Update, Nov. 11, 10:18 a.m.: FTX has filed for Chapter 11 bankruptcy in the U.S., and Sam Bankman-Fried has stepped down as CEO. The filing applies to Alameda Research as well as 130—yes, 130—affiliated companies. Whew!
Original article: During this year’s Super Bowl, cryptocurrency exchange FTX ran an ad for which it paid Larry David some unknowably huge amount of money. It was one of the best ads of the night, no question, the perfect combination of actor and script. FTX got America’s most famous curmudgeon to express skepticism toward various scenes of great innovation over the course of human history. The wheel? Larry David didn’t like it. The fork? Absolutely not. On it went: the toilet, coffee, the Declaration of Independence, the lightbulb, dishwashers, the moon landing, MP3 players, and … FTX, “a safe and easy way to get into crypto.” Based on prevailing rates, FTX probably paid tens of millions of dollars for the time alone, which it was able to do, no problem. “Don’t be like Larry,” the ad said. Try FTX!
Larry David, or at least “Larry David,” has been vindicated. FTX was not a safe way to get into crypto. The company is verging on bankruptcy after running out of money to cover withdrawals in its international business. CEO Sam Bankman-Fried, aka SBF, is 21 tweets deep into an apology thread that begins with “I fucked up” but only shines partial light on what’s gone wrong. In a sign that things are not going well, the thread (for the time being) wraps up with SBF saying it was “NOT ADVICE … IN ANY WAY” and that “I WAS NOT VERY CAREFUL WITH MY WORDS HERE, AND DO NOT MEAN ANY OF THEM IN A TECHNICAL OR LEGAL SENSE; I MAY WELL HAVE NOT DESCRIBED THINGS RIGHT.” It had looked until Wednesday like one of FTX’s rivals in the crypto exchange game, Binance, would buy out FTX and thus let it carry on without disaster. But Binance backed out of that, and SBF is now looking at an $8 billion hole that seems to be mostly other people’s money. If FTX goes bankrupt, those people will fight over whatever they can recover. SBF says his priority is ”doing right by users,” and then by investors and employees. Good luck to all of them.
SBF’s attempt at damage control befits a spectacularly dumb story. The nearly complete collapse of FTX’s international business (SBF says the U.S. operation is fine) is a strong entry in the pantheon of stupid business stories that have reared their heads in this still-young decade. There was a good run of them in the first quarter of 2021, which featured a now-subsided wave of special-purpose acquisition companies, the height of the memestock thing, and an admitted insider trader causing several stocks to melt down because his banks refused to stop giving him money. Humans, aided by ever-improving tech, have gotten very good at making large amounts of money appear and disappear quickly. In this case, SBF made a lot of it disappear. He may, in fact, be a trailblazer in how to make money disappear.
The mechanics of FTX’s downfall are somewhat winding. I liked this explanation by Matt Levine, which makes a good case that, in simple terms, FTX threw itself into a death spiral. It took a lot of intricate steps to construct that spiral. FTX’s simplest business is to take money from people, go and get crypto for them, and hold it in its app in exchange for a fee until the user wants to do something else with it. That is a good business. It only requires executing transactions in order to make money. But FTX also has a lending operation, where it loans either money or crypto to users (and, it turns out, institutions). Done right, this can also be a good business, and the lender can make a lot of money on interest. Done wrong, it can be very bad.
FTX did it wrong. Someone really influential in crypto circles raised a red flag about that and sold tons of little nonstock pieces of FTX’s business. This sequence made FTX users wonder about the company’s ability to carry on, so they went to withdraw their money. But FTX, at some point, didn’t have it, because it had twisted itself into knots in its lending business. The money wasn’t in the right place to be withdrawn, and it might have become even harder for FTX to get it because of the specific way that many people believe it was running its lending business. (More on that shortly.) The result is this whole mess. FTX is in dire straits, and SBF is reduced to groveling for investors to give the firm a big cash infusion. Meanwhile, the company is responsible for a lot of IOUs—certainly to its own investors, and also to an unclear number of regular people who entrusted their assets to FTX.
The dumbness of this story breaks into two areas. One is SBF’s fault, and the other is the fault of whichever regulatory authorities are supposed to prevent outcomes like this one.
