Crypto Is Running Out Of Dominoes

Sam Bankman-Fried, the 30-year-old cryptocurrency maven independently described as "schlubby" by each of Bloomberg, the New York Times, and New York magazine within a two-month period, woke up on Monday worth somewhere in the neighborhood of $16 billion, went to sleep Tuesday no longer a billionaire as his crypto empire took on water and began to sink, then started his Wednesday by watching his own lifeboat spring a leak. Pinning down a mega-wealthy person's net worth with any degree of real certainty is tricky—to take a timely example, what does it mean that so much of the wealthiest person in the world's fortune is tied up in stock whose price will necessarily dip the moment he attempts to liquidate said equity?—but while that $16 billion mark may have overstated how much Bankman-Fried was "worth," the magnitude of his collapse is stunning all the same. FTX appears to be dead.

Perhaps you remember those oily Super Bowl ads where Tom Brady and Larry David tried to convince you that you would die a sad loser if you didn't buy cryptocurrency on FTX, or maybe you have watched a football, baseball, or basketball game framed by the FTX logo. The company has tried to make itself omnipresent. Bankman-Fried runs (or ran, maybe) both FTX, one of the largest crypto exchanges in the world, as well as Alameda Research, one of the largest crypto hedge funds in the world. FTX racked up over $2 billion in investment at a $23 billion valuation, and over the past three years, Bankman-Fried emerged as the single most influential prophet of the crypto world and its court philosophies. His cultivated persona as a norm-bucking mad scientist, as "some sort of capitalist monk," helped add to his legend. From the start of the pandemic until about six months ago, business was booming, and FTX was at the vanguard. Within four years of founding FTX, Bankman-Fried was one of the youngest self-made billionaires in the world and a well-regarded semi-public intellectual, and he had already began to cultivate political influence as a check against any possible future regulation. (He once promised to give up to $1 billion to Democratic candidates in the midterms. He ended up spending a small fraction of that, perhaps for reasons that became clear this week.) The American attitude toward the mega-wealthy is something akin to oracular worship, and Bankman-Fried's position at the forefront of what as recently as this spring looked like the future made him all the more alluring.

When bad times hit the crypto market and the sector lost $2 trillion in valuation this year, Bankman-Fried seemed to have positioned FTX to weather the chaos and chart the course from this crisis into something resembling a harmonious future—mostly by snapping up distressed assets. After shady yield farming company BlockFi tanked this past summer when regulators successfully regulated them, FTX stepped in with a $400 million bailout and an agreement to buy them for somewhere between $15 million and $240 million, far lower than their $5 billion valuation. When Three Arrows Capital imploded and its founders disappeared, leaving $3.5 billion in other companies' assets in the lurch, FTX plugged at least one of the most significant holes. The crypto firm Voyager, who lied to customers about their deposits being protected by FDIC insurance, among other things, had to declare bankruptcy in the wake of the 3AC scandal, but FTX bought up their assets and ported their customers over to their own platform. As progressively larger and larger crypto firms went under, the bedrock under the entire industry seemed to be quaking uncomfortably, yet to the crypto optimist, Bankman-Fried's J.P. Morgan act was a sign that the sector at least had a floor, at least as long as you ignored how much yield farming resembled a Ponzi scheme.

Yet the Voyager collapse, and FTX's role in "bailing them out," raised a number of serious concerns. Voyager's financials revealed that Alameda Research owed them at least $370 million, and maybe even more than $1 billion. Last week, CoinDesk got their hands on Alameda Research's Q2 financials, which showed that everything was not as stable as anyone thought. Of their $14.6 billion in assets, $5.8 billion, a plurality, was tied up in FTX's native token, FTT. That should be extremely alarming, as the self-created crypto token has turned out to be one of the most obviously fake instruments in crypto. If a company can create and inflate value out of nowhere, by itself, in the form of a token that is untethered from the market, is it actually value? (No.) Was the $8 billion in liabilities, $7.4 billion of which in the form of loans, a sign that they had become over-leveraged? (Yes.) But if the Bankman-Fried empire was more exposed than previously thought, was it actually too big to fail?

We got the shocking answer to that last question on Tuesday. Days after Bankman-Fried was carrying on with his usual triumphant, nerdy flair, rival exchange Binance, the largest in the world, announced they would be selling their entire stash of FTT tokens because of "recent revelations that have came to light." That move, part of a long skirmish between the two exchanges and their founders, prompted a sort of bank run, which FTX was clearly not liquid enough to sustain. Hours after FTX inevitably halted all withdrawals, Bankman-Fried announced the news himself: He would be selling FTX to Binance for pennies on the dollar.

Then on Wednesday morning, CoinDesk reported that Binance would likely back out of the deal to buy FTX after looking at its books. Bloomberg added a bit more detail, reporting that Binance people didn't need much time to conclude that FTX was better left to die on its own:

Just hours into their due diligence, Binance executives found themselves staring into a financial black hole -- casting doubt on whether the firm should rescue its onetime top rival.

Bloomberg

It continues to get worse for Bankman-Fried. Revelations emerged on Wednesday that U.S. regulators have been probing FTX for "mishandling customer funds" (read: doing Ponzi stuff). Hours later, Semafor—which, hilariously, counts Bankman-Fried as one of its biggest investors— reported that "most of" FTX's legal and compliance teams had quit. If many firms were exposed when Terra or Voyager or 3AC collapsed, almost everyone is exposed if FTX collapses. In the immediate wake of Tuesday's announcement, investors started fretting about losing everything they put in, prices slumped across the sector, and the entire ecosystem seems more rickety than ever.

One read on this development is that Binance executed a shrewd leverage play to squeeze, then kill their biggest competitor. They will control over 70 percent of the trading market unless FTX somehow wheezes back to life. The problem with this is that would-be customers and investors would have to believe that FTX was independently full of shit and not that the entire edifice of crypto investing was built out of crap in the first place. This game only works on trust, and the sudden revelation that one of the biggest firms in the world is a mirage will obviously erode whatever trust people still have in crypto after the cascading losses of the past six months.

If Voyager's collapse helped bring down FTX, imagine what FTX's collapse could bring down. Binance is one of the final remaining bulwarks of the industry. Binance also will not say where their headquarters are located, are practically daring to be regulated with the way they flout international law, and their own native token is spiraling. To come to the conclusion that FTX's downfall is only an FTX problem is to misread how the industry works. Or doesn't work.