FTX Collapse. One week on. Yes you could argue that the collapse was less than a week ago, but having looked at the historical liquidity data, it would appear the point of no-return was reached last Wednesday.
FTX is a [trading platform] for crypto currencies, essentially identical to a stock exchange.
It’s led to the [fastest loss of wealth in history] for its founder and CEO Sam Bankman-Fried, aged 30.
Market confidence has taken a huge hit. According to investment materials seen by [the FT:]: $900M of liquid assets were held against $9B of liabilities the day before it filed for bankruptcy.
$470M of these were Robinhood shares held in the disconnected and Bankman-Fried, privately- owned ‘Emergent Fidelity’.
$7M were held in a holding called ‘TRUMPLOSE’..
A copy of the balance sheet is attached in the full article, with metadata indicating that it was put together by SBF himself, making it reasonable to assume the informal comments are his.
The evidence would suggest that Sam Bankman-Fried’s empire had poor risk management, opaque operational procedures and unacceptable decision-making emanating from SBF at the top.
As a market, we need to quickly move on to smooth investors and cannibalise poorly-run operations in order to to rebuild trust and welcome regulation.
Perianne Boring, founder and chief executive of the Chamber of Digital Commerce trade group, said in a [Bloomberg interview]: “He is not the face of the industry and never was.”
We saw this coming. The SEC said this would happen. And said there would be no bailouts.
Main Lesson Learnt:
Speculative and illiquid tokens, such as FTXs native token FTT, which have no liquid-asset backing, cannot and must not be used against fiat-balances, especially when it concerns customer funds.....
The FTX’s Collapse is not a tragedy. As an industry we need to learn lessons and move on.
FTX has fallen. It was a trading platform like any stock exchange and had offices in Chicago and Miami. Its headquarters were in the famously clandestine Bahamas, where a regime in motion is [promoted locally] as a regulatory jurisdiction ideally equipped to ‘create abundance’ for ‘a financial centre of the future’.
The collapse of the FTX exchange has quite rightly decimated confidence in the market. According to [investment] materials, $900M of liquid assets were held against $9B of liabilities the day before it filed for [Chapter 11 Bankruptcy]. $470M were Robinhood Shares held in a company called Emergent Fidelity (personally controlled by Sam Bankman-Fried, FTXs former CEO, commonly known as SBF). These were not included in 134 associated entities listed on the bankruptcy filing. Two hundred million US dollars of cash were held with Ledger Prime, in addition to roughly $5.5B of considerably fewer liquid assets, consisting of crypto tokens and very illiquid private equity. Despite bitcoin liabilities of $1.4B, there isn’t a single bitcoin asset listed.
But what does this all mean? It means that two of crypto’s biggest success stories turned disasters were not tragedies, but disgraces ([LUNA-Terra] fell earlier this year). This is not how businesses, least of all financial services companies, should be run. The whole concept of ‘banking’, which is essentially what FTX was offering most of its customers, is that there is a reserve. In traditional banks this could be a [central bank reserve], such as the Federal Reserve (Fed) and the Bank of England. For successful stablecoins like [DAI] and [USDC], this is cash or carefully monitored, dynamically valued crypto holdings.
FTX has gambled away its customers’ money, making poorly documented billion-dollar loans to its sister trading house Alameda Capital, and SBF alongside three other executives: Alameda CEO Carlene Ellison, SBF and two other FTX executives [being aware of the decision to make the loans,]totalling [$10B of customer funds]. It raises the question: who on earth did Sam Bankman-Fried have on his risk team? What was the motive of these clandestine loans, and how could they be so reckless with 10,000,000,000 dollars of money that wasn’t theirs.
As of Thursday, 10th November ‘22, the companies’ biggest asset was Serum, which was valued at $2.2B. On Saturday, the Serum market capitalization was $88M (according to [CryptoCompare], which also accounts for factors like liquidity in its market cap estimates). This presents a more subtle, but much more important point: native tokens can lose their value in quite literally a heartbeat. Cryptocurrencies fall, and they fall fast. Traditional currencies do not. Publicly listed stocks can and often do fall fast. Asset-backed cryptocurrencies do not, provided they are actually asset-backed. Therefore, having any direct dependence on a native, unbacked token from seemingly any ecosystem (with the exception of, perhaps, Ethereum, Bitcoin and a few others) should be considered very high risk. The hidden mechanisms, in the case of FTX, are private dealings and bad loans between sibling companies. The ‘cryptography’ of the goings-on behind the scenes and the sudden market exposition of such juvenile and unprofessional executive behaviour explains why there is no confidence, and a technology which could, and should, be the future of all financial services, is being hindered.
