Someone Please Explain FTX

[Tuur]

Seriously. I've tried to follow the rise and fall of FTX, and I don't understand it. I know cryptocurrency are all or mostly private fiat issuings and are driven by speculation, and growing up was fascinated by the Tulip Bubble, but I don't understand how FTX found that much in investments for what isn't even printed paper, or how the discovery that an associate company holding billions of their cryptocurrency would trigger the collapse.

Please, no conspiracy theories. This is just trying to understand what went on.

 

[Hans Blaster]

Seriously. I've tried to follow the rise and fall of FTX, and I don't understand it. I know cryptocurrency are all or mostly private fiat issuings and are driven by speculation, and growing up was fascinated by the Tulip Bubble, but I don't understand how FTX found that much in investments for what isn't even printed paper, or how the discovery that an associate company holding billions of their cryptocurrency would trigger the collapse.

Please, no conspiracy theories. This is just trying to understand what went on.

From what I can tell (and this is more of a news rather than politics story)...

FTX was a "crypto exchange" where you could:

1. Send them regular money and buy various kids of "crypto". Sort of like an unregulated brokerage. I send them $20,000 and they sell me one "Bitcoin" (BTC) in exchange.

2. I think they also had client-to-client transfer services. For example, if I owe you $200 I could write a check or pay cash, or I could have FTX move 0.01 BTC from my account to yours.

(In both cases, I believe the "crypto" stays in their accounts and you don't have direct control for external usage. In the Bitcoin parlance: it stays in the FTX wallet, no transactions on the blockchain. This is like if we both use the same bank and I write you a check for $200. When the bank processes my check $200 is debited from my account and credited to yours without any cash or other assets moving around.)

From what I understand, FTX had purchased a number of "distressed" crypto businesses recently and offered other "crypto" financial services.

As for the "other company" a financial firm called "Alameda" controlled by the same guy. Apparently Alameda ended up with large sums of FTX customer deposits and then the funds just disappeared. It seems a mess and certain to end up in a Federal indictment eventually.


A little to get things going. I'm sure others have things to add.

 

[essentialsaltes]

I don't understand high finance (or crypto) either, but this is what I understand (dimly). This adds to what Hans has to say above.

When you give a bank money, they don't necessarily place it in a big vault and lock the door. They go out and use it to make money by making loans. And they pay you a little interest for the use of your money.

Banks of course are regulated, and there are rules about how much of everybody's money they can invest and how much they have to keep on hand in case people want some of their money back. And the whole system is also guaranteed and insured by the govenment.

In the case of FTX, there were no rules, no limits, and no guarantees. So when investors heard that a lot of the holdings were being diverted to this other investment entity, they got nervous, and there was a 'run on the bank' as people pulled deposits out.

 

[Tuur]

Funny you should mention bank loans. During the real estate bubble, some banks got over-extended on loans. So when the bubble went pop and there was no one to buy the properties, people who were buying on speculation couldn't repay loans, and some banks got into financial trouble, up to and including failure. So even though banks are regulated, how did so many get over-extended? And now the US banking system seems to be heading to a federal cryptocurrency: U.S. Banks Launch a Digital Dollar Blockchain Pilot - Decrypt

After what just happened, that doesn't exactly give me a warm fuzzy feeling.

It's the nature of the thing. At least with the Beanie Baby Bubble, there was something tangible left behind, but cryptocurrency is just 1s and 0s in a blockchain.

 

[Hans Blaster]

Some more info...

After my post, I learned that there is now a class action lawsuit in federal court against the founder and a number of celebrity endorsers.

Here is the docket:
Docket for Garrison v. Bankman-Fried, 1:22-cv-23753 - CourtListener.com

Other fun facts I have learned here and other places:

Clients could deposit their own "crypto" into their accounts and the FTX accounts had a "yield". (Like interest.)

FTX promised high and steady yields on deposits.

FTX had their own "token" called "FTT".

Alameda is a crypto trading firm. It held large amounts of "FTT" as assets on its balance sheet.


Now the "fun":

The lawsuit follows another similar lawsuit against a crypto firm called "Voyager" that was filed last year and similarly included claims against "hype men". In that case Mark Cuban the owner of the Dallas Mavericks (NBA team) and a large shareholder in "Voyager".

