Notes 11/10: FTX Crashes

Regulation can’t come soon enough to cryptocurrencies.

The asset class, which surpassed $1 trillion in market capitalization during the pandemic, seems to be imploding under its own bloated valuations. FTX, the world’s fourth largest (or third largest, depending on the source) cryptocurrency exchange, has become the latest crypto entity to fall by the wayside.

The value of its native token FTT has plunged and the company’s balance sheet, apparently, has a massive hole. It needs a bailout but no one is willing to step up to the plate. Crypto exchange Binance, which kickstarted FTX token’s price decline, has backed off from a possible bailout.  

A Fast Collapse

FTX’s collapse was triggered by the publication Tuesday of a report in online publication Coindesk that discussed finances of Alameda Research. The research firm, which was co-founded by FTX CEO Sam Bankman-Fried, has $3.66 billion worth of “unlocked FTT” on its balance sheet.

It also has around $2.16 billion of FTT collateral and $292 billion of “locked FTT” on its liabilities side. Other “significant assets” on its balance sheet were also from companies that Sam Bankman-Fried has invested in or cofounded, such as Solana and Serum. FTX is also supposed to have made a loan $10 billion to Alameda using customer funds.      

That FTX and Alameda’s finances are intertwined is not news. It was already made clear earlier this year. But the extent of its exposure to FTT tokens, almost 40 percent according to some estimates, shocked many.

One of them was Changpeng Zhao or CZ, co-founder of Binance – the world’s biggest crypto exchange by trading volume. Thanks to crypto’s incestuous dealings, Zhang is also an investor in FTX. He threatened to sell all the FTT he had received as part of his investment after the Coindesk report was published. With a worth of roughly $2.1 billion, CZ’s FTT holdings were substantial.

A Run and A Failed Bailout Attempt

That action, apparently, instigated a stampede at FTX. Panicked investors began withdrawing their crypto from FTX and customers withdrew $650 million worth of assets from the exchange on November 7th. They also yanked 20,000 Bitcoin off the platform, bringing down its holdings of the cryptocurrency to just one. Meanwhile, CZ swooped in with a term sheet to acquire FTX.

The story does not end here. Binance has backed off from a possible bailout after learning of a $6 billion hole, or mismatch between assets and liabilities, at FTX.

Meanwhile, the price of FTX’s native token has crashed and it has stopped withdrawals on its exchange. Major players in the small crypto universe are distancing themselves from the fiasco by claiming that they do not hold FTT tokens. The website for Alameda Research has also gone down. Coinbase stock is up after analysts said FTX customers, if they still have the appetite to invest in crypto, might migrate their holdings to the exchange.

A Tried and Tired Script

For those who have tracked or followed crypto news, with even the mildest of interest, events in the last 24 hours are not surprising. It is a familiar cast of characters and script. The investor runs, the pause on withdrawals, the “holes” in balance sheets, the shrill hand wringing on crypto twitter…these are part of crypto’s hackneyed script and its bid for maturity.

In their attempts to imbue events occurring in its ecosystem with importance, crypto proponents and enthusiasts are using historical parallels. FTX was Bear Stearns two days ago and has morphed into Lehman Brothers now. Sam Bankman-Fried or SBF was the JP Morgan of crypto. He is now a fraud.

But Lehman was an established bank with a storied history when it fell. FTX’s life has been a relatively short one. It was launched in 2019 and the crypto ecosystem is a fledgling industry. JP Morgan also, singlehandedly, propped up the panic that spread through financial markets in 1906. SBF, for all his genius, is hardly a lone ranger in crypto.     

An Absurd Transparency

The most striking thing about the latest turn of events in crypto is its absurd nature. The world’s biggest crypto exchange invested in a competitor without due diligence and cannibalized its own balance sheet by attempting a hostile takeover during a run. The solution being offered to prevent similar mishaps in the future is an equally ludicrous mishmash of technical terms that mean nothing: publishing ‘proof of reserves’ or lobbying for on chain transparency.

As I have mentioned before, for an asset class that touts its transparency credentials, crypto is opaque. Simply being able to see your transactions online on a public blockchain provides no tangible benefit if the balance sheet of companies that interact with the public blockchain remain hidden.

Even after the latest FTX fiasco, several questions remain unanswered. How big is the size of FTX’s hole? Who are its customers in Asia – a company cannot claim to be worth $32 billion without some very big customers? How did FTX pass the scrutiny of investors and the press and manage to hide the discrepancies on its balance sheet for such a long time? What happens to all those crypto donations made by SBF and his brother’s Super PACs? Most importantly, what happens to the FTX Arena and Tom Brady – an investor in the exchange?

SBF had become a prominent voice for crypto regulation and regularly made Congressional appearances to argue his case. He will likely not be invited next time.

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