FTX Postmortem
What is FTX and What Happened?
FTX is (was) a cryptocurrency exchange that allowed people to buy and sell crypto assets. Along with Binance, the two exchanges process(ed) the majority of worldwide crypto transactions. Both are global companies and function unconstrained by regulatory bodies. Last week it was revealed that Alameda, a crypto hedge fun owned by FTX’s founder Sam Bankman-Fried, was using billions worth of FTT (FTX’s own cryptocurrency) as collateral for their loans. This FTT from FTX had no intrinsic value and called into questions FTX’s true liquidity. When it became known, Binance decided to sell it’s FTT holdings (it acquired these when it sold its equity stake in FTX back to FTX), totaling around $500 million. This caused the value of FTT to collapse and essentially started a bank run by FTX customers. Over $6 billion, billion with a B, in crypto tokens were withdrawn from FTX within a few days. The mass withdrawals created a liquidity crunch and solvency issues. Binance head, Changpeng Zhao, came out and said he was exploring a deal to acquire FTX to stabilize the crypto market, but then a day later he stepped away from the deal. Shortly after, FTX halted all crypto withdrawals. Previously SBF continued to say there were not liquidity issues but when the Binance deal fell through, SBF finally acknowledged the financial trouble FTX and Alameda were in. SBF told investors that FTX had loaned Alameda $10 billion, using customer deposits. It was reported by Bloomberg that there was a funding gap of $8 billion and that SBF stated he needed $4 billion for FTX to stay solvent. This past Friday, FTX announced it had filled Chapter 11 bankruptcy. The epic explosion of FTX caused all cryptocurrency to plummet, with total market cap dropping 24% in 2 days alone. On the week, the total crypto market cap fell over $200B.
The fall of FTX has triggered several discussions:
1. There are claims that Binance and Zhao orchestrated the collapse of FTX. Zhao and SBF have had differences in the past. Some have said that Zhao knew Binance dumping FTT would cause mass withdrawals at FTX and collapse the exchange. Reportedly Zhao knew that FTX would not have the liquidity to cover any mass exodus. SBF last week even cryptically tweeted “Well played, you won.”
2. The other major discussion has been around the accusation that FTX and Alameda were blatantly operating a giant Ponzi scheme and many entities turned a blind eye to it. Alameda took out loans and used customer deposits. They posted FTT as the collateral to borrow more funds, which was seen as cash on Alameda’s balance sheet. Rinse and repeat. I agree with those who think it was a massive Ponzi scheme. I do not think it was an innocent overleveraging that was the downfall of SBF and FTX, but believe there active intent to defraud customers. It was found that SBF secretly moved $10 billion in funds from FTX to Alameda. Of the money moved, $1-2 billion remains unaccounted for. SBF tried to cover up the $10 billion transfer, saying “we didn’t secretly transfer, we had confusing internal labeling and misread it” whatever that is supposed to mean. FTX legal and finance teams learned that SBF had implemented a “backdoor” in FTX’s books that allowed him to alter company records and move money without alerting others, including auditors. The backdoor also made it so that internal compliance was not notified, per FTX. Since the fallout, the SEC, CFTC and DOJ have started investigations into FTX’s lending activities.
Political ties, regulatory ties, and things that make you go hmmm:
Ties to MIT
SBF graduated from MIT.
Gary Ellison (father of Alameda CEO) Ellison is the Department Head of Economics at MIT. Before he became appointed to the SEC, Gary Gensler was a professor for the Practice of Global Economics and Management.
The former co-CEO of Alameda Research was also an MIT grad.
Gary Wang, the co-founder & CTO of FTX graduated from MIT and was reported as the wealthiest man under 30, yet almost no other information exists about him.
Silvio Micali, a professor at MIT, helped invent zero-knowledge proof and is the founder of Algorand. Skybridge (run by former White House Director of Communications Scaramucci) was a large investor and advocate of Algorand. Two months ago FTX bought 30% of Skybridge. In the past, Gary Gensler spoke of working with Micali and praised Algorand, despite being critical of PoS blockchain networks in the past.
The MIT Digital Currency Initiative was started in 2015 by Joi Ilto, who subsequently had to resign due to concealing his relationship with Jeffery Epstein. Bill Gates was also involved in funding the initiative.
James Lovejoy is another graduate of MIT who does research for the Fed in central bank digital currency (CBDC) and was involved in the MIT Digital Currency Initiative .
Government and regulatory relationships
SBF has pushed for crypto regulation and reportedly met with Gary Gensler to discuss a need for regulation. SBF also testified on Capitol Hill regarding this, and Gensler is on record saying that there needs to be more regulation in cryptocurrency. It is reported that SBF believed regulation would give FTX an effective monopoly in the US over Binance.
SBF met with David Solomon of Goldmans Sachs where thy discussed Goldman would help FTX get regulatory approval once regulation was in place.
The mother of SBF is a professor at Stanford and launched a Democratic PAC Mind the Gap. Shortly after, SBF became the second largest doner to the Democratic party.
Gabe Bankman-Fried, SBF’s brother, founded Guarding Against Pandemics and was a legislative correspondent for the US House or Representatives.
SBF’s dad in the past lobbied for hedge fund regulation in the US House Government Reform & Oversight Committee.
