Crypto carnage and the Sam Bankman-Fried meltdown

In the end, Musk passed up on Bankman-Fried’s audacious offer to co-invest in Twitter and accepted US$500 million from ChangPeng Zhou (or CZ as he is known), the founder and CEO of Binance, the world’s largest crypto exchange, and a rival of FTX. Two weeks ago, Musk completed the Twitter transaction and now runs it as the Chief Twit. And Bankman-Fried? Last week, he was staring at bankruptcy.

How a man who was worth US$26 billion just a few weeks ago and whose flagship firm was last valued by top global venture capitalists like SoftBank Group, TigerGlobal, ThomaBravo, BlackRock, Sequoia Capital and Paradigm Investment Group at US$32 billion go from “helping the world’s richest man” to try to save himself from near bankruptcy is all about audacity, leveraging up to the hilt on speculative crypto assets and trying to bluff his way just as the global economy is heading for a hard landing, central banks around the world are upping the ante with higher interest rates and asset prices from stocks to bonds, cryptocurrencies, commodities and real estate are in free fall.

Born on the campus of Stanford University to parents who were both law professors, Bankman-Fried (better known as SBF) attended a camp for extremely talented mathematics students in North America when he was still in high school. He graduated with a degree in physics and maths from the prestigious MIT and became the cryptocurrency world’s most visible poster boy with a fortune estimated at over US$26 billion.

Master self-promoter
After college, he worked at Jane Street Capital, one of the world’s largest market makers and high-frequency trading firms, as a proprietary trader on its International ETF desk. In 2017, he set up Alameda Research, a quantitative trading firm, to arbitrage — or take advantage of — higher bitcoin prices in Japan than in America. He moved to Hong Kong in 2018 and, just before the Covid-19 lockdowns in 2020, to the Bahamas, where he has been since. While in Hong Kong, he also founded FTX, a cryptocurrency exchange in 2019 which became the world’s number two crypto exchange behind Binance, owned by China-born Canadian Zhou, who was one of the first investors in FTX.

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Boyish looking with ruffled curly hair, now 30-year-old Bankman-Fried is a master self-promoter in the mould of Elon Musk and Donald Trump. He has long been a regular on CNBC, CNN and Bloomberg TV, donning colourful T-shirts and shorts with a Bahamas backdrop of palm trees and the ocean. He has committed to donating 99% of his wealth to good causes. He forked out US$100 million “to alleviate global poverty,” assisting developing countries battling the Covid-19 pandemic and global warming earlier this year.

As venture capitalists poured US$2 billion into his crypto firms, FTX bought the naming rights to the National Basketball Association Miami Heat home arena. He also hired US National Football League star quarterback Tom Brady and his then-wife, supermodel Gisele Bündchen, as spokespersons and had FTX’s logo displayed on the uniforms of Major League Baseball umpires. Indeed, Brady and Bündchen took a small stake in FTX and received FTX’s cryptocurrency, FTT, as part of an endorsement deal. Among FTX’s other “ambassadors” were US basketball star Stephen Curry, basketball icon Shaquille O’Neill, baseball giant David Ortiz and tennis star Naomi Osaka who bought stakes in FTX and were paid in FTX’s crypto coin. FTX value is now zero, and FTT’s value has plunged 90%.

Bankman-Fried also made huge political donations to Democrats ahead of the recent midterm elections. That gave him access to top politicians, close advisors to President Biden and key regulators. He bad-mouthed to regulators’ about a rival platform, Binance, which has no headquarters. He was being heard because he was the biggest Democratic donor behind billionaire Michael Bloomberg and hedge fund billionaire George Soros. According to the Washington, DC-based non-profit Open Secrets, FTX owner’s contributions in the recent midterms elections totalled US$39.9 million. He donated over US$10 million to Biden’s Presidential campaign in 2020.

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A cryptocurrency is a digital asset that works as a medium of exchange through a computer network that is not reliant on any central authority. The first cryptocurrency, Bitcoin, emerged in late 2008 after the global financial crisis as an experiment in monetary theory, enabling users to move a digital-only currency between holders on a decentralised, peer-to-peer network rather than by a government or bank.

Bankman-Fried was not only running a large crypto hedge fund but also the world’s second-largest crypto exchange. The complex relationship between FTX and Alameda and the conflict of interest resulted in a liquidity crisis at FTX that led to the firm’s collapse. 22% of all deposits and withdrawals for FTX digital wallets interacted with wallets belonging to Alameda Research. Moreover, 50% of Alameda’s trading volume is done on FTX, which holds information on every trader on its exchange and could use that information to exploit users for the benefit of joint owner Bankman-Fried by trading against them through Alameda. Imagine if Goldman Sachs owned the New York Stock Exchange and the options and futures market, CME and had the data collection prowess of Facebook.

