FTX Contagion

Sick and tired of it all

CEXs like FTX and Binance aren’t really exchanges in the way most people would think of an exchange. Unlike the NYSE or CME, trading venues such as FTX and Binance are more like broker-dealers. If you trade on an unregulated offshore CEX and hold assets there, you assume the full counterparty credit risk. This is true regardless of whether such CEX uses, or claims to use, cold wallets for some of customers’ deposits.

Up until Monday, 7 November 2022, I had about 1.5 BTC and around 130 FTT tokens on FTX. That’s a PA account. We now know that FTX commingled customer and firm assets, and that they gambled away customers’ assets, which is why they couldn’t withstand the concentrated withdrawals that were triggered by the “bank” run.

On Sunday, 6 November 2022, I smelled that something could be wrong because there was a lot of noise on Twitter regarding CZ and SBF and that CZ would sell all his FTT tokens. I decided to withdraw all my BTC from FTX and initiated a transfer to my Ledger wallet. It cost less than $1 to do this (network fees), and it was the right thing to do since I didn’t have any open derivatives positions on FTX for which I would have required the BTC as collateral. I could not withdraw the FTT tokens as those were staked.

Usually, based on my past experience on FTX.com, withdrawals took about 30 minutes to process and complete. I thought it would be the same this time around. However, I was wrong. On Monday morning CET the BTC still hadn’t arrived on my Ledger wallet. At 4 pm that day I had a call with colleagues of mine at EXPAAM and I told them “guys, I think something’s up.”

Just before we ended our call about 30 minutes later, I received an email from FTX saying that my withdrawal request had been successfully processed. I got out. It was pure luck as 30 minutes later FTX.com closed gates and stopped all withdrawals.

FTX was a relatively new player in the space. Founded in 2019, its 28 year-old founder and majority shareholder “SBF” (Sam Bankman-Fried) was a graduate of MIT and ETF trader at Jane Street.

Raoul, Moritz H. and I once had a Zoom with SBF when he was still living in Hong Kong to speak about his then newly-launched tokenized stock markets (e.g., tokenized Apple stock which users could trade 24/7 on FTX.com). We wanted to understand how it all worked. I remember being impressed by SBF (maybe in the same way the people at Sequoia Capital were) as he talked fast about really complex things and got them right. It was clear that he had very detailed market making knowledge from his ETF trading days at Jane Street. The call didn’t lead to anything and neither he nor us ever followed up on it. I presume SBF was too busy doing other things. What I remember though is that their tokenized stock markets involve a Munich-based market maker (my ZIP code) by the name of CM-Equity. I’m not sure to what extent they are exposed.

SBF established a two-year track record trading crypto assets through his personal hedge fund Alameda Research, focusing on the Sushi arbitrage which involved buying BTC relatively cheap in Europe or the US and selling it at a premium in Japan. It’s a location arbitrage trade. Some HFs and traders specialize in these trades, for instance in markets such as South Korea (Kimchi arbitrage), South Africa, Vietnam, or Turkey.

I’d really like to know who backed SBF’s Sushi trade. Was it all prop money? I don’t think so since he explained the trade in detail on an earlier Odd Lots podcast episode and it sounded like big dollars. Maybe the chapter 11 proceeding will reveal it.

I asked some people at Token2049 in London where I hosted the Crypto & Global Macro panel (watch it here on YouTube) with Dan Tapiero, Jordi Alexander, and Jean-Marie Mognetti. Nobody knew anything.

Presumably based on SBF’s trading success at Alameda, FTX managed to attract investments from some of the largest players on Wall Street and quickly became the second-largest crypto exchange in the world.

FTX began by offering trading services on a variety of crypto assets at low fees which declined further with volume, and users which had an exchange-held position in FTX’s native token, FTT, received commission discounts: The more FTT a user held, the greater the discount. FTX also allowed a lot of leverage, which attracted a lot of traders.

FTX had a $8 million seed round in early 2019. This was followed by a $70 million investment in December 2019 by CZ from Binance. In March 2020, FTX raised yet more capital (only about one year after its founding) and this round valued the firm at unicorn level.

FTX used some of that cash to acquire other players in the space, including Blockfolio and LedgerX - a CFTC-regulated derivatives platform.

