Notes From The Week #17

….and breathe.

What a week it’s been. I was thinking of doing my usual 3 topic breakdown but in all honesty the majority of conversations I’ve had this week have been surrounding the spectacular collapse of FTX and the surrounding events. I think it’s only right to take a deep-dive and carefully run through the events that have led to what people are dubbing as the Lehman moment for crypto. Be prepared to see a lot of tweets—after all we are talking about crypto.

The Rise of Sam Bankman-Fried

For all intents and purposes, it’s safe to say that Sam Bankman-Fried is gifted. This is an important statement as this helps to make sense of how some of the illicit activities that have come to light this week regarding his now bankrupt company FTX were able to be kept hidden and under wraps for so long. Sam was born in 1992 on the campus of Stanford University into a family of academics. He is the son of Barbara Fried and Joseph Bankman—both professors at Stanford Law School. Sam’s aunt Linda P. Fried is the current dean of Columbia University Mailman School of Public Health. From 2010 to 2014, Bankman-Fried attended the Massachusetts Institute of Technology graduating with a degree in physics and a minor in mathematics. In another instance, all this information would be excessive. But for a particular cohort—this would be the foundation of an investment thesis that would help Sam’s ascent.

In his penultimate year at MIT Sam interned with Jane Street Capital, a proprietary trading1 firm. There he traded international ETFs for three years—leaving in September 2017. After a brief stint working at the Centre for Effective Altruism Sam founded Alameda Research—a quantitative trading firm. In January 2018, Sam’s Alameda Research profited of an amazing arbitrage opportunity he and his team had spotted. As a result of an increased Bitcoin interest in Japan—Japanese exchanges had bitcoin trading for 10 percent more than on the American exchanges. He was able to take advantage of the 30 day price discrepancy—moving up to $25M per day. A year later in 2019 Sam would launch the cryptocurrency exchange FTX.

The Rise of Alameda Research & FTX

Going into 2021 Alameda Research were reportedly printing $1MM daily while FTX was quickly becoming the crypto darling for venture capital firms. Such a darling that we’re told in one of the final investment decision meetings with Sequoia Capital (one of the most successful venture capital firms ever) Sam had enthralled the Sequoia partners whilst playing League of Legends.

It was the growth of FTX that minted Sam as an official billionaire. The crypto exchange grew to be the second largest in the world and a titan of the industry, seeing $10-$15bn worth of crypto being traded daily on the platform. By the start of 2022, FTX was valued at $32bn. It had also made a push to become a household name via a range of marketing campaigns. Perhaps the most notable was the partnership with the Miami Heat to become the exclusive cryptocurrency partner with a $135M naming rights deal.

In hindsight, it was surprising that a quantitative cryptocurrency trading firm and a cryptocurrency exchange owned and ran by the same person never invited questions as to the nature of the relationship between the two entities. But as we fast forward to the present day, we see that was all about to change—and quickly.

The Fall of FTX and Alameda

With the background covered and the picture set—let’s get into Act Three. The events of the last week. It all starts with a CoinDesk article which looked into the assets and balance sheet of FTX and Alameda. When assessing the balance sheet of Alameda—it became apparent the sheet was full of FTX; in particular the FTT token. This token is issued by FTX and provides grant holders a discount on trading fees on its marketplace. In fact, as of June 30th, the company’s assets amounted to $14.6bn—with the single biggest asset: $3.66 billion of “unlocked FTT.”2 They also owned 10% of the cryptocurrency Solana. An incredibly large amount of equity in a base layer network.

A few days later as a result of the traction that the article gained in crypto circles. Alameda responded with their CEO Caroline Ellison tweeting:

An hour after Caroline’s tweets, Changpeng Zhao who is widely known as CZ (CEO of Binance) responds saying that the FTT Binance owns will be sold. Binance were an early investor in FTX. As FTX grew rapidly—Binance in 2019 decided to sell their stake in FTX and agreed to $2bn of the buyout in FTX’s native token FTT.

This is particularly notable as the tweet was sent out on a Sunday by CZ. Quite possibly the time when the liquidity3 of the market is at its lowest. A few hours later CZ followed up with another tweet discussing the FTT liquidation further, this time he references LUNA. The LUNA mention is quite significant as it references the former token that was launched by Terra in July 2019 which collapsed when Terra USD (UST) the algorithmic stable coin of the Terra network lost its peg in May 2022. In insinuating LUNA CZ provided a picture of a FTX that may have been operating in bad faith. A subtle yet powerful dog whistle to the market.

While there was a run on FTX as users have tried to withdraw their deposits from the exchange. The fatal blow came from the unwinding of the Binance position as expressed by CZ. It had been years in the making as CZ and Sam had shared a very interesting relationship as frenemies. The vulnerability of FTX was now exposed and Sam Bankman-Fried was left with nowhere to hide. He was now faced with very limited options. 1) Assure the market that FTX was indeed acting in good faith and that the chatter of the previous days was merely just that—chatter. 2) Find a way to keep afloat and seek capital (SBF had been raising for another round as late as last week) or a strategic acquisition. 3) Admit that FTX was vulnerable and thus had been acting in bad faith and be exposed to the elements. It became clear by limited responses from SBF that Option 1 was quite clearly off the table. It seemed for some time that Option 2 was in motion as Binance had announced their intention to acquire FTX. However, this decision would be reversed by Binance a day later—leaving Sam only with Option 3.

So this is where we are. FTX has formally filed for bankruptcy. The unravelling of FTX will continue to play out in the coming months as more information about the relationship between FTX and Alameda comes to the surface. It’s also a huge loss of confidence in CeFi (centralised finance). Things are looking incredibly bleak for the man touted the Crypto King. His net worth dropped in a day from $15.6 billion to $950M—which has subsequently dropped to zero.

He will have to answer to whether FTX violated its promise to not trade users funds. He will have to answer to the blurry relationship between his two companies.

Greed is an interesting phenomenon. It can take us to places we’d never imagine going and to do things we’d never imagine doing. I’m reminded of the story of the boy that put his hand in a sweet jar to take sweets after being told not to. For as long as his hand is clenched holding sweets he will be unable to remove his hand from the jar. The only way to remove his hand from the jar is to let go of the sweets and gradually ease his hand out. Sam’s hand is holding an incredible amount of sweets in the jar and it looks like he’s been caught in the act.

Until next week. Peace.