured. Binance held up FTX’s ability to get licenses in certain jurisdictions. Fed up with the stonewalling, in July 2021 FTX bought back Binance stake for $2 billion. $529 million of the purchase was funded with FTT.
SBF is a crook, but he’s no dummy. He literally handed CZ, his largest competitor and enemy, enough FTT to disrupt FTX and Alameda’s transfer mechanism. SBF gave CZ the button to blow up FTX and Alameda.
Why would SBF do that?
I have a few theories:
At the time everything was above board - It’s possible that in July 2021, when CZ received his truckload of FTT, FTX and Alameda were not using FTT tokens to collateralize client loans between the two entities. Perhaps that only started in 2022 when crypto markets imploded.
FTX staggering valuation and growth - FTX’s valuation went from $0 to $32 billion in 3 years. Its revenue grew from $89 million in 2020 to $1 billion in 2021. Binance’s lack of cooperation was stunting FTX’s growth. FTX was willing to do anything to get Binance out and continue growing its valuation.
Hubris - SBF thought he outsmarted everyone. As long as he kept the FTT price elevated, Binance wouldn’t sell. He became the face of regulation. He pushed for regulation that solidified FTX’s position and hamstrung Binance’s.
From a business standpoint, handing CZ a mountain of FTT was the worst possible move. It sealed FTX’s fate.
A different ending
In the US, brokers must keep client funds segregated. Mixing client funds with the broker's own capital is illegal. It appears FTX illegally used customer funds to backstop Alameda. That happened before CZ hit the nuclear button.
There are two alternative endings that could have played out.
1. CZ didn’t hit the FTT sell button
CZ accelerated FTX collapse by threatening to sell his FTT. However, FTX would have likely collapsed regardless of CZ’s move. Fraud eventually catches up. CoinDesk’s article surfaced a weakness in Alameda’s balance sheet. The market would have exploited it. CZ just did it first in size.
Had CZ not hit the sell button, Alameda may have survived long enough to have a prepackaged restructuring. Clients would have likely been better off. A prepackaged restructuring is when all stakeholders cordially agree to divvying up the assets among themselves. It’s a cleaner and faster restructuring process that usually leads to higher recovery rates for creditors.
2. FTX didn’t support Alameda
Crypto markets would have collapsed in the summer had FTX not backstopped Alameda as I suspect it did. The pain would be bad. The outcome for FTX clients may have been better. Their funds may not have been absconded.
Who knows. Unfortunately, in both hypothetical cases, FTX depositors could have been better off. What transpired is the worst possible outcome.
How it will end
The hyper drama is over. FTX, including FTX US, filed for bankruptcy in the US. SBF is out. Restructuring expert John Ray III, who presided over Enron’s and Rescap’s restructuring, is the new CEO. A long arduous legal process will determine FTX’s asset value and how to distribute it between creditors, shareholders and depositors. Filing for bankruptcy institutes a freeze. Lenders can’t enforce. Assets can’t be sold. Stakeholders try to hash out a deal.
FTX's main assets are its venture portfolio and the technology it built. Some of the largest venture positions are in public tokens like Solana, Aptos and Sui. Those tokens all got smoked with the market worried FTX was selling them to fund withdrawals. FTX has best in class technology, but there’s a catch. There’s no buyer for it. Large exchanges all have their own tech. Plus by the time a buyer could access it out of bankruptcy proceedings it could be obsolete. I suspect FTX has very little cash on its balance sheet and in client accounts. Otherwise it wouldn’t be in this situation. The $7.4 billion of debt on Alameda’s balance sheet could all be loans FTX made to Alameda with client funds.
FTX may also have liabilities on its balance sheet, which would be senior to depositors. FTX is not a regulated US bank. Depositors are not protected. This is the first large restructuring of its type. It’s possible depositors will be subordinated to creditors and equity holders. Depositors could be last to get their money out.
The outlook is dire for the $16 billion worth of client deposits. I suspect in several years time they may get cents on the dollar.
SBF will likely face criminal charges. Absconding customer deposits is a form of fraud. It’s illegal, at least in the US.
The wider impact
This is a calamity of epic proportions. People who were not aware of crypto, will now be aware of crypto and SBF for all the wrong reasons. Books and movies will be made on this. Coincidentally, Michael Lewis was already working on a book on SBF. He’s got a new ending, guaranteed bestseller status and movie rights.
