THE FTX AND ALAMEDA SAGA - Avinash Sharma

  

 

It barely took a week for Sam Bankman-Fried aka SBF’s net worth from $16 Billion to less than a billion dollars. Bankman-Fried, the son of two Stanford law professors, launched the trading company Alameda Research in 2017, only a few years after completing his MIT degree. He established FTX in 2019, and it rode the cryptocurrency bull market to a $18 billion valuation in July 2021, attracting investments from firms including BlackRock, Softbank and Sequoia Capital. Then on 2^nd November, 2022, his empire began to collapse.

 

Alameda Research 

Alameda saw early success arbitraging the price of bitcoin between different markets (mainly the US and Japan). As it expanded, it engaged in a variety of trades and dozens of investments in crypto projects. That includes having a substantial holding in the Solana blockchain, a rival to Ethereum developed by an ex-Qualcomm engineer.

 

FTX 

Short for “Futures Exchange”, FTX was launched soon after Alameda grew to be a major cryptocurrency trader. FTX operates a crypto exchange and is based out of the Bahamas.

One of the early-stage investors of the company was Changpeng Zhao, the founder and CEO of Binance, another crypto exchange. By 2021, FTX rapidly grew to become the second largest crypto exchange after Binance. While most exchanges offered simple trading of cryptocurrencies for casual traders, FTX went above and beyond by offering more advanced investment products like futures and options trading for crypto and tokenized stocks which tracked the price movement of listed companies like Tesla. In July 2021, FTX was recording $10 Billion a day in trading volumes and had a million users.

 

FTX had its own crypto currency called FTT tokens. Like other popular cryptocurrencies, such as Bitcoin, FTT holds value, can be traded and is used to carry out financial transactions. In terms of value accrual, one-third of FTX's trading revenue is used to purchase and burn FTT supply, so as trading revenue increases, it creates intrinsic value and increases the market cap of the FTT token. Token burning means removing coins from the overall supply of a cryptocurrency. This typically involves sending the coins or tokens to a wallet which can only receive assets, thus effectively making them inaccessible.

 

Prior to the crash, FTX took massive initiatives to build good PR by signing major stars for its endorsements and paying them in FTT tokens. The company became a member of the World Economic Forum and also helped fund Ukraine’s war effort against Russia. SBF and other executives also used their own money to fund election campaigns for both the Democrats and the Republicans, presumably to curry favor with policymakers.

 

An Unholy Alliance 

The relationship between Alameda and FTX had been a popular subject of speculation before last month’s revelations. Alameda conducted substantial trading on the FTX platform, which caused it to often profit when FTX's other clients lost money. Critics referred to this situation as a conflict of interest. SBF has previously defended the agreement, asserting that Alameda supplied essential liquidity — financial injections that allowed other clients to complete trades on the exchange. Skeptics also found Alameda’s investment offerings a bit fishy considering they promised 15% annualized returns with no downside. Public statements like “we don’t use stop losses” didn’t inspire a lot of confidence either, but as long as Alameda turned up profits, investor money rolling in and the skeptics were largely ignored.

 

Alameda Research's financial records were leaked on November 2nd, 2022, and they showed that the link between the two companies—which had been rumored to be close—was actually deeper than previously thought. A significant portion of the trading company's assets worth $14.6 billion were held in FTT, the native crypto token of FTX. This would mean that Alameda could very well pump up FTT prices to favor FTX and also investors with heavy holdings in FTT. This also signaled a clear conflict of interest and the fact that Alameda had such a huge exposure to a single crypto (that too FTT) was a worrying sign for Alameda clients. FTT tokens were trading at $25.50 at the time.

 

Crash and Burn 

Four days after the revelation, Binance declared that it would liquidate its FTT holdings. Alameda tried to buy back the tokens at $22 to limit the liquidation's impact on the market but the offer was declined by Zhao, Binance’s CEO. At one point Binance offered to acquire FTX at a discount to save the broader market from collapsing but during due diligence, Binance found that FTX’s books were a disaster and there was a huge gap between assets and liabilities. 

 

 A single tweet from Zhao triggered a chain reaction that collapsed SBF’s empire. 

 

 

This event was the beginning of the end for FTX and Alameda as FTT's price began to wildly fluctuate and plummeted to $6 in less than 2 days. As a result, FTX and Alameda were the subject of numerous federal investigations in the US and the Bahamas, where the authorities froze all FTX assets. By November 11, 2022, FTX, Alameda and dozens of other subsidiaries filed for bankruptcy following a rush of customer withdrawals from the exchange which led to a situation similar to a bank-run. FTX didn’t have enough liquidity to fulfill these withdrawals since they had $9 Billion dollars in liability vs $900 million in liquid assets leading to a temporary suspension of withdrawals. SBF resigned as CEO and was replaced by John J. Ray III, who famously oversaw the liquidation of Enron.

