Explaining The FTX Collapse — Is This The End of Crypto?
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Explaining The FTX Collapse — Is This The End of Crypto?

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2 months ago

CoinMarketCap Alexandria covers a full, detailed breakdown of the FTX debacle, and what lies ahead for crypto next.

Explaining The FTX Collapse — Is This The End of Crypto?

目录

“There are decades where nothing happens; and there are weeks where decades happen.”

It wasn't quite decades, but the last few weeks covered years of crypto drama. In this article, we recap the FTX collapse — probably the biggest collapse in crypto history when it's all said and done.
The one-sentence summary: FTX is bankrupt. According to its bankruptcy filing, FTX owes between $10 billion and $50 billion!

Here's the full play-by-play of how we got to this stage.

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Prologue: SBF and crypto regulation

A few weeks ago, CoinMarketCap Alexandria covered the beef between Sam Bankman-Fried and other influential crypto figures like Ben "Bitboy" Armstrong and Ryan Sean Adams from Bankless in our weekly Twitter round-up.
The TLDR: SBF had lobbied for more regulation of DeFi in front of Congress. Many people in the crypto industry vehemently opposed that. A video that made the rounds after a Bankless podcast discussion between SBF and Erik Voorhees, an influential Bitcoin proponent, accurately summarizes how views diverged:
That was only one episode in a long series of allegations that were making the rounds on Crypto Twitter: FTX allegedly trading against its customers, FTX listing tokens from the Solana ecosystem it backs to divest its seed round holdings, FTX splashing the cash on big sponsorship deals. Even though FTX surged in popularity in the last two years and was very popular with well-respected figures in the space, the narrative on the exchange and its founder Sam Bankman-Fried was already souring...

Part 1: Coindesk shouts fire...

The catastrophe all began with this CoinDesk article.
The TLDR:
  • There is almost no separation between FTX and Alameda Research, Sam Bankman-Fried's hedge fund.
  • Almost 40% of Alameda's $14.6 billion assets were locked or unlocked FTT. Another $1 billion was locked or unlocked SOL or SOL collateral.
  • At the same time, Alameda had $8 billion in liabilities.
  • In conclusion, FTT backed a lot of liabilities at Alameda, and Alameda and FTX are very, very close...

This article made people ask questions:

Why is so much FTT used as collateral at Alameda?

Could Alameda get liquidated on positions if the collateral value falls?

How close are Alameda and FTX in reality? Is there something funny going on...?

We covered this in last week's Crypto Twitter round-up.
One person reading the CoinDesk article and asking himself those exact questions was Changpeng Zhao, the CEO of Binance. With Binance being a strategic investor in FTX, CZ decided to pull the plug on their investment, announcing on Nov. 6:
This triggered a response from Caroline Ellison, the CEO of Alameda Research. In response to the CoinDesk article, she had assured everyone that the balance sheet in question was not the full picture. Alameda had another $10 billion in assets that were not covered there. $10B of assets that never were, as everyone was about to find out. Ellison proposed buying out Binance in an OTC trade for $22/FTT:
CZ did not directly respond, but in another tweet, he reasoned that this was "post-exit risk management, learning from LUNA."

Part 2: ...so people run to the exit.

Sam Trabucco, former head of trading at Alameda, called the CoinDesk story "bonkers" after it had broken. Bonkers indeed, with the hindsight of just a few days.
While these events played out, the market was spooked. The price of FTT quickly started collapsing, from $22 to $14, as we headed into Monday. Still, many believed that FTX would eventually be fine. That customer funds were not intertwined with Alameda's trading. That this was a short-term liquidity crunch at worst.

This is completely different from LUNA because FTX is a revenue-generating business, was the common consensus.

Until FTX halted withdrawals. Halting withdrawals during a liquidity crunch is a cardinal sin in crypto. It had already sunk Celsius and LUNA before FTX. Initially, on Nov. 7, SBF assured everything is fine and FTX was just dealing with a massive amount of capital outflows, over $500M in just two days. But then withdrawals were halted again. SBF went silent again on Twitter. Hours passed by, as Crypto Twitter was gripped by a state of panic and FTT continued dropping.

Then this happened on Nov. 9:

"A strategic transaction for FTX.com," as SBF explained, meant Binance would acquire FTX. Just like this, Binance seemingly looks on its way to buy FTX, in one of the most shocking developments in the crypto industry.

Or did he?

In the announcement by both CEOs, it was stated that this transaction was "subject to due diligence." In other words, Binance would take a good long look at FTX’s financials before deciding if they would go forward with the deal.

Part 3: fire breaks out for real.

As soon as the market realized that this acquisition was far from assured, panic set back in. FTT plummeted into single digits. So did the rest of the market.

Monday turned into Tuesday and the decision on the deal has yet to be announced, while customers' funds are still stuck on FTX. Up Only, a popular crypto podcast, hosted a spontaneous episode covering the utter mayhem that was unfolding in the markets. An Up Only summary covers the details but the biggest news was Do Kwon and Martin Shkreli joining the episode (with Shkreli telling Kwon that "jail is not that bad").
Oh, and Su Zhu, CEO of another failed hedge fund 3AC, reemerged as well. Talk about an eventful week.
The news coming out of FTX was getting worse by the hour. The majority of its legal team supposedly quit. The SEC is investigating the exchange.
Eventually, the announcement came on Nov. 10: Binance was not pursuing a deal to buy FTX. In short, the situation was catastrophic. As it turns out, there may be a $9.4B hole. Just how bad it is can only be inferred from what Brian Armstrong, CEO of Coinbase, is not saying:
FTX supposedly approached all major exchanges, but only Gemini and Kraken showed interest. None of them followed through, though.

Part 4: what now?

So what happened?

