🚨 11.9.22 🚨
History, and not the good kind: crypto's Lehman moment ... FTX submits to Binance, CZ dethrones SBF, and another hero propped up on leverage and centralization hits the mat
Welcome to the most stunning event in crypto’s history since Mt. Gox, and one that may even surpass the fall of the first major Bitcoin exchange in importance. When everybody’s bailout needs a bailout, an emergency newsletter is in order. These are, legitimately, extraordinary times.
This post will cover only one news item – Binance’s mega-acquisition of FTX following the latter’s ‘liquidity crunch’ – but it will try to unpack all that is publicly known on November 8, 2022. There will undoubtedly be follow ups shared in future newsletters. Please be warned: the commentary attached to this news is not measured in pinches or sprinklings but rather cups and quarts so the ‘views are my own’ disclaimer at the bottom has never been more relevant. I’ve been told I have strong opinions; that might come through here.
If you don’t have the context for why Mt. Gox is widely considered the most memorable event in crypto’s history, I direct you here. Considering its centrality as the de facto on-ramp to Bitcoin at a time when few other cryptoassets held any relevance, it was difficult to imagine another singular event surpassing it in magnitude.
Until today.
What follows is a summary of how we got here, why it matters, what it means, and where we’re going. The chaos is compelling enough but there will be gifs for you throughout and we’ll end with some highlights from that thing that Elon Musk bought and is running into the ground Twitter.
How We Got Here
🪢 The Entanglement
To understand what sits at the center of this entire event, we have to briefly cover the relationship between Sam Brankman-Fried’s two businesses: Alameda Research, the crypto trading firm, and FTX, the crypto exchange.
Alameda was the first born, a successful crypto hedge fund that pivoted to becoming a market maker in crypto. It earned a mixed reputation: somewhat good for delivering exceptional investment returns, and somewhat bad for quietly but unashamedly dumping on retail investors.
FTX came next, founded as a platform ‘for traders, by traders.’ Alameda acted as the first market maker for FTX, giving it the liquidity needed to get off of the ground. FTX ‘repaid’ that favor by settling in as Alameda’s piggy bank. And the virtuous cycle of the highly profitable exchange funding the highly profitable trading operation began.
But to simultaneously supercharge it and insulate each entity from scrutiny, a token was needed: enter, the FTT token. FTX would create FTT almost literally out of thin air, sell it to Alameda on the (very) cheap, position FTT as a valuable asset for traders (discounted fees) and retail investors (access to the privately-held FTX rocket ship), and then take it back as collateral from Alameda, lending out customer deposits to fuel Alameda’s trading engine. And poof: three years pass and there sits FTX as one of the largest global crypto exchanges, Alameda as a renowned trading firm, and SBF as the industry’s institutional figurehead. What could go wrong?
Oh yeah, and some on-chain sleuthing may have unearthed proof that FTX provided Alameda a massive bailout during that first wave of contagion earlier this year. SBF wasn’t exactly forthcoming about that, but as you’ll read, he believes transparency is more of a ‘do as I say, not as I do’ objective.
🧑🤝🧑 The Relationship
Going into this past weekend, Binance and FTX were two of the largest centralized exchanges in the world. In 2021, they combined to facilitate more than $27T in crypto trading volume. Not sure if you’ve seen a few trillion dollars before, but it’s a lot. Trust me.
Despite being competitors now, they actually began as friendlies – Binance was an early investor in FTX. But last year, FTX bought out Binance’s remaining shares in FTX, ending the previously amicable relationship. The devil, as he always is, is in the details: FTX paid Binance ~$2.1B for the shares, most of it coming in FTT, that sneaky little FTX token. We’re going to come back to that shortly.
💥 The Catalyst
Fast forward to this past weekend and recall that FTT-funded buyout. Changpeng Zhao, the founder and CEO of Binance and affectionately referred to as CZ, shared that Binance was going to sell all of their remaining FTT tokens – roughly 7% of the entire FTT supply – ‘due to recent revelations.’ No public warning, no ultimatum. Just a simple 811-character, four-tweet thread announcing a $2B+ trade and the thinly-veiled assertion that FTX’s balance sheet is short on solvency. Casually cutthroat. King shit. (Not great for the industry, though.)