 

FTT price movement during the crash.(Source: CoinDesk)

  

Subsequent investigations revealed that roughly $10 Billion in customer funds had been moved from FTX to Alameda. Around $1 Billion of this amount was unaccounted for. Of the funds that were accounted for, large chunks had been lost by Alameda in crypto trades. The supposed quant geniuses that shot to reverence over these last two years actually made so many bad trades they squandered their stolen money in the market.

 

This announcement was a farce as there was nothing routine about this transaction. SBF had just moved tokens worth $4 Billion from FTX to Alameda and was lying to users and investors. 

 

An Utter Disregard of Ethics and Corporate Controls 

Front-running is when brokers trade an asset when they have inside knowledge of a future transaction, and it’s been a problem in crypto for a while. Alameda also faced accusations of front running as they themselves were market makers for a large number of crypto currencies and also had access to trade information from FTX. Alameda purchased 18 different tokens between January 2021 and March 2022 before they were publicly listed on FTX, according to the cryptocurrency compliance firm Argus, and then sold them at a profit.

 

The FTX fiasco was a culmination of greed and a total negligence of corporate best practices. Despite pouring billions of dollars into the company, none of the outside investors (including VCs and Binance) had a single person on FTX’s board. As per a former employee, SBF and his inner circle had full control of the exchange’s code base and could easily have inputted their own numbers in the exchange. Also, anyone who disagreed with the founders was promptly fired by the HR head, who was also a close friend of SBF. The disclosures left even a lot of FTX executives shocked as they had been left in the dark while Sam and his friends continued to play with risk and were bleeding investor funds through bad investments.

 

FTX's collapse is drawing comparisons to earlier major business meltdowns. In a bankruptcy court filing, new FTX CEO Ray said: "Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented." The court proceedings also revealed that Alameda gave Sam Bankman-Fried a $1 Billion loan, financial records were often deleted, company funds were used for personal purchases for executives and major decisions were made over chats (which automatically got deleted soon after). Also, FTX and its subsidiaries never had a single board meeting.

 

It was also revealed that SBF wielded a great influence in Washington DC and actively lobbied for crypto reforms, especially for broker licensing which could adversely affect Binance and limit its presence in the US.

Binance CEO’s tweet after SBF’s lobbying became public. 

 

FTX also made questionable investments in a bank. Through a subsidiary, FTX invested $11.5 million in the parent company of Farmington State Bank, which has a single branch and, until this year, just three employees and is the 26th smallest bank in the United States with a net worth of barely $5.7 million. The purpose of this investment is still open to speculation and is being actively investigated.

            This infographic gives an overview of FTX’s financials(source: VisualCapitalist)    

 

Conclusion

This event had the intensity of Theranos but the collapse was as rapid as the Lehman Brothers. The crisis has sent reverberations through the crypto world, with the price of major coins plummeting. Within three days of FTX’s bankruptcy filing, the world’s top 15 crypto currencies lost a total value of $152 Billion. As per bankruptcy filings, FTX’s outstanding liabilities are estimated to be more than $50 billion (for comparison, Enron’s liabilities amounted to $23 billion). A large number of companies are tied in with FTX and Alameda as either investors, lenders or borrowers and the fallout from these events could have huge implications for these companies which also include a Canadian pension fund which made a $100 million investment in FTX.

 

This has also brought to question the credibility of crypto currencies as an asset class and has scared away a lot of investors. The biggest conundrum being faced by the crypto industry, investors and governments right now is to figure out a trade-off between regulations and decentralization. Gambling and investing with customer funds are a clear violation of norms in traditional finance but those rules didn’t seem to apply to Sam Bankman-Fried. He based his companies in the Bahamas because of their loose regulations and investors based in the US and other countries were left helpless as they saw their money vanishing in thin air with little or no legal or regulatory recourse.

 

This case also begs the question of where does a crypto token actually derive its value from. FTT was essentially a made-up currency and was artificially attributed value by FTX and was used by SBF to fund projects and also as collateral for loans which helped SBF buy other assets like Bitcoin and real estate. This house of cards continued to stand as long as both FTX and Alameda projected a rosy picture through their PR while riding the crypto bull run, only to fall when crisis struck. Now that nobody wants to buy FTT, much of Alameda’s books are illiquid and worthless.

 

This story also shows that in a bull market with an easy money supply, any investment idea can work and even the smartest investors (BlackRock, Sequoia et al) become drunk with making huge profits and can throw hundreds of millions of dollars at a 30-year-old and his team of degenerates, some of whom had little to no investment experience. This is remarkably similar to 2008, where firms made up complex financial products (CDOs) and took on huge amounts of risk and passed it to regular investors and institutions. The crypto industry was supposed to stop such things from happening by guaranteeing decentralization and transparency but ironically ended up making the same mistakes.