5MF (WEEK 46): TAKEAWAYS FROM FTX BANKRUPTCY FILING, BIG RECESSIONARY INDICATOR ARRIVES

Five Minute Finance

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BLOCK6

13 min readNov 18, 2022

The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.

Let’s see what’s going on this week:

Diving into FTX Bankruptcy Documents
Who Was SBF in Reality? Putting the Pieces Together
FTX Contagion Hits Yield-bearing Products
DeFi on the Rise — but Is It Sustainable?
Big Recessionary Indicator Arrives

“Unprecedented” SBF Fraud Explored

Are Regulators Behind FTX ‘Hack’? Creditors Appear to Think So (link)
FTX Lent Billions Worth of User Funds to Alameda Research: Report (link)

FTX Bankruptcy Paperwork Goes Deep into SBF Rabbit Hole

Sam Bankman-Fried’s fraud piñata just continues to grow.

No matter how many people punch it, the piñata keeps spilling out more conman-flavored candy. The shortest recap so far is this — SBF created tokens that he used as collateral for non-internet money loans, in addition to leveraging user funds for Alameda Research to gamble with.

The core purpose of FTX itself appears to have been to funnel money into Alameda, which was approaching its last legs when FTX launched in 2019.

The main SBF piñata puncher is now John Jay Ray III. As a 40-year veteran who restructured Enron out of its epic scandal (fake holdings and off-the-book accounting), Ray was appointed to do the same for FTX.

By the looks of Ray’s 30-page FTX bankruptcy report, we may have crossed a historic fraud threshold with FTX. Let’s start with his intro:

What’s so bad that could warrant such a strong term as “unprecedented”? In the briefest possible summary, here are the juiciest bits:

FTX didn’t have a CFO, an accounting department, nor board meetings. Remember, the company had a $32 billion valuation in January after getting $400 million in funding, led by SoftBank. SBF also paid $135 million for a stadium’s naming rights.
Alameda Research, run by SBF’s ex-girlfriend, gave SBF a $1 billion personal loan. Interestingly, the ex-girlfriend’s father is actually Gary Gensler’s former boss at MIT.
There was no separation between SBF’s operations. Specifically, between 4 business silos within FTX, as Ray points out that “Each of the silos was controlled by Mr. Bankman-Fried.”

SBF controlled the Alameda silo, a Ventures silo (FTX Ventures and affiliates), WRS Silo (FTX US, Ledger X and affiliates), and a Dotcom silo (FTX.com)
These silo directors had quite a game going: SBF paid himself $1 billion, Nishad Singh got $543 million, Ryan Salame got $55 million.
Instead of using the concept of accountants, employees submitted expenses over chats, peppered with emojis. The messages had a self-deletion ticker.
There was no cash management of any sort. Customer funds were allegedly used for buying employees’ and advisors’ properties in the Bahamas.
There was no proper record of who was employed. Contractors mixed with employees without proper documentation. There is also a possibility that some employees are fake because they can’t be located.
Customer deposits were omitted from the WRS Silo balance sheet. This suggests that user funds were directly funneled into slush funds for whatever purpose was present in the moment.

In the most recent storyline, FTX filed a surprising claim to the US Bankruptcy Court in Delaware on Thursday. Apparently, the Bahamas authorities ordered SBF to provide them with an “unauthorized access”, which he then used to transfer digital assets to the custody of the Bahamian government.

Does that mean that the purported “FTX exploiter”, who drained ~$600 million worth of funds, is actually the Bahamas Treasury? Stay tuned as this historically bizarre story unfolds.

Unfortunately for FTX customers, it appears there is not a single thing SBF didn’t lie about. The Chapter 11 bankruptcy filing places the fair value of liquid crypto assets at $659,000, instead of SBF’s previous figure of $5.5 billion for “semi-liquid” assets.

Overall, the total cash at hand appears to be at $564 million, which is much lower than the ~$900 million from initial reports.

SBF’s Fictional Public Persona Revealed

Sam Bankman-Fried Tries to Explain Himself (link)

Post-FTX Crash, Can Retail Investors Count on “Smart Money” Flows?

With millions of customers losing their FTX funds, and bankruptcies left and right, a question poses itself. Where was “smart money’s” due diligence?

Over the years, the legacy media had built up an image of Sam Bankman-Fried as the “crypto John Pierpont Morgan”, referring to the original JP Morgan saving the US banking system more than 100 years ago.

The media had also emphasized SBF’s veganism, frugality, and “effective altruism”. Sometimes, this became awkward.

For instance, Bloomberg’s piece on SBF in April was titled “A 30-Year-Old Crypto Billionaire Wants to Give His Fortune Away”, emphasizing that he drives a Corolla and sleeps on a beanbag. But at the same time, he gives himself a $1 billion loan and has a $40 million penthouse in the Bahamas?

It turns out, much of SBF’s persona was carefully crafted, as revealed by his own messages to a Vox reporter. For example, take a look at this exchange between a Vox report and SBF, where SBF’s words suggest his entire political engagement (he was second largest Democratic donor to George Soros) as fakery.