By mid-2021, FTX had over one million users and transacted more than $10 billion in trading volume per day. Then, in July 2021, FTX raised another $900 million at an $18 billion valuation. Participants included Third Point, Sequoia Capital and many other well-known investors. Sequoia invested $214 million in FTX.

Meanwhile, FTX’s revenues continued to soar, increasing from $89 million in 2020 to

$1.02 billion in 2021. In October 2021, just a couple of months after its last round, FTX raised another $420 million at a $25 billion valuation from investors such as Ontario Teachers’ Pension Plan and Tiger Global. Amazingly, again only three months later, FTX raised an additional $400 million, with Softbank taking a big chunk of it, giving FTX a $32 billion valuation.

SBF kept a cool (or maybe weird) image with unkempt hair (Marc Cohodes calls it a mop), shorts and XL-sized FTX t-shirts. Everybody wanted to hang out with SBF it seems, from Tom Brady to Tony Blair and Bill Clinton. He put the FTX logo onto the Miami Heat arena. He donated to members of the Democratic Party, organized a huge crypto event in the Bahamas, and ran ads at the Superbowl.

Caroline Ellison then became the CEO of Alameda so that SBF could focus fully on FTX.

And then SBF came back onto the Odd Lots podcast where he explained the “magic token box” to Matt Levine (which now turns out to be true for the FTT token). He actually describes a Ponzi scheme on that episode. At the peak of the Ponzi scheme, SBF’s net worth reached $26 billion.

Subsequently, SBF focused on lobbying Washington and exerting his own political influence. His $5 million donation to the 2020 Biden campaign was the largest save for Bloomberg’s, and his $40 million donation to the Democrats for the 2022 mid-term elections was second only to George Soros.

His plays in Washington started to become a threat to CZ and Binance it seems - his leading competitor and investor.

On 2 November, Coindesk revealed that it had received a leaked snapshot of Alameda’s balance sheet. Of FTX’s $14.6 billion in assets, $3.7 billion were FTT, $2.2 billion were FTT collateral, and another $3.4 billion were in crypto of which $1.2 billion were in Solana. Alameda’s balance sheet was a collection of “magic boxes” worth zero.

Then events started unfolding fast.

On 6 November, CZ tweeted: “As part of Binance’s exit from FTX equity last year, Binance received roughly $2.1 billion USD equivalent in cash (BUSD and FTT). Due to recent revelations that have came to light, we have decided to liquidate any remaining FTT on our books.”

The only reason CZ sent out this tweet was to bring down FTX. Otherwise, he would have sold quietly.

A response was tweeted by Caroline Ellison, the Alameda CEO, shortly thereafter: “If you’re looking to minimize the market impact on your FTT sales, Alameda will happily buy it all from you today at $22!”

She was trapped. If FTT falls too much in value, Alameda becomes immediately insolvent.

A little later SBF tweets: “A bunch of unfounded rumors have been circulating.... FTX keeps audited financials etc. And though it slows us down sometimes on product, we’re highly regulated.”

But now the market is worried and FTX clients are headed for the exit door with $5 billion in withdrawal requests.

On 8 November CZ tweets: “This afternoon, FTX asked for our help. There is a significant liquidity crunch. To protect users, we signed a non-binding LOI, intending to fully acquire FTX and help cover the liquidity crunch. We will be conducting a full DD in the coming days.” SBF responds: “All assets will be covered 1:1. This is one of the main reasons we’ve asked Binance to come in. It may take a bit to settle, and we apologize for that. But the important thing is that customers are protected.... Note that FTX US’s withdrawals are and have been live, is fully backed 1:1, and operating normally.”

One day later, Binance announces that it won’t follow through with the acquisition. “As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations, we have decided that we will not pursue the potential acquisition of FTX” tweets CZ.

Finally, on 11 November, FTX files for Chapter 11 bankruptcy in the USA.

In the end it took only a tweet to start one of the fastest “bank” runs in history.

All this is a major setback for the digital assets space, and it’s unfortunately distracting from the many advantages of blockchain technologies. I am sick and tired of people in our space pretending to run a first-class business in a first-class way… only to do the exact opposite. Alameda looted FTX’s balance sheet and FTX gambled with customers’ assets. That’s a no-go. That should (and hopefully will) mean jail-time for SBF.

I sincerely hope that all bad actors get weeded out quickly now.