📟 The Response
Caroline Ellison, the CEO of Alameda Research, was the first of the Empire’s admirals to respond, publicly debunking the rumors and offering CZ to buy all of Binance’s remaining FTT tokens for $22. Weirdly specific number. Clarifying the exact price level you would defend might not have been her best move, as those of us who studied the Terra Collapse of 2022 can attest. Somebody skipped class that day.
CZ passed on the deal. You know, for risk management purposes, applying ‘learning from LUNA.’ Knife, meet artery. All of this happened on Twitter, so yes, you will be paying $8 per month to use the app and no, nobody believes you when you say you can live without it.
Meanwhile, SBF remained eerily silent. It was deafening, especially when considering that the primary charge levied against his companies – insolvency – not only invites immediate reputational scrutiny and the risk of a bank run but is relatively easy to squash … if there are no issues. It would be one thing if SBF was a known recluse like Clay Calloway, but the guy writes a Twitter thread every 36 hours, is on CNBC more often than Jim Cramer, and lives on the campaign trail of crypto-friendly politicians. His social media disappearance did not go unnoticed. Red flag number one 🚩.
😨 The Reaction
Unsurprisingly, the market began to more seriously consider the concerns surrounding FTX. Two and two have rarely been put together quicker: FTX and Alameda owned ~75% of the entire supply of FTT, most of which was considered illiquid – any meaningful selling of it would trigger a price crash. FTX’s stablecoin reserves fell precipitously and the amount of ETH held on its platform dropped 70% in two days. Then FTX stopped processing withdrawals. Still, no word from SBF or FTX. Even senior FTX employees and investors were out of the loop. Red flag number two 🚩🚩. I’m pretty sure the recovery rate for every exchange that has stopped processing withdrawals while having their solvency questioned rounds to zero percent.
The contagion, of course, was not limited to FTX or FTT. All crypto asset prices were impacted. But the chaos introduced and the growing fears of this being the second coming of Terra-LUNA forced the FTX Empire to pull out the emerging market central bank playbook and hastily defend its currency (FTT), sacrificing other well-meaning but less critical assets (hi, Solana) in the process. [Solana was a large position on Alameda’s balance sheet and the Layer-1 blockchain network SBF has been closest to.]
And then SBF finally spoke, dropping an ‘FTX is fine’ tweet. If we’ve learned anything this year, it’s that such a tweet signals the end. Red flag number three 🚩🚩🚩. Curtains. [He has since deleted the tweet.]
🪦 The Result
FTX, in need of billions to plug a growing liquidity hole and an immeasurable amount of reputation likely lost forever, had no choice but to bend the knee and submit to Binance, culminating in the latter announcing a non-binding letter of intent to acquire FTX and its assets, excluding FTX.US (for now). Also, in the day’s least surprising news, SBF’s crypto bill is ‘dead’ in DC.
The acquisition offer may be legitimate, or it may simply exist to give the market time to find its nerves and help FTX find a buyer to fill their liquidity hole. (You can probably count Coinbase out.) Even if it is the latter, the hole is rumored to be in the billions (plural) and the phrasing used – ‘save the industry and users’ – implies that it is substantial. Know anybody with a few billion dollars who wants to prop up an over-leveraged, maybe-insolvent crypto exchange with zero reputation left? Bueller?
Considering the catalyst for this came less than a week after CoinDesk released a report questioning Alameda Research’s finances, the concentrated nature of its FTT position (41% of the firm’s holdings), and FTX’s ties to the trading firm, history may view CZ’s actions as a masterclass in subterfuge … if they don’t dock him points for permanently damaging crypto’s public reputation. What kind of person manufactures a bank run on his competitor, cuts that competitor off at the knees citing ‘risk management’, waits for them to bleed out, and then offers a lifeline, only to humiliate them further by publicly shaming their management ability? CZ just turned SBF into Reek.
As a side note, expect to see more news come out about lenders with exposure to Alameda as FTX wasn’t the only firm that lent to them. I can take an educated guess that the lending firms hit by the year’s earlier contagion – eg BlockFi – probably didn’t avoid Alameda either. Between the hundreds of counterparties attached to FTX in some form and those with direct relationships with Alameda, we are back on contagion watch. Get those hazmat suits out of the closet.