Image credit: VOX

More importantly, there was no self-reflection on breaching FTX’s own user agreement to not leverage customer funds. In SBF’s mindset, it appears that the only thing worth being regretful about is — losing the game.

In the aftermath, betrayed investors are bringing a class action lawsuit that targets both SBF and celebrities, some of whom are:

Kevin O’Leary
Tom Brady
Stephen Curry
Shaquille O’Neal
Naomi Osaka
David Ortiz

The lawsuit alleges that FTX took “advantage of unsophisticated investors from across the country”, demanding $11 billion in compensation. However, does it make sense to blame celebrities?

Temasek, Sequoia Capital, SoftBank, and MultiCoin Capital had poured billions into FTX, combined. They were all supposed to have smart analysts that did their due diligence (DD). Yet, it seems that nearly everyone went with the MSM flow. In the post-FTX crash, the flow appears to have continued.

Image credit: Twitter

The SEC missing in action is also revealing. In October, Gary Gensler’s SEC charged Kim Kardashian with $1.26 million for “unlawfully touting crypto security”. But after meeting with SBF in March, the SEC gave a no-action go-ahead for his operations.

Presently, lawyer John Deaton, in Ripple vs. the SEC, is gathering a petition for a full Congressional investigation into Gary Gensler. Some of the petition reads as:

“Now, evidence has emerged that proves that Gensler met with the mastermind of what may be one of the biggest frauds in American history, Sam Bankman-Fried, before the $14 billion collapse of FTX. Members of Congress have already been informed that Gensler was working with Bankman-Fried to give FTX a regulatory free pass while a massive fraud was going on right under the SEC’s nose.”

Exactly what was said between SBF and Gensler during that meeting is not exactly known. Gensler holds nothing was discussed which wasn’t previously discussed publicly. Other reports suggest Gensler was working with SBF and FTX to “work on legal loopholes to maintain a regulatory monopoly”, per Rep. Tom Emmer.

FTX Contagion Continues to Spread

Genesis Global Trading’s Crypto Lending Arm Halts Withdrawals, $2.8B in Active Loans (link)
With $3+ Billion in Deposits, Gemini Earn Halts Withdrawals (link)

Genesis Taints Gemini Exchange

In the unfortunate but not-too-surprising news wave this week, we’re seeing the FTX sickness continuing to spread — and toppling down the over-leveraged house of cards.

Genesis Trading disclosed it had $175 million locked in FTX two days post-crash. After Genesis suspended new loans and withdrawals this Wednesday, it is now seeking an emergency $1 billion in funding to boost liquidity.

Gemini exchange then halted its Gemini Earn program because Genesis Trading was its key partner. There is no reason to believe Gemini exchange itself is unwell because it is highly regulated and audited with 1:1 customer reserves. Yet, when people saw Gemini and Gemini “Earn” close together, it didn’t take much for a bank run to happen.

Gemini’s Bitcoin outflows took a severe dip after Gemini Earn paused withdrawals. Image credit: glassnode.

Once the Gemini Earn program was suspended, Gemini’s Bitcoin holders withdrew ~25,000 BTC in a single day, accounting for 13% of the exchange’s funds.

Overall, Gemini’s balance sheet shrunk from $2.2 billion to $1.7 billion in a couple of days, according to analytics firm Arkham Intelligence. Zoomed out from Gemini, over 220,000 bitcoins (~$3.6 billion) have been pulled out from exchanges since FTX crashed.

In the meantime, BlockFi withdrawals are still paused, with a bankruptcy filing the likely next step. After Terra (LUNA) collapsed in May, Bankman-Fried’s Alameda bailed out BlockFi with a $250 million revolving credit line.

What do all these companies have in common? They offered services beyond the custody of digital assets. Instead, users could employ their crypto assets to generate high yields. Like a bank does, when it uses deposited funds to create loan programs.

But, there is one big problem here, explained by one gnarly word — rehypothecation. To attract users, these platforms couldn’t just have 2–3% yields. Nope. For instance, Gemini Earn had as high as 8%, Anchor Protocol (on the Terra blockchain) went up to 20%, and Celsius had up to an 18% annual percentage yield (APY).

Who couldn’t resist that kind of passive income? As the “re” in rehypothecation implies, they had all reused customers’ collateral as a collateral for new loans to get those juicy, customer-enticing APYs up. This injects leverage risk directly into the financial veins, which tend to shrink in a bear market.

And you know what Warren Buffet says about leverage.

“My partner Charlie says there are only three ways a smart person can go broke: liquor, ladies and leverage,” he said. “Now the truth is — the first two he just added because they started with L — it’s leverage.”

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Unsurprisingly, DeFi Benefits from CeFi’s Eroded Trust — But For How Long?

Decentralization is Trending: DEX Tokens Surge Post FTX Collapse (link)

Could DeFi be the Silverlining of the FTX Collapse?

Now that it’s plain to see that Sam Bankman-Fried used customer funds as legos, where do we go from here?

Where can users put digital assets without them being obscurely abused? Based on the immediate reaction, the answer is clear — decentralized finance (DeFi).

