The FTX Apocalypse
A post-mortem of far reaching contagion
On November 11, 2022, the second biggest exchange in crypto declared bankruptcy. The once revered Sam Bankman Fried (SBF) has now turned into villain number one of the industry. How did a company that was once valued at $32 billion capitulate so quickly? How did a CEO that was once compared to Warren Buffet on the cover of Fortune manage to evaporate his net worth of $16 billion overnight?
During a bull market, everyone is a genius. But it takes real talent to manage risk and preserve capital during a bear market. Unfortunately, everyone was leveraged to the max, lined up for the supercycle, committed to 6 figure bitcoin…
Even veterans of the industry who have seen it all were shocked by last week’s events. This is not your average story of failure. This is a story of a man who portrayed himself as an effective altruist taking advantage of an entire industry. This is a story of such recklessness that even Adam Neumann would be appalled.
SBF was once a Jane Street quant trader who made his millions by arbitraging cryptocurrency in its early days when price gaps were significant. He used this trading model to raise capital for Alameda Research, his first trading fund, and subsequently the crypto exchange FTX in 2019.
As time went on, it appeared that Sam was invincible. Even in the wake of the Terra / Luna / UST chaos, FTX and Alameda not only managed to stay afloat, but they also bailed out Voyager Digital. They were widely perceived in the space as superhuman genius math-nerd traders.
However, the first cracks started appearing on November 6 when the CEO of Binance, Changpeng Zhao (CZ) announced that Binance was planning to liquidate the $2.1 billion of assets it received when exiting their FTX equity last year “due to recent revelations that have come to light”. $500 million of this equity was in the FTX exchange native token FTT.
Despite CZ promising to do it in a way that “minimizes market impact”, there was quite the commotion ripping through the market. Traders were nervous about a report leaked on CoinDesk the previous week about the balance sheet holes of FTX’s trading firm Alameda Research — $8 billion of loans against $14.6 billion of assets, but the majority of which were unlocked FTT at $3.66 billion and FTT collateral at $2.16 billion.
Most of these assets were illiquid. Alameda was holding more tokens than the current circulating supply — collateral essentially created out of thin air. With a market cap of $3.35 billion, any significant sale of FTT would immediately tank the price.
Which is exactly what happened.
The 28-year-old CEO of Alameda, Caroline Ellison, tweeted immediately that they would buy all of the FTT that Binance wanted to sell at $22. SBF followed on, reassuring that FTX assets are fine. The wall did not hold, however, as the market did not trust Alameda’s liquidity. Both have since deleted their tweets.
Users proceeded to rush for the fire exit as FTX saw $6 billion of deposits fleeing the exchange in 72 hours before withdrawals were halted due to a lack of liquidity.
Meanwhile, SBF was said to have been running around frantically trying to find $6 billion to plug the black hole in their balance sheet. Binance stepped in to sign a non-binding LOI to acquire FTX, which they later backed out of after due diligence.
As users were trapped on the exchange, a few peculiar opportunities emerged. First there was excitement that withdrawals had resumed, but in fact this turned out to be only a “family and friends” round. Various other windows opened for limited periods of time, including NFT purchases for millions of dollars to move balances, bribes for transfers through FTX Bahamas based accounts (claimed to be open because of the local Securities Commission but in fact done to recover personal funds), and FTX Turkey offramps. The oddest of all was a public offering of balance redemptions by Justin Sun through his ecosystem tokens, at an 85% haircut on the underlying value.
Just when things couldn’t get any worse, the exchange was hacked. Exchange balances were reported at $0 and there was suspicious on-chain activity as the exchange wallets were sending funds out to sell on decentralized exchanges, causing asset prices to drop further. Although not proven yet, it is believed to have been an inside job as “there is no way to have this much root access so quickly.”
Meanwhile, mysterious FTX co-founder Gary Wang was still committing code.
It later came to light that FTX had been transfering user funds to Alameda. Early estimates place unaccounted user funds between $1–2 billion, but actual amounts could be as high as $10 billion. Reuters reports SBF had built a backdoor into the accounting software to “alter the company’s financial records without alerting other people, including external auditors.”
Multiple warning signs had appeared before the event. On-chain transactions show $8.6 billion worth of FTT being moved on September 28. $4 billion worth of that transaction interacted with the FTT ICO contract, which was vested automatically and then sent back to FTX. Lucas Nuzzi of Coinmetrics believes that Alameda had actually blown up during the Luna eclipse of Q2 and used these vested tokens as collateral to secure funding from FTX to avoid bankruptcy and therefore forced liquidation of their vested FTT tokens in September. Supporting evidence can be found in the BTC and ETH balances on-chain declining significantly after the Luna collapse.
