FTX. SBF. WTF.

November 23, 2022

Gordon Gekko in Oliver Stone’s seminal Wall Street is known for many things: corporate raider, self-made billionaire, ruthless predator. What he may be most well-known for, however, is his famous speech, “Greed is Good.”  In it, he makes a compelling argument that the fortitude greed provides can lead to many “good” things. I don’t think Sam Bankman-Fried (a.k.a. SBF), the former CEO of FTX, thought that he was a Gordon Gekko. In fact, he styled himself like a modern-day Robin Hood. After looking at the man behind the curtain, however, it would certainly seem he followed Gekko’s Motto. Unsurprisingly greed, as it turned out for SBF, was not good. Not for him and not for so many others.

What the Eff-T-X?

Seriously. I really wanted to write about other things this month, but how could I? The spectacular implosion of FTX is everywhere, and the issues now coming to light around this once venerable and lauded exchange is turning out to make Enron look like the best managed company in America. For those few of you who have been living under a rock, vacationing in Bali or simply avoiding the news, I’ll provide a quick synopsis.

FTX, founded in the Bahamas in 2019 by SBF, grew to be a worldwide crypto exchange worth nearly $32 billion and third largest player in the ecosystem by volume. Seemingly out of nowhere it grew. With support from famous Sand Hill VC investors like Sequoia, endorsement from celebrities like Tom Brady and Larry David and branding on Formula 1 cars and sports arenas, the company had a global reach. It  projected itself as a pillar of credibility and a force to be reckoned with. The company even bailed out numerous other firms such as BlockFi in the wake of this summer’s Luna, 3 Arrows and Celsius debacles. Of course, all of those bail outs are now in jeopardy. BlockFi, for example, has now been forced to file for bankruptcy protection.

This was SBFs second company, the first being a trading company, Alameda Research. On paper they seemed to be distinct entitles with little relationship. A CoinDesk report was issued on Nov 2nd, however, which questioned the relationship between FTX and Alameda Research. Simply put, the article noted that Alameda’s value was propped up by FTT, the native token of FTX which allowed its holders discounted trading fees on FTX. It seems that Alameda took a hit during the crisis this summer and FTX gave 173 million FTT tokens to Alameda which, on paper, made the company solvent. The just over $4 billion worth of tokens then combined to create nearly $6B of FTT on Alameda’s balance sheet.

Shortly after the CoinDesk report, Binance announced that it would liquidate over half a billion in FTT, which sparked a “run on the bank.” FTX couldn’t cover all the withdrawals and that created a liquidity crisis. It seemed like another Celsius meltdown (which now, by the way, we’ve all but forgotten about in the wake of this madness) whereby FTX (and Alameda) had too much of its own token overvalued on its balance sheet. Then things unraveled fast. An aborted acquisition attempt from Binance led to a quick meltdown. Alameda and FTX both filed for bankruptcy just a few days later.

It Gets So Much Worse

All this looks like just bad business – nothing necessarily illegal mind you – just bad business. Until you actually look. The bankruptcy court appointed as CEO the man who was in charge of the unwinding of the legendary Enron, John Ray III. In his initial report to the court Ray stated, “In his 40 years of legal and restructuring experience,” he had never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” Ray went on to say, “The concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals was unprecedented.” These are statements from a man who unwinds companies for a living.

It turns out, among other things, FTX had no CFO (what?), lax security and controls, misuse of important passwords, non-audited financials, no real internal processes and, apparently, even used software to conceal the misuse of customer funds (the same type of software (in)famously used by Bernie Madoff.) FTX further loaned upwards of $8B to Alameda, which then loaned it back to the executives of FTX and… well… you get the picture. Total impact seems to be billions as all of the carnage is sorted through, and that’s directly. That doesn’t even consider the impact on related parties who did business with FTX.

The FTX story continues to get even weirder as $477 million of crypto was wired out from the company after the bankruptcy in what looked like a hack but now appears to be SBF acting under the direction of the Bahamian government. It looks like a face-off between the Bahamas and Delaware courts is all but inevitable as regulatory bodies weigh in on who has jurisdiction.

I’m not going to go through any more of the sensational details, but for those of you that are fascinated with car wrecks, you can find a surprisingly good synopsis on Wikipedia and a summary of the bankruptcy filing from MarketWatch.

No, It’s Not Because of Crypto

A collapse of this size makes headlines and, unsurprisingly, naysayers are coming out all over and using this as evidence that this is a problem with crypto. It’s not. It’s a problem with greed. It’s a problem with gross mismanagement. It’s a problem with people. Yes, it’s in the crypto space and yes, it’s going to have pretty big knock-on effects. Many firms of many types were entangled with FTX. These include hedge funds, other crypto exchanges and companies, ventures that FTX bought, ventures that FTX had lent money to… there’s a long list, and it’s going to take some time to untangle. As a cautionary tale, the future of Genesis Global Capital, which had $175 million on FTX that is now not accessible, is still not clear. While this is surely lining up to be a poster child for corporate collapses, it remains a business problem. It’s not because of the tech, any more than the implosion of Enron was because of some fundamental evil of electricity.

