The rise and fall of FTX (caveat emptor, as they say)

The trial of Sam Bankman-Fried, founder and creator of what many call a Ponzi scheme called FTX, has started in New York. FTX was a cryptocurrency exchange that, like MtGox a decade before, lost millions/billions of dollars of investor’s money. C’est la vie.

There’s lots of reportage out there about the trial, the background, the situation and more but, for those unfamiliar, at its height the key facts are these:

• FTX had over 5 million active users.
• On average, FTX’s daily volume in 2021 exceeded $12.5 billion.
• FTX was expected to reach $1.1 billion in revenue for 2022.
• Prior to the collapse, FTX’s valuation in 2022 was estimated at $32 billion.
• FTT, FTX’s platform token, had a $4.6 billion market cap in 2022.
• FTX had approximately 200 employees.
• FTX’s net income in 2021 amounted to $388 million.
• Most of FTX traffic came from South Korea.

So far, so good.

But then Terra/Luna, a supposedly stablecoin, collapsed and, in short order, people realised that FTX was more like a Ponzi scheme than an exchange. This is because, like Terra/Luna, FTX was propped up by its sister company, Almeda Research. Every dollar invested in FTX was switched with Almeda was switched with FTX was switched with Almeda and so on … or that is the claim.

Specifically, the collapse of FTX was caused by a liquidity crisis of the company's token, FTT, which served as the atom bomb for its bankruptcy. Prior to its collapse, FTX was the third-largest cryptocurrency exchange by volume and Sam Bankman-Fried, its founder, was the poster child of crypto.

Then, on 2nd November 2022, CoinDesk published an article stating that Alameda Research, a trading firm affiliated with FTX and owned by FTX chief executive Sam Bankman-Fried, held a significant amount of FTX's exchange token, FTT. Following the allegations, Binance—a competing cryptocurrency exchange and a prior investor in FTX—announced it would sell its FTT, leading the market price of the token to crash. The move also triggered a spike in withdrawals from FTX, causing the exchange to freeze withdrawals and creating a liquidity crisis.

You can read more over here.

The result is that FTX imploded and lost billions of dollars for its users. Sam Bankman-Fried was accused of fraud and his colleagues entered plea bargains against him to get off the possibility of jail.

The star witness is testifying this week. This is Caroline Ellison, the former CEO of Almeda Research, and one of the few people in Bankman-Fried’s inner circle whom prosecutors say knows the truth behind the alleged siphoning of billions of dollars in FTX customer funds to the sister trading firm.

Gary Wang, the former CTO of FTX, has also been testifying as part of a cooperation deal with prosecutors. He went into detail about how Bankman-Fried granted approval of the special privileges Alameda had on FTX, including the ability to withdraw customer funds as early as 2019, eventually giving it a $65 billion credit line.

There are more details over here on Bloomberg but, for those who do not have access, the trial is likely to take a month or so and the headline is that FTX lost almost $9 billion ... in other words, if you remember a guy called Bernie Madoff, this is a bigger deal.

Martin Peers at The Information summarises the situation well:

Just when it seemed there was nothing new we could learn from the SBF saga, the FTX founder's onetime deputy (and onetime romantic partner) Caroline Ellison testified in court on Tuesday. And her account of Sam Bankman-Fried’s attitudes toward risk, which helped set the stage for FTX’s bankruptcy, was truly mind-blowing …

At one point in late 2021, Bankman-Fried directed Ellison and others at his hedge fund, Alameda Research, to “borrow as much money as we could from whatever sources we could find at whatever terms we could get” …

[And] “these are the clowns entrusted with $2 billion by venture capitalists and billions more by lenders and customers. You can blame customers for being stupid enough to listen to celebrities promoting FTX (why would Tom Brady know anything about crypto?). But the lenders and venture capitalists are even more blameworthy, although deciding which group is the more incompetent isn’t easy. Perhaps the lenders have the most egg on their face: After all, if they’d done an ounce of due diligence on even the value of Alameda’s collateral, they might have helped avert the FTX disaster.”

Interestingly, whilst all this was going on, one of my favourite authors in the financial markets, Michael Lewis, was writing a book about Sam Bankman-Fried. The book – Going Infinite – is just coming out to coincide with the court case. Great timing.

The Economist has reviewed the book, and portrays the FTX founder as a bit of a weird guy:

Sam Bankman-Fried is “a puzzling yet oddly magnetic personality. He struggles to make sense of his childhood. His appearance is alienating. (He has to teach himself how to smile.) He hates fashion, sporting cargo shorts and unkempt hair. A hilarious passage describes him playing a fiendish video game while speaking to Anna Wintour, the editor-in-chief of Vogue, on Zoom. His hyper-rationality sets him apart from almost everyone. He views people not as good or bad, but as probability distributions around a mean.”

Interesting.

For me, I always found it funny that a fried banker could become the operator of the third largest crypto exchange in the world and, like MtGox – the crypto exchange that imploded a decade before  – we have yet another operator running a scheme that is effectively a sham. Caveat emptor as they say.