Last week, FTX, one of the biggest crypto exchanges in the world, collapsed in truly stunning fashion. FTX’s now-former CEO, Sam Bankman-Fried, often referred to only as SBF, wrote a series of contrite tweets in which he admitted that he “fucked up twice.” In the process of FTX’s implosion, a huge amount of customer money was wiped out, as was faith in the crypto industry.
On Sunday’s episode of What Next: TBD, I spoke with Felix Salmon, host of Slate Money and Axios correspondent, about how a darling of the crypto world and his firm imploded—and took a big bite out of crypto’s reputation on the way. Our conversation has been edited and condensed for clarity.
Lizzie O’Leary: What would you call this FTX spectacle?
Felix Salmon: It is an implosion and a meltdown, but it is also now an actual bankruptcy proceeding in Delaware. There is a Chapter 11 case happening as we speak, and that is now going to supersede everything else. Sam Bankman-Fried himself has resigned as CEO, so he’s basically just an onlooker at this point.
If I had asked you a month ago—even maybe a week ago—to describe FTX, what would you have said?
That it was the second-biggest crypto exchange in the world. Hugely central, hugely important, run by this wunderkind, SBF, based in the Bahamas, the place where everyone goes if they want high-speed, low-fee, fast trading in crypto.
Tell me about Sam Bankman-Fried.
He is the face of crypto more than any other individual in the world. If people point to one human being who represents crypto, it’s him. He’s not only, well, as of a week ago, a multibillionaire crypto entrepreneur; he’s also this philosopher king who signs on to these very crypto-friendly ideologies like effective altruism. He’s also the son of two very high-profile Stanford professors. He’s very well connected.
He’s got his personal look of, like, kind of schlubby guy wearing shorts on stage with Bill Clinton and Tony Blair. He’s very good at creating an image, sticking to it, getting publicity. He’s very press-friendly, and really trying to be the sort of acceptable face of crypto, going on podcasts and being very honest about the shortcomings of crypto.
His journey from wunderkind to tweeting “I fucked up” was frankly remarkably fast. On Nov. 2, the crypto news site CoinDesk published an article that cast doubt on the health of SBF’s other main business, a hedge fund called Alameda Research. Reporter Ian Allison showed that Alameda held a lot of FTX’s own crypto token on its balance sheet, a token called FTT.
The two big exchanges in the world are Binance and FTX. Both of them have their own token. Binance has BNB; FTX has FTT. They’re a little bit like frequent flyer miles that you give out to your users. That keeps your users loyal and keeps them coming back. If you own the token and if the exchange is successful, then the token goes up in value and you can make extra money that way.
There’s this whole ecosystem around these two big exchange tokens. What we discovered from the CoinDesk article was that the overwhelming majority of the exchange tokens were actually held by SBF himself, which felt a little bit weird. This is meant to be for customers. This isn’t meant to be a way for SBF’s hedge fund to make money. People got a little bit worried about this, especially when they started wondering, “Look, this is a hedge fund. What it does is it takes on large amounts of leverage. It borrows against its holdings to invest in various other crypto shenanigans.”
If Alameda Research, the hedge fund, is borrowing against the FTT tokens, then that could be really dangerous, because what happens if the FTT token goes down in value? People worried about this, and specifically this guy Changpeng Zhao, who runs the biggest exchange in the world, Binance. He’s worried about this. He owns a large chunk of FTT because SBF bought him out of FTX.
Basically, a few months ago, Sam Bankman-Fried cut ties with CZ and with Binance and paid him a huge chunk of FTT tokens. Then CZ was like, “I don’t actually want these tokens, especially after having read this article. I’m going to sell them.” And that was the beginning of the end.
The larger crypto world smells blood in the water, freaks out, and that triggers the crypto version of a bank run.
Remember that we’re not talking about dollars here, we’re talking about crypto. People try and sell their crypto for dollars. What you have is people selling their FTT for dollars.
Which causes the value of the FTT to plunge.