Regu-late

Of course, the regulators are now speaking up as well. They should. While the CFTC and SEC continue to spar, it’s time for clarity from Capitol Hill.  Already called out by the EU, who have just put forward the MiCA law (see my last blog), the US has been woefully slow to provide guidance which is absolutely essential if now, in the wake of FTX, a little late. Here’s why: this ecosystem isn’t going anywhere, even in the wake of this catastrophe. The fundamental tenants of blockchain technology – peer-to-peer digital transactions, digital ownership, smart contracts – are all elements that are not only desired but required as we enter the Age of Autonomy, where AI, Robotics and IoT all come together with blockchain to create new, and powerful, autonomous systems.

This meltdown is yet another example of how central entities (FTX) with a single point of failure (SBF) are simply not serving us. Blockchain technology is decentralized so that there is no single point of failure within the system itself, and crypto is about generating and extracting capital value from blockchain systems. While there are certainly a lot of dubious projects (Doge), there are also projects that are laying the foundation for a new ecosystem of cooperative collaboration (Ethereum), better financial systems and yes, even virtual worlds. We can’t tell you who is going to win and we’re not going to name drop here – that’s not the point. The point is the genie is out of the bottle and it’s not going back.

Now regulation is not a panacea, as the SEC proved. For example, regulation or not, the SEC completely fell down with regards to the Bernie Madoff scandal as even with “…detailed and substantive complaints…. a thorough and competent investigation or examination was never performed.” But, any start is a start and would largely help. Proper regulation here in the US provides the opportunity for businesses to grow and also for investors to participate while understanding the guardrails. Lack of such and, well, money will follow the innovation offshore. Conversely, too much regulation (and accompanying taxes) will also drive companies offshore, as California has learned by watching so many companies migrate to other states. We need to do better. FTX, as poorly run as it was, demonstrated one thing clearly – that there is there is demand for the innovation in this space. What we need now is the ability to find that oh-so-difficult balance between innovation and guidelines. I hope we’re on the way now. Biden called for “game changing” crypto rules and the G20 all seem to be in agreement that we need proactive rules for digital assets. Finally. Now let’s get it done.

Unicycles 

So, back to investors. Everyone wants to catch a unicorn (a venture-backed start up that has grown to a market cap of $1 billion+.) I might offer that those hunting the famous unicorns need to pay attention to the unicycles they ride. Ok, pun aside (I couldn’t resist) this may be a little too soon as there is still carnage to be wrought, but I’d be remiss not to point out the opportunity for savvy investors. We are bottoming here. Fortunes are created in the wake of disaster, as we saw in 2008/2009, and everything moves in cycles. We think it is clear that fundamentally good blockchain projects will succeed, so if this is indeed a dumpster fire, then we also have a fire sale.

Everyone wants to buy low and sell high, and with bitcoin at 76% off it’s all time high and core metaverse and defi projects at 90% from peaks, well, the Black Friday sale is here. It’s hard to deploy when there is so much fear, however, and I’m not giving advice on what to do. I am saying that’s what our fund did, because these prices are exceptional when playing the long game.

I can’t tell you how long it’s going to take to recover or exactly when we’ll have the next run. A lot will hinge on the Fed, quantitative tightening and if there is any additional collateral damage. I can tell you that if you understand the fundamentals of the technology then you also understand there is a great opportunity. When everyone is fearful be greedy. I have never seen so much fear in a marketplace as now.

In Closing

EFF-T-X is a cautionary tale that is destined to go down as the biggest collapse in crypto to date. Though Enron still tops the chart with an estimated $74B in losses, the complete lack of controls and management will ensure FTX has its own place in the world of corporate calamities. It will continue to have ripples for years to come. It’s going to cost the market and investors billions. It’s going to have people pause. It’s going to spur regulation. It should. Finally, even though it’s not the technology’s fault it is time, perhaps, to get some responsible adults in the room.

People are still people and do greedy people things when allowed. I wish that wasn’t a core part of human nature but it is. SBF was obviously way out of his league. I wish it didn’t take a star going supernova and then imploding to get proper attention, but sometimes it does. Ultimately this shows us that Gekko’s seminal phrase is not correct. Intrinsic greed is not good. However, if we consider Buffet’s sage advice, well-timed greed may actually be great.

That’s all for now. Until next time, be well, stay safe, and I’ll keep Decrypting: Crypto for you!

About the author James Diorio

James is a Principal and Chief Executive Officer of Tradecraft Capital.