A proper DeFi platform is self-regulated inherently. As they are hosted on a public blockchain, all transactions are visible. And as major decisions have to be voted on by all tokenholders of that platform, personality quirks and liabilities can be rendered harmless. Many have taken note of this, which is now manifesting.

Decentralized exchange (DEX) tokens, consisting of Uniswap (UNI), DyDx (DYDX), Balancer (BAL), and others, have outperformed CEX tokens by +26% since November 11th. That was not that difficult, considering their CeFi counterparts had Bankman’s FTT in the basket.

By the looks of it, SBF severely thrashed the credibility of CEX tokens. Image credit: Delphi Digital

By the same DeFi token, daily DeFi revenue jumped $8.25 million post-FTX crash. That’s a major upswing after having stagnated in the $4 million range since Terra collapsed in May.

DeFi revenue spike coincided with the bank run followed by FTX’s collapse. Image credit: The Block

Given the fact that most of these dApps are hosted on Ethereum, its on-chain activity trumped Bitcoin’s for the first time this year, as ETH volume outpaced Bitcoin by $650 million on Monday.

Adjusted on-chain volume (7-day moving average) on Ethereum vs. Bitcoin. Image credit: The Block

More tellingly, in the middle of November, on-chain stablecoin volume is setting for an ATH this year, at $532.54 billion. Clearly, SBF-created coins such as FTT, MAPS, and SRM spurred people to seek refuge in fiat-backed digital assets.

It remains to be seen if an uptick in self-custody will trend in the future. After all, fiat money conditioned consumers into centralized trust. Without it, the traditional fiat system wouldn’t ever work.

Trust in U.S. Government Debt Wobbles

Yield Curve That Matters Is Predicting a Recession Now (link)

Big Recessionary Indicator Shows Up

Something odd is happening — the yield curve is inverting. Sounds boring, right?

It doesn’t if you understand what’s at stake.

The latest data shows that the 1-month treasury yield is 3.93% while the 30-year treasury yield is 3.89%. What does that mean?

The federal government covers its shortfalls by allowing people to buy its debt. This debt can either be a treasury (up to one year maturity) or a bond (over one year maturity). Yes, the government raises money based on promises.

Except, the US government is backed by the IRS and, well, nuclear weapons. In return for buying government debt, investors get an interest rate — the aforementioned yield percentages.

Let’s say you bought $100,000 worth of government bonds at a 2-year maturity. After two-years, you would have gained $4,495 on that $100k.

Year-to-date, US bond with a 2-year maturity yield. Image credit: Trading View

Although nothing to write home about, that gain was guaranteed by the US government. Now, consider the range of maturities for buying government debt, from 3 months all the way up to 30 years. Each range has its own yield rate, generating…you guessed it…a yield curve.

In a healthy economy, a yield curve would go upward at the longer range. Of course it would. If you hold onto something for over a decade, it stands to reason your dedication would be rewarded with higher yields. Accordingly, the US treasury yield curve is supposed to look like this.

Healthy yield curve. Yield differential between 3-month and 10-year U.S. Treasuries is now at its widest point since the 1980s. Image credit: US Treasury

Now that the 30-year treasury yield is at 3.89% vs. 1-month at 3.93%, the yield inverted. What does that tell us? Investors don’t trust the government’s ability to service its debt. Imagine borrowing $1,000 from your friend. If he gave you the option of returning it in one month vs. 10 years, which one would you pick?

In macroeconomics, inverted yield curves are super predictive. For the last 7 recessions, they foreshadowed all of them, all the way back to the 1970s.

In recent years, the inverted yield curve in August 2019 was followed by a recession in March 2020, while the great recession of 2008 was followed by an inverted yield curve in August 2007.

This is just further evidence suggesting the Fed is not going to get its “soft landing” after all.

Tweets of the Week

It’s official.
The US Treasury curve is now more than 70% inverted.
In the last 50 years of history, every time we have surpassed this threshold a recession followed.
We are now at 76% with the Fed still hiking rates and doing QT.

@TaviCosta

2021 SPACs:
1) Cazoo, ‘’the digital revolution of car buying’’
-98% from ATH
2) AppHarvest, ‘’the 4th agri revolution’’
-96% from ATH
3) Galactic, ‘’leaving Earth for worlds beyond’’
-91% from ATH
4) Luminar, ‘’ground-breaking self-driving tech’’
-79% from ATH
We never learn

@MacroAlf

The 10 greatest acquisitions of all time

@QCompounding

The negative premium of Grayscale Bitcoin Trust Fund (GBTC) expanded to 42.7%, and the negative premium of ETH Trust expanded to 40.12%, both hitting record lows. Grayscale said it was not affected by the collapse of Genesis, also a subsidiary of DCG.

@WuBlockchain

Coinbase approached the SEC about offering a 4% yield product.
They received no clarity. Instead they received the threat of litigation.
Meanwhile, Celsius, Voyager and BlockFi were allowed to offer 10%+ interest products while gambling with user funds.
Good job, Gary.

@scottmelker