This summer, Voyager sought protection under Chapter 11. In Late September, FTX "swept in" to purchase Voyager for about 1.4 billion (in what kind of "money" is not clear). Voyager clients thought they might get some of their money back. About six weeks later FTX collapsed. How did that happen?

Their was a large transfer depositor crypto from FTX to Alameda and because the transfers of crypto are public, people noticed.

Then came in the largest crypto exchange - Binance. Binance owned a large amount of the FTT token from previous investment deals. In the course of a few days:

1. Binance (knowing about the relationship between FTX and Alameda) decided to dump there FTT tokens on the market and it drove down the price.
2. Binance agreed to buy FTX.
3. Binance pulled out of the buy-out and publicly noted the transfer of FTX client funds to Alameda.

This wiped out FTX and sent them to bankruptcy.

 

[FireDragon76]

Crypto is a giant ponzi scheme obscured in technowizardry, it simply can't do what its proponents promised. So I was not surprised by FTX running into financial and regulatory problems.

 

[Tuur]

Crypto is a giant ponzi scheme obscured in technowizardry, it simply can't do what its proponents promised. So I was not surprised by FTX running into financial and regulatory problems.

Or pyramid scheme - unless funds were diverted and income was derived from new investors. There are all sorts of things that have aspects of pyramid schemes. Such as the ostrich and emu craze locally about two to three decades back. Thought about getting into that myself, then noticed most of the ads were to sell ostrich and emus to start-ups, and went "Nope."

I guess what throws me about cryptocurrency is that it's based completely on speculation with nothing tangible. It's a Tulip Bubble without any tulips.

Thanks to the posts here, I think I'm starting to see why an associate company holding several billions in the other's cryptocurrency raised red flags. It wasn't so much the cryptocurrency itself but that it involved the transfer of funds. It's like finding an associate company is holding a good chunk of another's junk bonds. At least, I think it is.

 

[trunks2k]

In the case of FTX, there were no rules, no limits, and no guarantees. So when investors heard that a lot of the holdings were being diverted to this other investment entity, they got nervous, and there was a 'run on the bank' as people pulled deposits out.

My understanding is that the big problem with FTX is that they told their account holders that, unlike a bank, they were NOT using their deposits for other purposes and instead make money off transaction fees (and use that to invest elsewhere). The value of a given crypto may crash, but if you deposited a bitcoin, FTX would hold onto it always, like putting cash in a vault. It'd always be there to withdraw.

However, instead of doing that, FTX was giving those funds to Alameda, which "lost" it all.

 

[Paulos23]

Crypto is a solution looking for a problem, and what happened to FTX shows the problem with non-central, non-regulated banks.

It is a big risk with no safetynet.

 

[Tuur]

FTX may have just become political. The owner gave big donations to several Democrats, as businesses tend to do to politicians of both parties. Now there's talk of clawback to get those donations back for investors who lost money, and that could get interesting. Have heard of clawback, but don't know if its applicable in this case since they themselves were not part of FTX.

 

[trunks2k]

Crypto is a solution looking for a problem

Incorrect. It's a BAD solution looking for a problem.

 

[DaisyDay]

FTX had their own "token" called "FTT".

Alameda is a crypto trading firm. It held large amounts of "FTT" as assets on its balance sheet.

Their FTT token reminds be of the junk bonds of the 80s. Back then, corporate raiders would find a public company with a fully funded pension system. The "interesting" part was that they would borrow money against the pension funds, that they didn't own but hoped to acquire, and use the borrowed funds to buy the company in a hostile takeover. Once they owned the company, they replaced the grade-A stocks and bonds with an "equivalent" amount of junk bonds which had no good backing. Eventually, when there was a market down turn, the junk bonds revealed themselves to be worthless junk and the pension fund was wiped out.

One thing FTX did was borrow against their client holdings. They used spent the money on advertising (FTX stadium, sports figures' endorsements, influencer endorsements), ill advised buyouts (Voyager) and political campaigns (both parties but more heavily Democratic). On the books, they balanced their debts with FTT tokens which were worth whatever they said they were worth - until there was a run on the exchange and they no longer had the actual cash to redeem the tokens.

In the meanwhile, FTX the exchange opened a backdoor to Alameda Research, their trading company, which allowed Alameda to siphon client holdings (Bitcoin, Ethereum, Solana) to gamble with undetected.