There is still no clarity on exactly how FTX and Alameda got themselves into this situation. Lucas Nuzzi traced on-chain data back to a potential bailout for Alameda covered by FTX funds. Alameda apparently blew up during 3AC collapse and FTX customer funds were used to plug the hole. This was not only illegal but also very dangerous since these funds did not really appear on Alameda's balance sheet. What did appear was FTX's token marked as equity. Or in the words of Lyn Alden, its "clown bucks:"
The lessons from CZ struck a similar note: don't use your own token as collateral, and don't use customer funds to trade on the market. Rumor has it that these illegal business practices have been going on since 2021.
Most of the FTX team has gone dark since. According to a leaked SBF letter to investors, refunding customers is a priority. However, investors like Sequoia have written off their investments. A Slack message seen by news outlet Reuters quotes SBF saying he feels "sorry" for the situation. Another verified message cites Bankman-Fried saying on Slack that FTX is planning to conduct a raise by next week to "do right by customers" (and "maybe myself as an investor").
Justin Sun came in with an undefined "solution" via his Tron blockchain, causing the price of Tron to trade at multiples on FTX compared to liquid exchanges. This was later updated to FTX processing withdrawals via the Tron network, amounting to a steep haircut for those that buy TRX.

Part 5: SBF speaks.

On Thursday morning, Sam Bankman-Fried reemerged with the following intro:

In a nutshell, SBF blames the collapse on "poor internal labeling of bank-related accounts" and maintains that FTX has enough assets to cover client deposits.

Industry figures almost univocally slammed SBF for his thread. Anthony Sassano said he "didn't believe a single word." Altcoin Psycho questioned why Alameda would be "winding down trading." Cobie felt "even more confused," while others just took the meme route:
Meanwhile, U.S. law enforcement asked Tether to freeze FTX-related USDT and lawmakers are calling for an investigation. BlockFi paused withdrawals. The Bahamas Securities Commission froze FTX’s assets. Bizarrely, a small circle of people seems to have been in control of financials while co-living and dating in the Bahamas headquarters.
Over the weekend, Reuters reported that SBF had set up a “backdoor” to alter the company’s financial records without triggering internal compliance (SBF denied this). The Wall Street Journal reported that several FTX executives knew about customer funds being moved to Alameda.
In an even more shocking turn of events, over the weekend on Nov. 12, a combination of black-hat and white-hat hacking drained FTX of hundreds of millions. The true extent of the hack is still unknown:

The FTX app was compromised as well, which reportedly contained malware if users update, as announced on the official FTX telegram channel:

Part 6: the fallout.

The fallout from this collapse is colossal. With FTX filing for bankruptcy, the true extent of contagion will continue surfacing over the following months. There is a long list of prominent FTX investors and other crypto exchanges and entities with exposure to FTT. Galaxy Digital confirmed a $76.8 million exposure, but other funds have been eerily quiet for now. BlockFi paused withdrawals and will likely go under due to its exposure to FTX. DeFi price oracles partially depend on FTX prices and are impacted by the converging prices on the exchange compared to others. Miners are turning rigs off as a result of the collapsing Bitcoin price.
The court case could take years to resolve and many believe those with funds stuck on (or stolen from) FTX are unlikely to see most of it ever again:
Regulators were quick to call for harsher regulation of the industry, conveniently overlooking the fact that FTX US was the U.S.-regulated branch of FTX (and was also brought down by the bankruptcy). Even more interesting are the close ties between US regulators and the families of FTX executives. Crypto Twitter was rife with conspiracy theories, but several threads also posed fair questions about the true motives of SBF cozying up to Gary Gensler and other US financial authorities.
On Crypto Twitter, the number one reaction was anger. Anger about SBF sitting in front of Congress seemingly projecting when he speaks about collapsing TradFi institutions with "unknown amounts of risk." Anger about a seeming God-savior complex permeating the FTX team. Anger about how much this will set back the industry as a whole:
At the time of writing, SBF still seems to be in the Bahamas, albeit “under supervision” of local authorities.

Epilogue: is crypto now done?

Anyone that has browsed Crypto Twitter over the last few days is feeling the sentiment of utter devastation among those working in crypto.

While the collapse of LUNA caught many off-guard, several figures had been flashing warning signs about its unsustainable business model.

But FTX was different. Or so it seemed.

An exchange run by a man many tipped to be the "next Warren Buffet." A functioning business with real revenues and a network that extended to the highest political circles in Washington. To investors, SBF had pitched FTX as a financial "everything app." An app where you would not only trade crypto but eventually do all your personal finance on.
Unsurprisingly, many honest and well-meaning industry figures and key opinion leaders advertised for FTX. Although doubts were creeping in recently, no one imagined such a catastrophic failure.

So, is this the end of crypto?

The cryptocurrency industry will over the coming months and years have to take a hard look in the mirror. 2022 has been, by all standards, a catastrophic year for the industry. It has proven crypto doubters right on almost every account. Only by embracing ethical business practices can crypto slowly and over time win back customer trust. Practices like proof of reserves are a good first step. But they can only be the first of many.
Most likely it will set crypto back by years, both in terms of valuation and loss of trust. The pitchforks are well and truly out now and that is understandable. FTX almost certainly engaged in highly criminal behavior. Law enforcement will almost certainly come into this at some point. And contagion risks are almost certainly still out there. After all, FTX seemingly got caught up in contagion itself and almost managed to sweep it under the rug.
Even if a somewhat orderly dissolution of the exchange happens, many will simply not trust crypto anymore. Even though Bitcoiners feel validated by industry excesses, it is not as simple as renouncing all coins but Bitcoin. The responsibility of all to be good actors in the industry is even greater if crypto wants to be adopted by the masses.
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