There was actually news this week in crypto that wasn’t related to FTX … but those things will have to wait. It feels incomplete to not pass along the news of Friday, so consider this an abbreviated issue to cover what we can now that it is the weekend. This may be the last FTX-specific issue – assuming we can do something we haven’t yet this week, which is to go 24 hours without another shocking revelation – but we will undoubtedly have related stories included after returning to our regularly-scheduled programming. This is going to be with us for a while.
Before getting into today’s issue, let us be very clear about what FTX is and what it is not. This is for those who think it is now open season on ‘crypto.’
FTX is not and has never been crypto. It sold ‘crypto’ as a product, marketed itself as ‘crypto,’ and attempted to position itself as the face of ‘crypto.’ In reality, it was a traditional financial institution that co-opted ‘crypto’ for profit while neither building nor supporting the open-source innovation movement that true crypto represents.
‘Crypto’ means open-source, transparent, decentralized, and verifiable. It means opening the kimono such that all layers of its infrastructure and incentive structure are publicly-available, free for anyone with internet access to learn about, review, and interact with. In the next fifteen minutes, I can go look at Uniswap’s codebase to understand how its protocol functions, how usage of its protocol is incentivized, what funds sit in its treasury and how the governance process operates to deploy those funds, and how users are interacting with the protocol in real-time, down to the individual transaction level – who is doing what, when, and with how much value.
FTX was none of these things. It was an organization built for opacity, one which only a handful of people had access to its technical infrastructure and financial reality. It was structured far more like a traditional bank than a crypto protocol, and the sooner people recognize that, the sooner we can hold an honest dialogue about what crypto is, is not, can be, and shouldn’t be.
That was serious, but this is fun. Because the best jokes have an element of truth in them.
The Finale (Extensive Post-Credits Not Included)
FTX filed for bankruptcy protection in the US early Friday morning. The writing was on the wall the minute Binance stepped away. FTX and Alameda Research were so entangled that they filed for bankruptcy together, and the filing estimates that the two firms had between $10B to $50B in liabilities. That is a massive range … and it is almost unfathomable how they could have run up a bill approaching the size of Lithuania’s GDP. Because the FTX Empire was propped up by shell companies, there are more than 130 affiliated companies that have filed for Chapter 11 bankruptcy, too. Get ready for very long and very complex proceedings.
As part of the bankruptcy filing, SBF has resigned. The guy is still dropping Twitter threads, driven by what appears to be a compulsory need to hear himself type. Through all of this, the man has at least retained his incurable addiction to lying: ‘I was shocked to see things unravel the way they did earlier this week.’ He’s also broke.
Even after filing for bankruptcy, FTX continues to bless us with content: FTX’s new CEO, John J. Ray III, was the lawyer that was brought on to clean up Enron. I checked this in four places – here, here, here, and here – and it’s true. Movie producers had to be behind this announcement. There is no other explanation.
Then late Friday night brought the next set of twists and revelations.
First, it was reported that SBF implemented a backdoor into FTX’s bookkeeping system, allowing him and his inner circle to alter the company’s financial records without alerting others, including external auditors. In case you’re wondering how someone can move $10B of customer deposits off the platform and avoid triggering internal compliance notices, that is how you do it. Malicious intent, through and through.
It also confirmed what had already been suspected and widely assumed: the FTX and Alameda Research executives knew they were using customer funds. This wasn’t ‘mislabeling’ or a ‘poor decision’ – this was outright fraud of the worst kind.
Lastly, more than $600M of assets were drained from FTX International and FTX.US accounts, from both the company’s treasury wallets and customer wallets that had seen withdrawals locked earlier in the week. This was initially feared to be an insider running off with the remaining funds, but it has been confirmed that the entire platform was hacked. The chaos refuses to end. [PSA: Do not install anything related to FTX, turn off all automatic updates for any FTX-related apps on your mobile devices, and remove any bank accounts linked to FTX.]
Asked about the missing funds, SBF responded, “???”. Screenshot for proof:
I called this crypto’s Lehman moment previously, and I stand by that for what it means to the industry. But there is a very important distinction that should be made: whereas Lehman’s collapse was followed by taxpayer-funded bailouts from the government (for other companies, not Lehman), such a ‘lifeline’ will not be provided here. The US government spent $787B of taxpayer money bailing out banks and waved away any serious effort to prosecute involved individuals.
That isn’t to say this is a good outcome – as my wife put it, those who have lost everything on FTX would probably appreciate having the government backstop their losses right now – but it does show a market correcting itself organically. Again: I think everybody’s preference would be to avoid an event like this, which is why poor policy and questionable diligence processes should be thoroughly examined, as should the allowance of an offshore, unregulated, opaque financial institution to fabricate an image of legitimacy. Regulators should have investigated why a company servicing US-based users opted to create a web of offshore legal entities; maybe FTX investors should have pushed for a company with billions in venture capital funding and worth $40B to put together a board of directors.
It is never good when the modern caricature of corporate greed drops this quote about you:
The Infection
Those with minimal or no exposure to FTX were the first to go public. Now, expect to see the trickling of information on those not as fortunate.