FTX Director of Engineering Nishad Singh spent close to $8 million donating to Democrat campaigns.
FTX US hired Mark Wetjen, who used work with Gary Gensler and took over the CFTC chairman position when Gary Gensler left.
SBF reportedly said he would spend around $1 billion in the 2024 elections.
The General Counsel for FTX included Ryne Miller, who used to be legal counsel with the CFTC and Gary Gensler.
Another counsel, Trevor Levine worked for the Justice Department.
FTX acquired Ledger X, which became the first approved US-regulated bitcoin options platform. The CEO Zach Dexter serves on the CFTC Technology Advisory Committee Cybersecurity Subcommittee.
FTX hosted a crypto conference in the Bahamas that included former US President Bill Clinton and Former UK PM Tony Blair.
Ryan Salame, Co-CEO FTX Digital Markets helped facilitate a $1.5 million donation to the Bahamas government.
The same Ryan Salame dated Michelle Bond, who used to serve as international counsel for the SEC for the implementation of Dodd-Frank and now is CEO of ADAM, Association For Digital Asset Markets, who works in partnership with leading financial firms and regulatory experts to devise a code of conduct for digital asset markets.
CFTC Commissioner Caroline Pham met with the FTX team earlier this year.
Other Sketchy stuff
Unknown where SBF got the large amount of seed money to get started and where he made his initial money.
Gary Wang is on the Board of Sequoia, yet he is literally unknown.
Chief Regulatory Officer Dan Friedberg was involved in the Ultimate Bet Poker cheating scandal that defrauded players of over $50 million.
SBF moved from Hong Kong to Bahamas to live on a commune with 6 others.
FTX had ties to Ukraine and backed a cryptocurrency donation platform and helped convert crypto into fiat.
Alameda previously released a report about tricks used by crypto exchanges to fabricate volume. A report by Bitwise indicated about 95% of transactions were bogus.
So what do I think? I think at the worst SBF is a fraud and that FTX was a large Ponzi scam. At the best, SBF knew he was misappropriating customer funds and lacked any risk controls. I believe SBF fostered government and regulator connections to influence them to regulate cryptocurrency and exchanges. His plan was to essentially give FTX and its entities an inside track to controlling US cryptocurrency transactions. It seems like Gary Gensler was working hand and hand to help advocate and facilitate regulation that would directly benefit SBF and FTX. There are allegations that PACs and other acquisitions were being used as fronts to launder money as well. In my opinion, SBF’s plan was to donate as much money as possible to increase his profile and become essentially untouchable. SBF donated around $40 million to Democrats in the midterms and $10 million to Biden in 2020. FTX also spent endless money on sponsors including Tom Brady and Steph Curry. FTX spent $135 million to name the Miami Heat stadium, $10 million to sponsor the Warriors, $17.5 million to UC Berkley football field naming rights, $210 million to TSM Esports naming rights, and an undisclosed amount also to Mercedes Formula 1 racing and the Major League Baseball. This money was spent to increase his celebrity and give SBF insulation. In 2022 when crypto lost over 50% value, it is unclear even how SBF and FTX were making the money they purported. There is a lot of smoke and with due time we will have more color. In my opinion this ends with SBF in handcuffs and many others implicated in a scandal that will end up possibly being bigger than Enron and Madoff.
Contagion?
At its peak last year the crypto market cap reached $3 trillion and in less than a year has fallen to around $820 million. FTX was the center of crypto investing in the United States. They were involved with major funds, including BlackRock and Sequoia. On top of that, FTX and Alameda were large investors in the overall crypto ecosystem. For example, they heavily backed Solana (SOL) and as FTX collapsed, so did SOL, down over 50% recently. SBF owns a 7% stake in Robinhood and Silvergate Capital (SI) is also looking at fallout as FTX made up a large portion of Silvergate’s deposit base. The run on FTX has also brought up liquidity concerns for other exchanges. Just today Gemini halted withdrawals and are said to not have enough funds to cover deposits and are actively trying to raise capital from investors. I believe more crypto exchanges will go under and liquidity questions could expose more frauds in the Crypto space. It my opinion, it has long been an open secret that the money is not really there backing crypto assets. Crypto has suffered in the global risk off environment of 2022 and with FTX blowing up, this has made the space even riskier. As the economy slows and risk-off continues in 2023, I expect more money to continue to flow out of the crypto space. Interestingly, the regulation that SBF fought for may become more likely after the FTX debacle. I think this massive failure will help push reform through in some degree. Today it was released congress is calling for a December House Financial Services Committee hearing regarding FTX.
Did SBF intentionally create a Ponzi scheme to defraud investors and enrich himself and others? Were government officials and regulators in on the fraud? Was this just a case of carelessness and poor risk management gone bad? What are the long-term implications for cryptocurrency. Hopefully we get some of these answers over the next few weeks, months, years.
*On a side note, one of the stocks I have talked about being a long 3-5yr hold $OSTK will probably be a beneficiary of any regulation. They own a portion of TZero, which is now being overseen by a leader of ICE (parent company of NYSE). The TZero platform was built to be SEC and FINRA complaint and will be a winner from any regulations passed by congress.
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