Last week, digital assets-focused news site CoinDesk published a piece showing that most of Alameda’s net equity was FTT tokens issued by FTX. FTT is not a cryptocurrency but shares in FTX in digital form. Alameda had US$14 billion in assets, of which the largest and third largest holdings were US$3.66 billion of “unlocked FTT” and US$2.16 billion of “FTT Collateral”. The document also showed that the company had US$8 billion in liabilities, of which US$7.4 billion were loans the company took on. In essence, most of Alameda’s US$6.6 billion in net equity —US$14.6 billion in assets minus US$8 billion in liabilities — is FTT Tokens printed out of thin air by FTX, which is owned by the same person who also owns Alameda: Bankman-Fried.

Conflict of interest
In the financial services industry, there are all sorts of conflicts of interest within institutions. Banks pretend to police themselves with “Chinese Walls” to prevent problems. The crypto industry is, of course, entirely unregulated. But here is why the FTX-Alameda relationship was a much bigger problem: Last week, there were US$5.1 billion in FTT tokens in circulation. That meant Alameda had more FTT tokens on its balance sheet than the rest of the world’s crypto trading community. Indeed, Alameda had enough FTT Tokens to double the supply of all FTT tokens in circulation at then time. As word of the inherent conflict spread, crypto traders became wary that FTT tokens were at risk of dilution if Alameda ever decided to liquidate its tokens.

On Nov 6, soon after CoinDesk published the piece, Binance CEO ChangPeng Zhou tweeted that he would sell all of the FTT tokens his firm had held on their balance sheet. Binance, an early investor in FTX, had received US$2.1 billion in cash and FTT tokens when it sold that stake back to Bankman-Fried last year. Zhou’s tweet succeeded in creating a run on the bank over the weekend. That eventually forced FTX to pause withdrawals from its platform, which spurred more fear, causing the FTT token to drop further. “Binance exploited FTX’s seemingly shady connections to Alameda to trigger fear,” notes Alejandro Barreto, who runs Wall Street Odds, a financial website in Toronto. “Once the fear had taken hold, it used FTX’s weakened state to purchase them at what is likely to be a significant discount compared to what FTX would have been worth just a few weeks ago.” As a direct competitor to FTX, Zhou would be a beneficiary of investors moving their funds from FTX to Binance.

Initially, FTX denied it had liquidity issues. Then on Monday, Bankman-Fried reached out to Zhou for help. “There is a significant liquidity crunch,” at FTX, the Binance CEO said in a tweet. “To protect users, we signed a non-binding LOI (letter of intent) to acquire FTX.com and help cover the liquidity crunch fully. We will be conducting a full (due diligence) in the coming days.” On Nov 9, Binance said it was pulling out of the deal. FTX.com, the international arm, which makes up 95% of the business, is officially out of business. For his part, Zhou claims there was “no masterplan” to bankrupt and then take over FTX. Indeed, he claims, the collapse of the rival crypto exchange was “not good for anyone in the industry.”

FTX’s collapse triggered a massive sell-off in cryptocurrencies. Bitcoin, trading at over US$68,000 a year ago, fell to US$15,500 on Nov 9. Bitcoin is now down 26% over the past week. Its price has plunged 78% from its peak 12 months ago. Crypto-related listed companies like Coinbase and MicroStrategy have seen their stocks hammered. The sell-off has sparked fear and uncertainty in the cryptocurrency ecosystem legendary for its “HODL,” or Buy-and-hold forever investors.

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Ironically, just five months ago, Bankman-Fried was hailed as a saviour. He was on the cover of Fortune and Forbes as business publications were falling over each other to profile him. “He is bailing out cryptocurrency markets the way John Pierpont Morgan did after the crisis of 1907,” said Anthony Scaramucci, founder of SkyBridge Capital. The founder of JP Morgan, had used his own money to rescue ailing banks and brokerages before the US Congress helped set up the US Federal Reserve, or the central bank. For his part, the FTX founder printed his own currency FTT to bail out crypto lenders like BlockFi and Voyager Digital after the collapse of Singapore-based crypto hedge fund Three Arrows Capital in June. He also bought a 7.6% stake in Robinhood Markets, the pioneer of commission-free stocks and options trading, which also sells crypto. Now the man rescuing troubled crypto firms is being rescued himself.

Crypto investors took too much debt on top of their speculative assets. Borrowing too much during boom times leaves leveraged players vulnerable during a downturn that invariably follows. The concern is that as the contagion spreads, investors will be forced to sell whatever they own as they take massive hits on their crypto assets. FTX collapse has strengthened the hands of regulators. Instead of paying too much attention to use cases, utility and whether someday crypto might become a store of value, regulators must focus on how best to protect retail investors.

Assif Shameen is a technology and business writer based in North America