One of the problems covering cryptocurrency is that many aspects of the space have nothing at all to do with finance—and the financial aspects of the subculture/movement are often not very interesting.
The FTX debacle, which is still ongoing, is an exception. This is very much a story of finance, the financial details of the story are some of the most salacious and interesting, and the lessons to be learned go far beyond the world of crypto.
Let’s start at the beginning. The story began on Twitter, where a mix of accusations and attacks from Binance CEO Changpeng Zhao (CZ) about Sam Bankman-Fried. It’s worth noting that neither are really financiers; SBF did work with prop trading firm Jane Street, and CZ did work on some futures trading software in the mid-2000s, but both are tangential to the main corridors of power in high finance. Maybe that’s what compelled both to get into alternatives in the late 2010s, with CZ launching Binance in 2017 and raising $15 million and SBF launching Alameda Research in 2017. FTX, which launched in 2019 from Alameda, and swiftly ballooned to manage around $19 billion in AUM.
Things have not been going well for either firm publicly, although Binance has emerged from the crisis so far as the winner. FTX is a big, big loser, as are its million or so clients, who have lost in total tens of billions of dollars.
That $19 billion of AUM is gone, SBF is on the run and under investigation, and FTX is going through a fast-track bankruptcy. It is not exactly clear what happened, except that CZ tweeted that FTX’s assets looked overvalued and, after due diligence, the company would neither help bail out FTX as its token crashed in value nor take over the firm. This is crucial, because Binance was an early investor in FTX and many crypto traders look at Binance’s CEO for guidance. While many have suspected FTX’s tokens are worthless for a long time, when CZ asserted the same, it caused both a liquidity crisis for FTX (as traders sought to withdraw their funds at the same time) and for FTX’s coin (which fell in price to worthlessness).
It wasn’t just CZ’s wisdom that the crypto subculture followed, however. CZ had about $500 million of FTX’s FTT coins, which he publicly announced he would sell immediately due to no value at FTX. This encouraged other FTT holders to sell at the same time, causing a collapse in price and greater scrutiny of the coin.
While FTX tried to stop the implosion by providing some public information about its books, this had the opposite effect. FTX’s internal auditing books were suspicious to say the least. Without evidence of a dual entry accounting system or any sort of diligence in its backend, the sheets caused more panic and horror. The Financial Times was the first to report on the balance sheet in detail, noting that it had “just $900mn in easily sellable assets against $9bn of liabilities” and that $470mn of that were shares in Robinhood (HOOD) owned by a separate entity itself owned by SBF (not FTX).
FTX’s own balance sheet was described by the FT as a “spreadsheet listing FTX international’s assets and liabilities…references $5bn of withdrawals last Sunday, and a negative $8bn entry described as ‘hidden, poorly internally labeled fiat@ account.’” Where that $8 billion went and whose it is remains a mystery. To make things even worse, the rest of the assets on the spreadsheet are “$4.4bn of ‘less liquid’ assets consisting of crypto tokens, and $3.2bn of illiquid private equity investments.” To say the least, these kinds of speculative investments are precisely not what FTX legally can or financially should do with clients’ funds. And while FTX wasn’t using the billions it was custodian of to fuel a billionaire lifestyle for its founders, FTX quite clearly was using the billions it had responsibility to care for to wallpaper the failures in its own financial incompetence and dishonesty.
If this story sounds familiar, it is. Earlier this year we saw a similar collapse of a crypto project that has turned out to be a criminal fraud conspiracy: Do Kwon’s Terra/Luna project has become worthless, and Kwon has become a criminal. What SBF is currently enduring is almost identical, although the technical details differ slightly.
What does not differ is the illegal fraud and misuse of funds—except in one way: size. SBF’s near $20 billion in AUM and million customers has made him unusually high profile and his project scrutinized more closely. What has been discovered is, simply put, fraud: SBF’s firm took customers’ money and used it to make bets that didn’t pan out. It is much like the CEO of a bank taking cash out of customers’ savings accounts, depositing them in the CEO’s own private business account, and then using that cash to play roulette. While SBF’s theft is more complex and nuanced, the end result is the same: misuse of funds, fraud, theft, and a loss of capital. Again, none of this should surprise anyone; we’ve seen this story many times in the crypto world.
If you want to follow this story more in depth, both the Financial Times’s Alphaville and Bloomberg’s Matt Levine are closely following the story as it develops while also providing valuable and informative context.