Why It Matters
FTX has infected a large number of capital market participants, including but not limited to:
Crypto startups who held assets with FTX;
Crypto lending companies who were bailed out by FTX;
Crypto lending companies who lent to Alameda;
World-renowned venture capital funds of both the traditional and crypto-native ilk;
A massive Canadian pension fund that has had exposure to nearly every rotten apple from this cycle;
And even traditional finance institutions that saw FTX as ‘clean’ crypto.
FTX was viewed as something more akin to passive crypto beta than anything that would exist in the same stratosphere as the scary, shadowy coders perpetuating the radical idea of decentralized and permissionless services. This made it the preeminent partner and investment target for the crypto curious, and why we will be stuck with this as a leading story for however long the contagion and media decides.
Let us briefly cover why FTX’s fall from grace is as historically stunning as it is destructive.
From media darling to dust, in days. Over the last two years, FTX became the industry’s media darling, largely on the back of founder and CEO Sam Bankman-Fried’s rapid ascent up the billionaire rankings and his and the company’s growing position as the regulator-friendly face of crypto. The image cultivated was one of ‘clean’ crypto: FTX, and by extension SBF, was a crypto brand open to working with regulators and rubbing shoulders with politicians, one that could be confidently plastered across NBA arenas and MLB stadiums, one that brought legitimacy and institutional gravitas to an industry plagued by anonymous figures and shadowy dealings.
In reality, he was a trader first, crypto champion distant second (third?), and spent much of the past few months grandstanding about the need for more regulation, better governance, increased transparency, and eliminating leverage-fueled practices … only to commit neither of his private businesses to those ideals. Greedy, touristy grifter sounds too strong, but … if it fits?
Celsius, FTX, and others dug the grave; regulators are coming to fill it in. Regulators are going to use FTX (and Terra-LUNA, and 3AC, and Celisus) to bury the crypto industry, or at least the parts they find most abhorrent. Crypto won’t die – I’m far too optimistic of a person to believe that – but … woof. Crypto can live with smart, thoughtful regulation that doesn’t violate the neutrality of code. It’s just hard to argue from a position of strength when several of the biggest tokens have been proven as Ponzis and the largest lenders and exchanges are insolvent.
Still, the fight rages on in the immediate. While the CFTC is now ‘monitoring Binance’s acquisition of FTX,’ one must ask the question: where were they when a major exchange and custodian was propping itself up by lending out customer assets in the first place? I know they didn’t miss the opportunity to look into FTX; we just spent the last six months hearing how integral SBF was to discussions with regulators. And I know they wouldn’t possibly miss something as big as this to go after the one segment of crypto that is transparent, financial services built on open-source cod … oh, wait.
Too big and too well connected to fail … fails again. FTX was backed by fucking everybody, the kinds of names that should all but guarantee an outcome such as today’s is impossible: Sequoia, Paradigm, Lightspeed, Ribbit, Multicoin, Circle, BlackRock, Tiger, SoftBank, VanEck, Temasek … I think you get the point. Sequoia, specifically, invested in a $420M round at a $25B valuation a year ago and a $400M round at a $32B valuation ten months ago. It’s hard to think of a worse or more public outcome in their recent history. None of those firms have clarity on what value their equity stakes have, if any. To see that and have all of these names around the table of one of the largest centralized exchange companies in the world – one of the more straightforward business models in crypto, if run reasonably – and have it dissolve in a matter of days is a dot-com bubble- and Lehman-like event. The precedents are events without precedence.
An investment portfolio in flux. FTX also backed several very meaningful startups themselves through their own venture arm, including Yuga Labs; Circle; Layer-1 blockchain networks Near Protocol, Sui, and Aptos; BlockFi; and countless others. One project has already come forward to share that in the midst of FTX’s attempts to protect itself, it violated a vesting agreement prohibiting it from liquidating the company’s tokens. To put it bluntly, few will escape the contagion.