We have seen several companies come forward confirming that their corporate treasuries were held on FTX and are now inaccessible, likely lost forever. It is widely reported that BlockFi is such a company, and Ren Protocol has self-reported themselves similarly. It has also surfaced that SBF is trying to liquidate FTX’s Robinhood equity behind BlockFi’s back, despite those shares being used as collateral and, thus, the property of BlockFi. Anthony Scaramucci’s SkyBridge Capital is trying to buy back FTX’s 30% stake in his company; good luck with that. A hedge fund, Galois Capital, has admitted to having $100M, half of its capital, stuck on FTX. Many of the smaller projects that raised money from FTX or Alameda Research were asked to keep those funds on the platform as part of the deal, so that FTX could ‘monitor the investment’ steal those funds and use them for leverage. It appears that they lied and stole in every conceivable way.
Trading firm Genesis has at least found a backstop in their parent company, Digital Currency Group, receiving a $140M equity infusion to offset their treasury assets currently stuck on the FTX platform.
This extends beyond crypto. It is rumored that SBF’s reach included university funding, and as such researchers at those university programs are losing jobs entirely unaffiliated with crypto (aside from the fact that, you know, they were funded by crypto customer deposits).
Large centralized exchanges and intermediaries continue to release proof-of-reserves. Crypto.com decided to share transparency on their customer assets:
Yes, that graphic shows that less than 12% of assets on their platform are stablecoins and nearly 20% are held in Shiba Inu, a Dogecoin-like derivative. These are customer assets, not the platform’s treasury reserves, but … woof. That is a lot of memecoin on a single platform. The company was pressed to provide proof-of-reserves, to which they said they will ‘in the next couple of weeks.’ That is … not encouraging. That sound you hear is the phone ringing at Staples, Inc. headquarters as the putrid Los Angeles Lakers beg for their old sponsor back.
In what is now a footnote to this entire story, the Miami Heat have already begun stadium renovations to remove the FTX logo. The organization is also looking to end its 19-year (!) deal, worth $135M, less than two years into it. At the time, SBF shared this about the sponsorship: ‘We don’t need the other 18 years to have the funds … It’s been a pretty good year for us.’ How long ago last year now feels.
Fight vs. Flight
It is unsurprising to hear those outside of the industry express concern or caution about continuing on with crypto. It is also understandable that some within the crypto industry are questioning their place. It is rumored that tranches of senior leaders across the industry may leave their posts for more traditional pastures; the brain drain from traditional industries into crypto is officially on pause, and may be headed the other way for the intermediate term.
It feels like there are two camps of believers: the first finds this event tiring and demoralizing, the straw that has broken the camel’s proverbial back and may push them to step away; the second finds themselves motivated to double down and further commit to helping this innovative technological breakthrough fulfill its potential. I fall in the latter camp, but that is because my optimism for what crypto can be is unrelenting and uncompromising. Nobody said it was healthy.
The Future
This event has and will harm the crypto industry’s reputation but it should neither define it nor invalidate its promise.
Going forward, there appear to be two paths to building sustainable, reputable businesses: regulated, US-domiciled platforms and fully decentralized protocols. Everything in between is noise. If you are building in crypto and choose to avoid regulations and onshore oversight, you better build an antifragile organization that puts open-source software at its center and removes the potential for a small group of individuals to act without recourse.
Fed Up
We’re pretty over the SEC, at least given current leadership. There is noise swirling about Gary Gensler’s friendly relationship with SBF, specifically that the SEC was concocting side deals with FTX to allow them to move onshore and gain amnesty. That this approach to working with FTX stands in stark contrast to how the SEC has dealt with almost anyone else building in crypto would make the confirmation of these rumors even more damaging.
Some good news, relatively speaking: the dreaded DCCPA bill that SBF supported and lawmakers were trying to hastily push forward following FTX’s collapse sounds like it is on life support. The leaders of the bill still want to pursue it, but all of that FTX lobbying power is gone. Also, we could be looking at a new Whip (Representative Tom Emmer) and lead for the House Financial Services Committee (Representative Patrick McHenry), both of whom are pro-crypto and anti-Gensler. Next year could be the first that we see meaningful pro-crypto legislation.
More ‘How Did We Miss This?’
This section exists entirely to point out this interview that the CEO of Alameda Research, Caroline Ellison, gave in which she admitted to ‘not using math’ and ‘not using stop losses’ while running a crypto trading book worth billions. It’s shocking how nonchalant they were publicly about what they were doing.
Okay, this section also exists to call out this: Alameda promised ‘high returns with no risk’ as part of their 2018 fundraising pitch. That should have been a red flag for regulators. At least they’re catching on now.
A Speculative Theory
Last Bits of Fun
This sums it up about as well as one can for all generations and asset classes.
And we saved the best for last:
Source Code
FTX Files for Bankruptcy Protection in US; CEO Bankman-Fried Resigns
Embattled Crypto Exchange FTX Files for Bankruptcy
Alameda, FTX Executives Are Said to Have Known FTX Was Using Customer Funds
Exclusive: At least $1 billion of client funds missing at FTX
SBF’s disgrace could make things awkward for Gary Gensler and the Democrats
[Disclaimer: Any opinions expressed are solely my own and do not express the views or opinions of my employer. Because the information included in this newsletter is based on my personal opinion and experience, it should not be considered professional financial analysis or advice.]