What makes this even more interesting is that leading on-chain analytics and fraud prevention firm Chainalysis did not alert the public to this comingling of deposits — perhaps because they also were a creditor of FTX. Chainalysis was also responsible for FTX’s AML and KYC systems.
It appears that SBF bailed out Blockfi and Voyager (who Alameda was a debtor to) in order to prevent their assets from being sold off in a bankruptcy auction — remember the circulating supply of FTT was too low to handle large sales. Plus this allowed SBF to put forth an image of “responsibility” and solvency in the face of industry turmoil.
Which brings question to his relentless agenda for regulation. This may even be the root cause of the initial spat between SBF and CZ before all the selling took place. Sam was pushing a DCCPA bill that would have had crippling effects on the industry by effectively requiring centralized oversight for all DeFi protocols. Sam had also previously called for “Blocklists” and the ability to freeze funds, despite not being able to explain why regulation is needed.
Such stifling policy would have destroyed the permissionless and trustless ethos that drives this industry.
A bit of digging into Sam’s background shows he is very well connected. Clinton and Blair (not to mention the second largest donation to the Democrat party), the WEF, the SEC, to name a few. The press coverage was cringeworthy — Fortune magazine compared him to Warren Buffet and J.P. Morgan, Bloomberg portrayed him as Robin Hood, and Nas Daily called him the most generous billionaire.
Even worse was how the mainstream media covered his blatant fraud. Reuters said he did the financial system a favor, NYTimes made it look like an accident (not to mention that he was sleeping just fine), The Washington Post celebrates his political contributions and lobbying efforts. They were too busy coloring him as an innocent entrepreneur who expanded too fast and was attacked by a competitor to notice that he had zero awareness of risk and had been taking the media for a ride all along.
Other coverage was more than revealing. In a series of chat screenshots to Vox, he admitted he regretted filing for bankruptcy and effective altruism was just a sham. Lending out customer deposits was “messier and more organic than that” and he seems to think he can still raise $8 billion. The NYMag published a complete exposé on him, including how he has been manipulating the press.
Meanwhile, Sam looked for every excuse possible. First, over the span of 48 hours he tweeted out “WHAT” and then “HAPPENED” letter by letter. Then he claimed Alameda and FTX had enough assets as of Nov 7 — which was a lie, provable by the blockchain. Then he blamed it on leverage — but exchanges write the rules of leverage.
More and more stories have been emerging about Sam’s reckless past. A billion dollar loan to himself. Exemption of Alameda from liquidation. His amphetamine abuse. Romantic relations with co-workers. Caroline’s strange Tumblr reflections. $74 million of company funds on Bahamas real estate.
So when FTX finally filed for chapter 11 bankruptcy on 11/11 after their assets were frozen by Bahamian regulators, it looked like a death blow to the industry and that we would be settling in for a long, harsh winter. The Bahamas Security Commission has seized all FTX assets. Depositors will likely receive 5 cents on the dollar according to the Block.
As John Ray III took the helm of the ruined FTX to supervise its bankruptcy with his 40 years of legal and restructuring experience from criminal activity and malfeasance at Enron to cross-border asset recovery and maximization at Nortel and Overseas Shipholding, he admitted that he had never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.”
This is truly the story that never ends. Early estimates place losses at over $15 billion, but just how far reaching the contagion will be is yet to be fully understood. Nearly all FTX Ventures Portfolio Projects had used FTX as their treasury and will see their tokens auctioned off in bankruptcy court to reimburse user funds.
One of the more concerning issues is just how much the Grayscale Bitcoin Trust Fund is wrapped up in this mess. The GBTC, a “protected” investment in BTC by the SEC, has reached an all time low of -46% to its underlying BTC. What’s more is that they refuse to provide proof-of-reserve, citing “security concerns.” Some on-chain analysts have already started taking steps to identify GBTC addresses. Coinbase has since confirmed that it holds 635k bitcoin secure for the GBTC.
Counterparty risk runs deep in crypto, especially as entities become overly entangled in highly leveraged trades, helplessly hoping for the supercycle to resume. Here’s the latest updates.
- FTX contagion chart, including Galois Capital who had half of its assets and Ikigai who had a large majority of their assets on FTX.
- Paradigm have marked their FTX investment down to zero.
- Multicoin, who had 10% assets under management on FTX, lost 55% of its capital
- Silvergate, one of the only two banking relationships that US crypto firms have, has reportedly been subpoenaed for money laundering.
- Digital Currency Group has a $1.1 billion balance sheet hole and Genesis is halting withdrawals. Investigation into their balance sheets has revealed some “amazing coincidences.”
- Tether is tied with FTX’s chief regulatory officer and an online poker scandal.
Trust has been shattered in the industry, at least in the short term. However, a long winter is not nearly as bad as the dystopian regulation that SBF was gunning for. Crypto may have lost the battle but it looks like it may be positioned to be winning the war in the long term.