The wider impact is:
1. Contagion
The knock on effects of this will be larger than the spring’s crypto implosions. Nearly everyone outside of the US interacted with FTX. Notable funds, including Multicoin, had significant assets that are stuck on FTX. Assets on FTX were likely used as collateral for loans. Those lenders are now screwed. Funds will undoubtedly face redemptions, which will force even more selling.
The various assets FTX is associated with will be toxic. No one will want to own them fearing they’ll be getting dumped. That’ll trigger even more liquidations.
The spiral will continue.
2. Counterparty risk
Markets rely on trading counterparties. Counterparties provide custody, margin, trade execution and liquidity for buyers and sellers. Counterparties are the lubricants of the financial system. This episode teaches market participants not to trust crypto counterparties. That’s a shame.
Centralized exchanges represent 50% of crypto trading volume. They are a form of counterparty. They are also necessary. They are the onramps into crypto. They need to be trustworthy.
3. Regulation
SBF was the face of crypto regulation in DC. He had private meetings with prominent politicians and regulators. Heck he was even on Capitol Hill explaining how the bilateral bespoke lending that sank the financial system in 2008 did not exist with FTX because everything was transparent on chain.
Unbelievable.
Politicians are embarrassed they cozied up to him. He has been one of the largest Democratic donors. He pledged to contribute up to $1 billion to the Democratic 2024 Presidential campaign. Everyone was duped.
The White House has been monitoring FTX’s implosion. No one is of the mind to cut the industry any regulatory favors.
I suspect in western countries regulation of crypto on-ramps will be severe. They’ll be treated as brokers and/or banks.
4. Distrust
FTX is the third epic collapse in six months. Consumers are fed up with the nonsense. Optically, FTX collapse is worse than 3AC and Terra/Luna. The collapse was unexpected. FTX was a trusted reputable institution. SBF was the industry’s poster boy; a crypto American hero. FTX was the industry’s biggest success story. It all turned out to be a fraud of epic proportions.
5. Liquidity
Liquidity has dried up as a result of the second largest exchange imploding. Less liquidity means prices will be more volatile.
Did CZ orchestrate FTX’s fatal blow?
I don’t think so. But let’s play things out on the premise that a crypto calamity of this proportion is bad for everyone, Binance included.
So why did CZ push FTX over the edge?
1. Acquire FTX on the cheap
Binance was never interested in buying FTX. There was nothing of tangible value for Binance to buy.
Customers - No - There is an overlap between FTX and Binance customers. Binance can compete for these customers. It doesn’t need to blow up FTX to get them.
Deposit base - No - From the time CoinDesk published its article people were on to something shady going on at FTX. Deposits dwindled overnight.
Technology - No - Binance has its own top notch trading product.
FTX portfolio - No - Binance sees every private deal FTX Ventures was shown. The rest of the portfolio are public tokens anyone can buy.
There was no point in buying FTX.
2. Eliminate FTX
Pressing the nuclear button would eliminate FTX. But then why announce you’re then trying to save it?
If CZ did this knowingly, then surely he also knew it would be calamitous for the markets and crypto in general. Plus he helped eviscerate $16 billion of client deposits that Binance could have competed for.
That’s a steep price to pay to knock out your competitor. Who you already knew was on shaky footing.
3. Thwart regulation
SBF was close with key regulators in DC. Maybe CZ was worried something was afoot that would lock out Binance from the US market. Blowing up FTX at any cost may be worth not being regulated out of the US market and likely all western markets. That is sheer speculation.
4. Didn’t realize
Maybe he just didn’t realize the extent of his actions. By the time he did, he offered to save FTX. He then realized it was too much of a mess. Perhaps, but I think CZ is more clever than that.
The saga continues
Millions of crypto enthusiasts are crushed by the turn of events. Many have lost lots of money. The FTX bankruptcy will be a painful reminder on people’s minds not to get involved in crypto. I don’t think it will stop crypto.
People didn’t stop using banks or investing in the aftermath of 1929 and 2008. Nor did they stop using the internet after the dot.com bust. The difference is that banks, financial markets and increasingly the internet in the early 2000s was critical to daily day life. Crypto is not. It’s aiming to improve day to day life, but is falling short.
There is never a dull moment of crypto….but man the excitement is costly.
Stay curious.
Follow me on Twitter @samuelmandrew for my latest updates.
A special thank you to those who helped form my thinking including @jonwu @milesdeutscher @MikeBurgersburg @LucasNuzzi