Market Update -FTXed

There are times when decades happen in a week. 

Without a doubt, this week is that week. The crypto time-lapse machine has teleported straight from the 2000 Dot-com bubble l, right into the 2008 banking liquidity crisis. 

The drama of CZ ditching an FTX rescue with a 😭 emoji came just 24 hours after SBF tweeted his gratitude about a done deal. 

This is crypto’s equivalent of the weekend of Sep 13, 2008 – when Lehman’s last ditch meeting with rivals Barclays and Bank of America to stimmy up a takeover failed spectacularly, and their stock opened Monday down 93%, thereby sealing their bankruptcy fate. 

You can bet that CZ was also SBF’s last ditch attempt at stemming failure, as were Barclays and BAC for Lehman. The bad blood between both founders was clear to see, and comes just months after SBF had conspired with Sequoia to buyout Binance from their remaining FTX ownership with a fee of BUSD and FTT –  the latter of which ironically provided the fate-sealing bullet for FTX.   

In the 5 days since the weekend of 5 Nov, FTT lost 96% of its value. This was the token of an exchange that was “Triple-A” grade within crypto,  just as Lehman was. In fact it had arguably become the most trusted of all exchanges by non-US retail and institutions alike. 

It took six long months from the failure of Bear Sterns in March 2008 to Lehman’s final demise in September 2008. Consistent with crypto’s speedrun of financial history however, this time it took just six days for everything to crumble. 

1. How did this crisis unfold so quickly? 

Just six days ago, on 5 Nov, SBF was still being cast as the saviour – retweeting Voyager’s announcement of the completion of their sale to FTX US, saying he was excited to return their customers’ assets quickly (Chart 1).

The expose of Alameda’s leaked balance sheet on 2 Nov shocked the industry as to the extent by which what was assumed to be a money-making behemoth, was actually being propped up entirely by SBF’s own illiquid tokens FTT, SRM and MAPS etc. 

On the asset side they mark-to-market their massive holdings of un-circulating tokens, while on the liability side they use those same tokens as collateral to FTX, who then loan real cash back to them. The extent of this was immense. Just using MAPS as an example, after this selloff its market cap is only $4.8m, with a fully diluted market cap of $1.07bn! (Chart 2) 

It is now believed the Alameda hole could be $10bn, masked by the token flywheel and most crucially of all supported by FTX customers’ deposits.  

All it took was the collapse of these token values, and the subsequent bank run on FTX for the liquidity tide to go out and the shock of a naked SBF there for the world to see. 

2. How did everyone miss this freight train coming? 

Just like the 2008 subprime crisis, in hindsight the red flags were obvious. The massive transfers of FTT, and the post-LUNA resignations of Sam Trabucco and Brett Harrison, the most key persons in Alameda and FTX respectively. 

Most damning of all was the industry missing the token flywheel scheme (as the Dirty Bubble guys call it) at play again here, something which had taken down Celsius just months ago. However the market believed that both FTX and Alameda had to be highly profitable apart from this, with real revenues to back.  

Fundamentally, SBF was crypto’s blue-eyed boy, and while everyone knew Alameda was on the other side of most of FTX’s trades, the assumption was they were making money at the expense of FTX users. Afterall the game was certainly rigged to their benefit. Most of all, nobody would have ever believed SBF was capable of siphoning customer funds for personal use. 

The public image also worked in their favour – 300 headcount at FTX and less than 100 at Alameda managing billions, versus over 6000 employees at Binance or Coinbase was supposed to be testament to their effectiveness at keeping costs low, while delivering standout products. The high spending on political donations, sponsorships, industry bailouts

and charitable projects were also evidence of the supposed high cash on hand. 

Perhaps it was also the effective-altruist mantra that SBF carried that led to the trust many prominent institutions placed in him. That it was never for personal gain, and he was trying to make the world a better place and help the most people – both within finance and outside of it. Unfortunately it has always been with the best of intentions that ironically he has ended up hurting the most people now.

Finally there was also the facade of regulatory oversight. After many authorities around the world banned Binance it consequently drove users over to FTX. Together with their FTX US license, investments from large sovereign funds in the parent, and close political connections that many believed FTX were doing everything above board. 

Nonetheless when all is said and done,  there is a lot of soul searching to do for an industry that has democratization and transparency as its founding ethos. This year has been a wake-up call for everyone to clean up their act and stay true to this mandate, much more so after success comes knocking at the door.  

3. Is this LUNA/UST all over again?

If anything this is probably closer to Enron. The FTX guys were certainly also the smartest guys in the room. 

Luna was an ideological failed project (algorithmic stablecoin) that got too big due to the greed of users attracted by Anchor’s 20% APY. This time rather it is the greed of the operators who had hoodwinked users. 

Therefore it is likely the fallout of FTX will be more extensive, in that more parties will be affected, but the scale won’t be as large as Luna where over $40bn was lost on LUNA and $14bn on UST alone. 

Having said that, we had written in our post-Luna crash Q2 Just Crypto piece “Zombieland”  that the repercussions of the Luna fallout was still to be seen. Alameda and FTX was the next domino, and institutions who were exposed to both crashes could now be in real trouble. 

4. Is there no hope left?

SBF’s claim that FTX and Alameda has assets > liabilities is likely overblown based on the illiquidity of most of their token assets. 

While hopes for a white knight or consortium large enough to plug the multi-billion USD hole is fading by the day, there is argument there is still some enterprise value to FTX – an exchange that was valued at $32bn mere months ago after due diligence by prominent VC firms. 

It is also clear that SBF will do all he can to refund users at least partially. So not all is loss. 

The market’s equivalent of FTX’s credit default swap (to a limited degree due to the $13m/week withdrawal limit) is the FTX / Huobi TRX spread (Chart 3). Right now it is at an 85% haircut (probability of default) for FTX assets.  

With trading not halted on FTX, many are finding ways to monetize the “monopoly money” in their accounts. Creative ways people are “moving money out of FTX” include RV trades like long SOL on FTX and short SOL outside – on the premise that this trade should lose money, and if SOL does rally it would likely mean some hope for FTX. There are risks to such trades though, such as in our partial refund outcome. 

5. When the dust settles, how badly will this hurt?

This will hurt badly, more so than any other crisis our industry has faced before. 

Trust, the most expensive commodity outside of time has been lost, and it will take a lot of time to build back as a whole. 

Even steps taken now by other CeFi institutions to publish their assets are a step in the right direction, but insufficient if they omit the other side of the ledger. Especially exchanges with liabilities consisting of their own token in particular.

Having said that, it is still our firm belief that BTC/ETH and DeFi/NFT will come out  of all this even stronger than before. And institutions who survive this would have had to do so by keeping the trust of users – something that a crisis like this can only cement further.