Mutual crypto-destruction assured | Financial Times

The cold war between FTX’s Sam Bankman-Fried (SBF) and Binance’s Changpeng Zhao (CZ) went nuclear this week. Only one was left begging for mercy.

SBF tweeted on Tuesday that he had gone to CZ for help, and CZ whispered “no” made some tweets that can be summed up “may be! but also #RIPBoz lol“. Then someone told Coindesk on Wednesday that Binance might be getting cold feet.

There was plenty of fallout, of course, with ethereum down 24 percent, solana down 46 percent, and FTX’s token FTT down more than 75 percent. Even BNB, the token of apparent crypto war winner Binance, is selling off.

Oh also, former inmate (/“fake Peter Pan cat”) Martin Shkreli and Interpol fugitive Do Kwon both appeared on a Twitch stream Tuesday to discuss the situation. Shkreli comforted his fellow degenerates with an assurance that prison wasn’t so bad.

Everything ready then?

Wait, what?! This is all so strange. I thought the guy with the funny hair seemed smart.

There is a good reason for that! SBF has marketed itself very aggressively as The One Legit Cryptocurrency Guy, made a boatload of political donations, and helped promote an entire philosophical movement that rationalizes wealth accumulation as a moral good.

It’s starting to look like it all the good press documented some major vulnerabilities in FTX’s operations.

It was fragile enough that the founder of Binance, a major competitor, could cause market panic with a series of tweets. These tweets reportedly prompted SBF to look for another round of investment, eventually forcing him to go to CZ, cap in hand.

So FTX’s biggest competitor…started a panic…hurting FTX’s business? And then leveraged it to buy FTX?

In a way!

But Binance only signed a “non-binding LOI”, or letter of intent. So it doesn’t need to buy FTX’s global business, or really help FTX in any way.

Is it legal?!

Unfortunately, the guys who would prosecute – a government and/or regulator – operate within jurisdictions. And we need to chat with a bunch of Bahamian and international law experts to find out who has that reach.

Presumably some has jurisdiction over Binance’s exchange, but CZ has not disclosed where the main exchange is located. The firm is also said to have moved money on behalf of Iranian crypto exchanges, despite strict US government sanctions against Iran. ¯\_(ツ)_/¯

And this brings us to another point that has been missed in all the drama: SBF also tweeted on Tuesday that the LOI is for FTX’s global operations, not FTX.US.

If SBF has to sell FTX’s international business, why doesn’t he have to sell the American business?

Great question! We’ve been trying to figure out its meaning since yesterday.

FTX’s US platform is separate from its international exchange, as SBF said in its Tuesday tweets. He described FTX US on Twitter as “not yet affected by this”, without saying whether “this” is the need for cash or the Binance LOI. FTX US also appears to be open to dollar withdrawals.

On the one hand, this is a sign that American regulation more or less worked in the areas where it is currently built to work (dollar deposits on financial platforms).

6) (Note that and separate companies – are currently not affected by this. their withdrawals are and have been live, fully supported 1:1 and working normally.)

— SBF (@SBF_FTX) 8 November 2022

Nevertheless, it says that FTX’s international exchange has far better liquidity. So it seems sub-optimal for SBF to lose that part of the business, right?

Questions also remain as to whether FTX’s two platforms have — or, had — significantly different relationship with Alameda Research, a Hong Kong-based trading firm that SBF created before starting FTX.

Concerns about Alameda’s balance sheet were the original cause of the market rout.

Alameda!? Is there a third company involved in this? At least it’s not an abbreviation.

Yep! Although it’s not obvious exactly how separate Alameda is from FTX. While CEO Caroline Ellison told Bloomberg that there is a “Chinese wall” to stop information sharing between Alameda and FTX, a Nov. 2 Coindesk report raised questions about funding (not informational) ties.

Coindesk saw documents showing that at least one part of Alameda had a very large amount of FTT on its balance sheet as of June 30, with $2.2 billion in FTT held as “collateral.”

It may not be Lehman, but it sounds like another lesson in the danger of using off-balance sheet vehicles to give a business poorly secured leverage. The report suggested that FTX was effectively able to increase leverage by issuing tokens to Alameda, because Alameda could then borrow against those tokens and reallocate the money back to FTX’s platform.

But when the price of a token – or any security – falls, a firm must put up more money against its loans. And when a firm’s holdings are so concentrated in a single asset, it’s hard to hedge against price declines or raise cash (especially if the asset is issued by a related entity!).

Scare enough people about the value of a financial firm’s ability to repay its loans? Voilà — you have a run on the non-bank.

Now Binance appeared to be threatening to liquidate only about $530 million of FTT, and there was reportedly more than $5 billion outstanding when Coindesk’s story was published on November 2nd.

But Alameda’s CEO added some fuel to the fire on Sunday. In response to CZ’s liquidation threats, she tweeted an offer to buy Binance’s stash of FTT outright at $22 per token (rather than, you know, just buying it.)

Not only was the offer publicly rejected, but the entire market watched as the price of the FTT token fell below $22 and continued to fall. It recently traded at $5.

What do tokens really have to do with FTX’s business? Are they like a stock?

They are very different. In fact, tokens cannot be too much like stocks, or their issuers will run into trouble with the Securities and Exchange Commission.

The way FTX ran its FTT token makes it sound a bit like an airline miles program, if the airlines periodically bought back their miles. When you buy an FTT token, you don’t really get any equity or guaranteed interest payments. But you get benefits. For airlines, it’s travel. For FTX there are discounts on trading.

Really?! I guess may be I kind of get the appeal if they should be bought back. What happened then?

In this case, imagine that Airline A owned a bunch of Airline B’s miles, and then told everyone that it thought Airline B was dangerous, and that it sold those miles to anyone who would buy them (there is no infrastructure to do this as far as we can tell).

How would you feel if you had lent to Airline B against its miles? (Bonds backed by airline miles exist, as many of you know, and have been quite popular for the past decade!) You probably won’t be eager to buy those miles even at a discount, because who else wants them?

That’s what Binance did with FTX, more or less. People weren’t sure about the value of FTT, in part because CZ was threatening to sell. FTT’s dive can have taken down Alameda because, as Coindesk reported, the trade store owns a lot of it.

The collapse of FTT also broke something at FTX, either directly or indirectly through its ties with Alameda. Bloomberg also reported in September that SBF owned “almost all” of Alameda. (It’s also hard to tell how much of Binance’s hesitancy to buy FTX is based on balance sheet concerns, and how much is the result of CZ trading/mining.)

Messy! So… uh… now what?

In short: there is still a lot to sort through! While more details emerge, why not read through this old Odd Lots podcast script? Lots of talk there about black boxes and crypto fairy dust. One thing we are sure to say is that the Expanded SBF Universe needs money.

An interesting side note: Binance also has a native token, called BNB. When news of the deal first broke, it rallied, but then gave up all those gains and is now down 20 percent over the past 24 hours.

Even Bitcoin is down now, down 15 percent. Bryce’s Cold War analogy was close, but this one did end in mutual destruction.

Price action means that some market-making businesses were carried out on a stretcher yesterday. One theory is that these market makers were not particularly well hedged in options markets for these kinds of rare events, as a market maker elsewhere would hopefully be.

The extent of the fallout is still becoming clear, so stay tuned. We’ve also heard that wunderkind prodigy crypto types may be looking for new jobs… if you are and feel like chatting/complaining/etc, you know where to find us!