Exactly. That causes massive problems for Alameda, because they have borrowed a whole bunch against their FTT holdings. So when the value of the FTT plunges, they automatically have to liquidate their FTT to meet their margin calls. The amount of money that Alameda owes FTX, who they borrowed the money from, is more than they actually have.
They are insolvent.
Alameda is insolvent, and then FTX has wound up basically loaning a bunch of its customers’ crypto to its hedge fund that can’t afford to pay them back, which means that it can’t afford to pay back its own customers.
There was a brief moment when it seemed like maybe Binance was going to ride to the rescue here. What happened there?
Basically SBF had this big problem, which is that all of his customers wanted their crypto back and he didn’t have their crypto to pay them back, and he’s like, “Shit.” On Tuesday morning, he barred withdrawals from FTX, which you don’t do if you’re an exchange. If you’re an exchange, you need people to be able to put money in and out as much as they like. The minute that he stopped doing that, I was like, “OK, this is the end of FTX.”
But CZ rode to the rescue and he’s like, “You know what? I can give you the crypto you need to make your customers whole,” in a deal where basically Binance buys FTX for some presumably nominal sum, although there was some reporting that maybe it would’ve been for a couple billion dollars. But then CZ had to do due diligence on it. And 24 hours after beginning the due diligence, he basically said, “Yeah, no, the black hole here is far too big. I am not comfortable with the compliance. I’m not comfortable with the balance sheet. I’m not going to buy FTX after all.” FTX, absent that white knight, ended up filing for bankruptcy.
You mentioned using customer money to prop up their trading arm. That is a big no-no.
If they were a U.S. institution that was regulated by U.S. regulators, that would’ve been completely illegal. It’s not clear that it was illegal under Bahamas law, where they were incorporated. I’m not going to come out and say it was illegal, but it was certainly not something that a reputable exchange should ever do.
I think if you are someone who is not into crypto or into finance, how all of this works seems really difficult to grasp. Is it as simple as: This guy was playing around with his customers’ money?
Underneath it all, yes, that was the proximate cause of the implosion. And if he just allowed his hedge fund to fail and hadn’t tried to bail out with the customers of his exchange, then he would be in a much better place right now.
If he were, say, a bank, this is the time when the FDIC would step in, but he is not a bank. Crypto is this wild, unregulated place.
Exactly. There is no lender of last resort in crypto. The closest thing we had to a lender of last resort was ironically FTX itself. When companies like Voyager started going bankrupt, FTX would swoop in and rescue them.
I wonder, is there a reality where Sam Bankman-Fried didn’t really know how bad things were with FTX?
That’s what he says. He put this Twitter thread out basically saying, “I didn’t know how bad things were. I was looking at the wrong column in a spreadsheet,” or something, or “I didn’t realize where the lending was happening, and I thought there was much less leverage than in fact there was.” That’s his story, that he was unaware of the magnitude of the difficulty at FTX.
Also, it should be noted that all of these problems are relatively recent. It all dates from the past few months. Up until then, he really was a billionaire and had lots of money and could afford to rescue people and could afford to try and go to Capitol Hill and persuade them to regulate him, and that was the right thing for him to do then.
Do you think he really wanted regulation?
Oh, everyone in crypto wants regulation.
Because right now it’s a shit show, to use a technical term. There’s no regulation, there’s no laws. The result of that is people wind up incorporating in weird places like the Bahamas because it’s the only place they get any vague semblance of regulatory clarity, and they just want to be able to hire a lawyer and say, “What am I allowed to do? What am I not allowed to do? Let’s do the stuff we’re allowed to do and not do the stuff we’re not allowed to do.” That’s really, really hard in the U.S.
You and I both covered 2008–2009. I really do not want to throw around the word contagion lightly, and yet it does feel like there is this sort of contagion-like phenomenon happening in crypto right now.
One hundred percent. It all started with this hedge fund called Three Arrows Capital, which got overleveraged and wound up borrowing a bunch of money it couldn’t pay back. That caused Voyager to go bust. That caused BlockFi to go bust. They wound up getting rescued by SBF. But in doing that rescue, he took on a bunch of liabilities, and that started creating a bit of a hole in the balance sheet of Alameda Research. The first contagion goes from Three Arrows Capital to Voyager. The second contagion goes from Voyager to Alameda. The third contagion goes from Alameda to FTX. And now we have the FTX contagion, which, who knows where that’s going to start.