The SBF part is the most compelling, in the “How could someone even think up something like this?” way. The 30-year-old now-former mogul controls not just FTX, but a hedge fund called Alameda Research. FTX has its own crypto coin, called FTT. FTX is a private company and its stock doesn’t trade on exchanges, but FTT functions almost, a little bit, like a stock. The market sends the price of FTT up when things are good for FTX and down when they’re not. FTT ownership confers some small member benefits, but it goes up because SBF’s company (and apparently his hedge fund) will buy a bunch of it from time to time. If FTX is doing well, it might buy more FTT, and the price will go up. All of that seems like fair play.
The crypto publication CoinDesk reported this month that SBF’s hedge fund held a huge amount of FTT. SBF’s hedge fund can hold whatever token it wants, and if that token goes down, then the fund loses money. But what if things could get really bad? What if the hedge fund is using its FTT as collateral so that it can borrow more cryptocurrencies from FTX? That would be a big risk, because the collateral that FTX was holding for the crypto it had loaned out would be inherently tied to confidence in FTX’s business. If people started asking questions about FTX’s viability, then in addition to rushing to withdraw their money, they might also sell their FTT. These events could reinforce each other, with the price of the coin going down further and further as FTX makes more headlines for, say, not being able to process customer withdrawals. And why couldn’t FTX process those withdrawals? One possible explanation is that its collateral from Alameda for various Bitcoins it had lent out was in FTT, which was rapidly losing value. In this event, FTX would be more or less busted, which it is now.
That has been a working theory of what happened, and the Wall Street Journal reported Thursday afternoon that it was roughly the size of things. The paper reported that SBF had told investors that the hedge fund owed $10 billion to the exchange. (It didn’t specify what FTT’s role was in that debt.) Earlier, SBF sent a very vague, denial-ish sounding tweet that said Alameda isn’t “doing any of the weird things that I see on Twitter—and nothing large at all. And one way or another, soon they won’t be trading on FTX anymore.” Either way, FTT has lost almost all of its value, and that did happen after someone said he was offloading a lot of FTT. Specifically, the seller was Binance CEO Changpeng Zhao, who also is known by his initials. CZ had said that “recent revelations” led him to liquidate a $530 million holding in FTT. Binance had held the stake because it was an early investor in FTX. SBF’s disjointed apology thread alludes to a “sparring partner” whom he might have more to say about later, but who beat him in this round. That’s CZ, who seized on a massive vulnerability and set in motion a chain of events that has brought SBF to his knees. In business rivalry terms, it’s a big win.
SBF has no way of looking nonterrible here, but one way for him to look extra seedy would be if it turned out that FTX was not just lending out crypto that belonged to its users, but was doing so to SBF’s own fund and that the collateral FTX accepted in that lending was a coin that was directly tied to public confidence in FTX. That would indeed be a recipe for doom, and doom is what FTX got. No matter how it got there, people are going to lose a lot of money, including lots of regular crypto investors who are not rich venture capitalists. There should in theory be some agency or law working to prevent this foreseeable nightmare from materializing. But it’s not clear that there is, and it’s also not exactly clear who has oversight. FTX is headquartered in the Bahamas. This scandal involves its international division, but the company also does business in the U.S. The Securities and Exchange Commission and the Justice Department are looking into everything, which they probably need to do. The chairman of the SEC sounds pretty chapped about the whole thing, but mostly in a philosophical way.
Maybe you’re anti-crypto and think that anyone who had significant holdings at FTX was playing with fire anyway—that dabbling in the crypto pool is reckless in the first place, so anyone who gets burned by FTX deserves it. But this arc is a bit different than the typical way a retail investor loses their shirt. Usually, in these very 21st-century stories, it happens because an investment doesn’t work out in the market. Someone bought into Bitcoin at the wrong time, or did the same with a rapidly moving Reddit stock. Maybe they took a shot at an initial public offering on Robinhood, and then the stock went down. Those are the breaks of the game. But here, crypto investors are at risk of losing their investments not because of anything that happened in the market more broadly, but because one of the biggest companies entrusted with managing their assets proved not to be up for the task. And if this one wasn’t, then crypto is quickly getting low on places that are.