This might also be a good time to remind everybody reading that FTX bought a 7.6% stake in Robinhood in May. Remember when SBF had dreams of acquiring Robinhood on his way to acquiring CME and Goldman Sachs? Fun times.
What It Means … And What It Doesn’t
First and foremost, grab a jacket because we’re in for a long winter. The kind that Ned Stark tried to warn everybody about.
Put some respeck on Coinbase’s name. We are all Coinbase stans now. For all of their issues, they operate within regulatory boundaries (as best as they can, considering), produce audited financials regularly (a ‘perk’ of being a public company), and don’t take unnecessary risks with customer funds; they play the long game and they play it clean.
Crypto solved crypto’s problems. FTX’s stunning demise is a black mark on the industry; of that, there is little doubt. However, FTX’s liquidity crunch was not solved by a government, taxpayer-funded bailout but by a competitor stepping in to acquire their assets and liabilities. Distressed acquisitions using corporate assets are a healthy and necessary market function. Let’s not forget that.
Crypto and DeFi, again, is not the problem. DeFi continues to run transparently, orderly, and without interruption. DeFi liquidates without discrimination; centralized lenders will often show preferential treatment (on underwriting, liquidation timing, or both) to ‘trusted’ counterparties. The blow-ups, market stress, and public relations nightmares continue to come from one primary source: opaque, centralized entities. I have no doubt that the headlines will pin FTX’s failings on crypto’s shortcomings. Maybe this will be the time we learn that the fundamental problem lies in centralization, not crypto. I doubt it.
Let’s reconsider what we mean by ‘regulated entity’. ‘Regulated entity’ should mean transparent operational practices and periodic proof of solvency. It shouldn’t stand in as a phrase that only pretends to promote those things, and more practically implies bending the knee for financial surveillance. Regulators are going to use FTX to eviscerate the crypto industry while ignoring that DeFi and well-meaning regulated entities (hi, Coinbase) already deliver the goods. Unless, of course, you care less about consumer protection and more about political capital and collecting data on your citizens.
Decentralization is the way … if we can stop putting centralized entities on a pedestal. It continues to be hilariously ironic (read: not actually hilarious) that an industry built on the ethos of decentralization and motto of ‘trust, don’t verify’ repeatedly shoots itself in the foot by propping up individuals and opaque businesses that aspire to centralize power and influence.
At least we can trust Binance. I have no desire to go after CZ – the dude is a ruthless, stone cold (business) killer and wielded Twitter like a surgical instrument – but … who bails out the guy who bailed out the guy who bailed out everybody else? The default assumption has to be to assume default for any unregulated centralized crypto entity with a major public figure … right?
Where We Go From Here
We go down, obviously. Red is your new favorite color; you won’t see green again until the spring. Of 2025.
More constructively, the road forward is long, unclear, and a bit dark. Having been propped up as the white knight of crypto, FTX’s two-faced turnaround seriously fractures the already tepid belief that mainstream participants have in crypto. I mean, c’mon: the guy who was lobbying for regulation to eliminate debt-fueled business models was leveraged to the neck himself. I have made myself pretty clear several times now regarding the differences between CeFi and DeFi and why the former’s failures do not represent the latter, but it’s semantics to industry outsiders. Who would take crypto seriously again, and how long until they do?
😮😮😮
Pharma Bro Martin Shkreli telling Do Kwon that ‘jail isn’t that bad’ hours after Binance acquires FTX. You could try to make this up, but you actually can’t.
Some Facts
Some Fun
And we saved the best for last, if you made it this far:
Source Code
FTX Agrees to Sell Itself to Rival Binance Amid Liquidity Scare at Crypto Exchange
Binance’s Deal for Rival FTX Marks Power Shift Amid Crypto Turmoil
FTX appears to have stopped processing withdrawals, on-chain data show
Bankman-Fried’s priority crypto bill ‘dead’ after FTX sells to Binance
Yuga Labs, Circle, SkyBridge Among Investments FTX Ventures Made Prior to Liquidity Issues
FTX’s Push for US Crypto Clearing Left In Suspense By Binance Deal
FTX Venture Investors Fear Total Wipeout in Binance Rescue Deal
[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.]
Fabulous!!! Thank you Wally.