It could keep going other places?
The only place it could drop within the crypto-verse that is bigger than FTX would be either Binance, which is the biggest of them all, or Tether, which is this massive stable coin—everyone is a little bit uncertain how much money it really has. People are looking askance at Binance and Tether. Binance seems as though it’s relatively safe, and CZ is adamant that he doesn’t lend out customer funds in the way that FTX was doing. I think people are going to try very hard to pretend that they have clarity on what’s going on at Binance because they don’t have any choice at this point.
The good news here is that so far there is zero evidence of any contagion from the crypto world into the real world.
Because the big banks have only dabbled a little bit in crypto, or because they are subject to the kind of regulation that you’ve talked about?
For both of those reasons, and also just because the avenue for contagion is always debt. Normal, real people and banks and actors in the real economy haven’t lent money to crypto. It’s not like I had a bunch of loans to Sam Bankman-Fried and now he can’t pay them back. Crypto has its own world, and it was curiously cut off from the real economy.
A key point of crypto is that it’s supposed to be decentralized, right?
Yet exchanges are centralized. It seems like it’s vulnerable to the exact same thing that its advocates say it is not vulnerable to.
There are two different flavors of crypto. There’s centralized crypto and decentralized crypto. FTX and Binance and Coinbase and the companies that you’ve heard of are centralized crypto, and they are vulnerable to exactly what we’re seeing. If they go down, that causes ripple effects and contagion. Then there’s also decentralized crypto, which is just a computer program running on the ethernet computer, and that really is decentralized and can’t really fail in the same way. No one described FTX as being decentralized. It clearly wasn’t. It was centralized in the Bahamas.
This all has echoes of the Luna crash that happened a few months ago, when $60 billion was wiped out in a couple of days because TerraUSD, which is a “stable coin,” was supposed to be pegged to the dollar and wasn’t. Is this similar?
This is different. What we saw when Celsius went bankrupt, what we saw when Terra lost all of its value, was good old-fashioned losses. People were buying things they thought were relatively safe dollar investments, and then all of the money evaporated. That was really bad. There were people around the world who lost their life savings. They thought they were investing in something relatively safe and they weren’t.
In the case of FTX, you don’t have normal-people losses in that sense.
What do you mean by that?
Most people don’t hold crypto at FTX. They hold crypto at somewhere like Coinbase, or they just hold it on their own wallets. The people who are trading on FTX were real traders. They’re trading in and out very quickly. They’re very sophisticated. They are the kind of people who are walking in with their eyes open and they can ultimately afford to take losses on those trades, not get their money back, that’s really kind of OK. That’s the part of the world with very high-risk appetite. What we learned in 2008, what we learned again when Celsius and Terra went bust, was that the really bad financial crisis is what happens when people lose money that they thought was safe, where you have people with low-risk appetite who lose money.
Let me push you on this a little bit because regular people, not super crazy intense traders, are going to read the stories about Sam Bankman-Fried. They’re going to see that there is this big crypto crash happening. I just wonder if that colors the public perception of crypto.
Absolutely, and it should. If what this does is serve as a salutatory reminder that crypto is highly risky and that it is completely unregulated, then yeah, it will put people off. And that’s good because there’s no particular reason why people should invest in crypto.
Where, ultimately, do you think the FTX implosion leaves the larger crypto world?
Hobbled. Severely damaged. It’s really hard to recover from this. It’s not fatal. Binance is still going. The DeFi protocols are still going. The Ethereum computer is still ticking along. Crypto still exists. But as you say, the dream of the crypto world is always that it wouldn’t just be a bunch of nerds trading pictures of monkeys. It would wind up expanding, in SBF’s dream, to be something you would use to buy a banana. I don’t think anyone is going to buy a banana with crypto at any point in the foreseeable future.