This discussion could be extended into the nuances of what Sam Bankman-Fried’s trading vehicle Alameda Capital was up to. One such nuance was the [Twitter spat ] between SBF and Changpeng Zhao (aka CZ, CEO of Binance, the world’s biggest crypto exchange) which started the run on the bank and the $5B of withdrawals[SBF permitted last weekend]during that very run. Fundamentally, as far as the evidence shows, management was in a very bad state, with less than satisfactory governance, poor operational procedures and risk protocols, low transparency and an overpowered CEO.
Sam Bankman-Fried apparently had a cocksure attitude and acquired companies that were doing poorly. SBF lobbied Washington, becoming the largest Democratic party donor, and [spending millions in funding Joe Bidens’]presidential campaign. He pursued tighter regulation to get his business closer to US Banks and even bailed out companies struggling in last years’ crypto crash. A true white-knight with-an-opinion.
But despite this, Sam Bankman-Fried’s company never even reached [SOC2] compliance, a standard indicating high quality internal procedures. ‘FTX hit every red light it could hit,’ [said Joshua Peck], founder of TrueCode Capital, a crypto asset manager and author of an upcoming book on Cryptocurrency Risk Management: ‘it’s a total mess’. This is somewhat ironic considering SBF’s pro-regulation attitude. The regulation that exists for financial services in the EU, North America and the United Kingdom simply wouldn’t have let this happen, as their exposure monitoring is of a higher quality. FTX’s primary entity wasn’t regulated in the US, as it had a restricted subsidiary: [FTX.US, which will be scrutinised closely by the SEC]. Nonetheless, proper practices and procedures would have helped avoid this. Hopefully this will be the catalyst for more widespread and accessible regulation.
Crucially we must hear what SBF has to say. For the $8Bn wiped out of the digital asset economy, including funds and individuals losing millions... “I f****d up” he said.
Not good enough Sam. Not good enough.
My initial reaction was that surely the customer funds would be bailed out by the SEC, with regulations brought in quickly and an improved digital asset economy moving forward. Wouldn’t that be nice. But [recalling United States Securities and Exchange Commission (SEC) commissioner Hester Peirce], who is arguably the most pro-crypto commissioner in the SEC, she argued that, for now, it is better for “these things to play out”.
“When things are a bit harder in the market, you discover who’s actually building something that might last for the long, longer term and what is going to pass away.” She has spoken out against crypto company bailouts, arguing it’s actually better to “let these things play out,” to create a more sustainable industry.
So let us learn some lessons:.
1. Speculative and illiquid tokens, such as FTXs native token FTT, which have no liquid-asset backing, cannot and must not be used against fiat-balances, especially when it concerns customer funds. These tokens should not be treated as liquid, for in times of struggle they are not easy to convert to fiat. If they are accounted for in fiat-denominated value, the value must be risk-adjusted to 80% or 90% (plus) when evaluating solvency.
2. Speculative tokens can thrive, but they should be backed with an asset (something tangible that also has speculative value) or built carefully and sensibly. Don’t overly leverage them unless demise is what you seek.
3. Be sceptical, be very sceptical. If you are using a crypto-financial services’ entity, especially one like FTX, see if they have SOC2 compliance, or if not, good policies and operating procedures. Have they got independently audited financial accounts and attestation? Check for red flags, looking back on the history. Earlier this year, in Q2, there was evidence that key risk-requirements at FTX weren’t being met. Orthogonal Credit closed [Alameda’s borrower pool on Maple Finance in Q2 due to ‘key weaknesses’. ]
Four years on, we still seem to be in the Wild West, with roaming [crypto cowboys]. Too many and too dispersed for the regulators to shut down and not enough consensus on mechanisms of regulation to enable well-controlled, insured, and properly reserved crypto-banking firms. If you want to find some reliable crypto-entities, go, and look at Wyoming, where we see a legislative agenda moving towards a stable crypto-banking economy. One that I have been personally following is [Custodia Bank], go check them out! The models employed here are well-thought-out; the companies leading the charge we don’t expect to be stripped naked in disgrace over the unacceptable and market-damaging behaviour of certain individuals.
On a personal note, as a young CEO, I am fiercely determined to grow the environmental credit market to capture decentralised finance and cutting-edge technologies to effectively and efficiently scale the carbon markets to fight climate change. I see the fall of FTX as a setback. It slows everything down. It makes an already dark time in the capital markets even more of a fight and the carbon consensus more fearful of digital assets. It also increases the asymmetry all over environmental assets. All the while, the planet is heating up, apex predators are going extinct and coastal communities are being pushed out of their homes. As I write these words, I’m returning from COP27 at Sharm El Sheikh, having spoken first-hand to the communities and indigenous groups suffering the most. The death of millions will be blood red on all our hands, and we need all the help we can get.
By Billy B Richards