FTX was run by Sam Bankman Fried, aka SBF, while Alameda was run by his main squeeze, Caroline Ellison. Both companies were run by a group of polyamorous buddies in the Bahamas, where banking and security regulations are largely non-existent.

 

[DaisyDay]

FTX may have just become political. The owner gave big donations to several Democrats, as businesses tend to do to politicians of both parties. Now there's talk of clawback to get those donations back for investors who lost money, and that could get interesting. Have heard of clawback, but don't know if its applicable in this case since they themselves were not part of FTX.

It was always political. Sam Bankman Fried gave to the Democrats while Ryan Salame. (CEO of FTX marketing) gave to the Republicans so they would be covered. Their aim was to stave off regulation of cryptocurrency or, at the very least, be in the position of making the rules and putting FTX in the forefront of "approved" market makers.

 

[variant]

Seriously. I've tried to follow the rise and fall of FTX, and I don't understand it. I know cryptocurrency are all or mostly private fiat issuings and are driven by speculation, and growing up was fascinated by the Tulip Bubble, but I don't understand how FTX found that much in investments for what isn't even printed paper, or how the discovery that an associate company holding billions of their cryptocurrency would trigger the collapse.

Please, no conspiracy theories. This is just trying to understand what went on.

There are at this point many known problems leading to a liquidity crisis.

They were self dealing in that they had set up a hedge fund that borrowed money from them, which problematically loaning client funds (something they explicitly said they wouldn't do) to themselves to trade. Then that fund traded in their own made up tokens which were linked to their company which were linked to it's health. It owed them tens of billions of dollars that were now tied up in a coin that tracked the health of their own company and inflated their balance sheet.

The Fund and FTX also spent the summer trying to bail out failed crypto projects of other people which is both expensive and of little value. At some point one of their major competitors Binance got wind of this and withdrew 10 billion all at once and waved their hands around wildly to alert everyone else to a problem in the system. This caused a run on their unregulated banking system, which has to rely on it's own holdings to allow people to withdrawal their money.

They don't have it. It's all either in illiquid assets that can't be traded for 10's of billions of dollars overnight or doomed valueless assets tied to the very company that is in trouble FTX. They lie about not having it and try to get other company's loan them money to bail them out but all that stuff they were doing wards off any potential help from other investors and have to declare bankruptcy because they can't meet withdrawals.

 

[variant]

Crypto is a solution looking for a problem, and what happened to FTX shows the problem with non-central, non-regulated banks.

It is a big risk with no safetynet.

It's not. Crypto is an unregulated banking system for the purpose of constructing all the ponzi schemes that normal banking practices won't allow for.

Fried is a hypocrite who lectured congress on the ills of the banking system and then went on to do everything he railed against and more.

 

[DaisyDay]

Coindesk is an informative site for crypto-news.

 

[Tuur]

It was always political. Sam Bankman Fried gave to the Democrats while Ryan Salame. (CEO of FTX marketing) gave to the Republicans so they would be covered. Their aim was to stave off regulation of cryptocurrency or, at the very least, be in the position of making the rules and putting FTX in the forefront of "approved" market makers.

Thanks. Where I first saw that didn't mention Republican donations, but given the source, it would have been surprising if it did. What do you think about the clawback angle?

 

[DaisyDay]

Thanks. Where I first saw that didn't mention Republican donations, but given the source, it would have been surprising if it did. What do you think about the clawback angle?

I don't know what the clawback angle is/means?

ETA: Do you mean the lawsuits against the people who shilled for FTX, such as Tom Brady and Larry David? Or the youtube finance gurus who didn't disclose that they were being paid to tout the exchange? The athletes may have an out in that as sports stars, why would they be expected to be giving sound financial advise, but on the other hand, they got paid a ton of money for their endorsements.

 

[trunks2k]

It's not. Crypto is an unregulated banking system for the purpose of constructing all the ponzi schemes that normal banking practices won't allow for.

No you don't understand. It's a bad solution in search of a problem. The problem they decided to solve was "how to implement a ponzi scheme and avoid normal banking regulations"

 

[variant]

No you don't understand. It's a bad solution in search of a problem. The problem they decided to solve was "how to implement a ponzi scheme and avoid normal banking regulations"

I simply don't believe it was by mistake.

What they wanted was an unregulated banking system, and that is why you might want one.