Your Daily Dose of FTX

The first domino

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You may have heard FTX filed for bankruptcy. If you haven't heard of FTX and it's architect Sam Bankman-Fried, think Elizabeth Holmes, Bernie Madoff and Enron vibes.

There's a lot of noise going around, so I'll keep this one short and highlight my learnings on the situation (with occasional memes scattered throughout).

Hold on tight.

Read time: 3 minutes

Your Daily Dose of FTX

To give you a primer on the situation, let's introduce our players. Sam Bankman-Fried (SBF) owns an exchange called FTX where people and buy and sell cryptocurrencies. He also owns a hedge fund called Alameda Research. If you're a regulated financial services business like FTX you’re required to hold customer assets 1-1 in the denominated asset the customer deposited. 1 bitcoin = we hold 1 bitcoin, 1 dollar = we hold 1 dollar etc.

Simple right? Well, not so much. When you co-mingle customer deposits with your hedge fund, things start to get interesting.

To cut a long story short, Alameda borrowed $10 billion of customer funds from FTX and used their own token (FTT) as collateral. This represented more than half of FTX's $16 billion in customer assets. What's more, when you ask yourself what inherent value the FTT token holds, you'd be greeted by a bold four letter answer: None. FTT tokens were created out of thin air in the first place. This first domino had beed tipped.

Alameda used FTT holdings as collateral to borrow other cryptocurrencies from FTX. Let the contagion risk commence. What's contagion risk? Let's break it down:

Financial markets are dependent on one another. Because of this interdependence, an event in one market can create a knock-on effect in another market. It’s a bit like being unwell and catching another disease. Your immune system is already low, meaning negative effects are magnified. This is happening right now with FTX. Firms that had money sitting on their exchange are now going through bankruptcy court. Multicoin Capital, a blockchain investment company, had 10% of their portfolio with FTX. Coinbase CEO Brian Armstrong on the All-In Podcast said that he had other firms attempting to access emergency financing. The domino trail was falling.

Back to the mystical FTT token. There's a new player in our story. Changpeng Zhao, better known as "CZ" who's the Co-Founder and CEO of Binance, the world's largest cryptocurrency exchange. CZ got wind of the truth and was holding a lot of these FTT tokens. As a result he signalled he would dump his stake, causing the price of FTT to plummet. Because the FTT token was collateral to FTX customer deposits, things went south fast.

After FTX put itself in a dire state, CZ saw an opening to step in and acquire the company. 29 hours pass and the covers are pulled back– no hope. Binance pulls out the uno reverse card.

This part you can't make up

It turns out the Chief Regulatory Officer (head of compliance) of FTX, Daniel Friedburg, was behind the Poker cheating scandals at Ultimate Bet (UB) and Absolute Poker in 2008 which did the exact same thing, cheating poker players out of $50 million. He had been a top attorney for UB and had actively helped to cover up the scandal.

The crypto-poker commonality draws on. A decade ago, Full Tilt poker (a leading poker site) didn’t properly separate its player funds from their operational funds. In turn, they weren’t able to cash out players. This tweet from Melissa Burr wraps it up perfectly:

How do you unwind the mess?

The bankruptcy court will go through and find any assets of value with FTX. The tokens they hold, their venture portfolio (SBF owns c. 9% of Robinhood) etc. They’ll auction these assets off to willing buyers at a discount.

Former Treasury Secretary Larry Summers said this was similar to Enron:

… whiffs of fraud. Stadium namings very early in a company’s history. Vast explosion of wealth that nobody quite understands where it comes from.

There is an American proverb which dates back to the 1850s “Love many, trust few, and always paddle your own canoe.” The whole point of crypto is to trust nobody. Decentralisation is the game. FTX violated this principle being a centralised exchange.

The US needs to make a big decision on crypto. It’s now a political problem. SBF was the Democrats’ second-biggest donor. Crypto needs to be directed constructively through the correct regulation– education is the opening.

Mark Twain once said that “History never repeats itself, but it does often rhyme.” Elizabeth Holmes, Bernie Madoff, Sam Bankman-Fried…

What can we learn? Moving customer funds to backstop your hedge fund isn't the answer. I'll finish with a little something I worked up below after rumour escaped SBF was on the way to Argentina in his private jet. Until next week!

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