Cryptocurrency has a serious problem: The party’s over. Fresh dollars from naive retail buyers aren’t coming in anymore after the crashes in May and June, despite a round of advertising during the Super Bowl in February reaching every consumer in the United States. Without those fresh dollars, the holders can’t cash out.
Crypto trading firms hold large piles of assets whose “market cap”—their alleged mark-to-market value—supposedly adds up to a trillion dollars. But this number is unrealizable nonsense because the actual dollars just aren’t there. Everyone in the system knows it. What to do?
The regulated U.S.-based exchanges are just the cashier’s desk for the wider crypto casino. The real trading action, as well as price discovery, is on the unregulated offshore exchanges. These include Binance, OKX, and Huobi. Until Tuesday, Nov. 8, they also included Sam Bankman-Fried’s FTX, which cut off customer withdrawals around 11:37 a.m. UTC on Nov. 8 and then revealed around 4 p.m. UTC that it was suffering a “liquidity crisis”. FTX is just the latest casualty in a series of collapses that began with Terraform Labs’s UST stablecoin; that took out Celsius Network, Voyager Digital, and many other crypto trading firms; and that is now gradually driving the price and trading volume of cryptocurrencies to what they should be: zero.
FTX desperately sought more funding, but to no avail; at press time, FTX had been shut down by its Bahamian regulator and put into liquidation, as well as was filing for bankruptcy in the United States and Bankman-Fried has resigned as CEO. But the fall of FTX has been particularly remarkable in part because its founder was unusually feted.
Sam Bankman-Fried, often referred to as SBF, was born in 1992 to parents who were both academics at Stanford University. After gaining a physics degree at the Massachusetts Institute of Technology, he was introduced to the “effective altruism” quantified charity movement by “longtermist” William MacAskill, and he took a job at quantitative trading firm Jane Street in 2014 with the aim of “earning to give”, a buzzword among effective altruists who believe that the most effective way to do good is to make a lot of money first—even in ethically dubious ways—in order to give it away.
After three years at Jane Street, Bankman-Fried started his own cryptocurrency hedge fund, Alameda Research, during the 2017 bitcoin bubble. He has said that he made the money to start FTX from an arbitrage opportunity. In 2018, bitcoin cost more in Japan than it did in the United States; everyone could see this, but for unclear reasons, only Alameda was in a position to exploit it.
FTX was founded in May 2019. Alameda could trade there and served as the exchange’s market maker. In most regulated markets, this would not be allowed because of the obvious conflicts of interest and the incentives to trade against your own customers—but offshore crypto is unregulated. FTX rapidly became very popular, offering complex products such as options trading, perpetual futures, and tokenized stock market shares, and it was perfectly placed for the 2021 crypto bubble, when bitcoin rocketed to $69,000, the volume of trade soared, and ordinary people the world over were sold hard on getting into just a bit of crypto. FTX did not allow U.S. customers but started a separate exchange, FTX US, in May 2020.
During the 2021 crypto bubble, Bankman-Fried started promoting himself as a billionaire public thinker with big ideas and a deliberate mystique. He posed for the front covers of Fortune and Forbes. He was invariably photographed in shorts, a T-shirt, and untied shoes. He reportedly said, “I think it’s important for people to think I look crazy”. This worked on the venture capitalists, such as Sequoia Capital, which bought his pitch—hook, line, and sinker—with a writer on its website saying: “And, since SBF is obviously a genius, I should simply assume that, compared with me, SBF will always be playing at level N+1”.
High-profile visitors would be scheduled to arrive when Bankman-Fried was asleep in the office beanbag. He spoke to the media about his charitable mission—even if the charities’ goals sometimes seemed odd, such as fighting risks from hypothetical future artificial intelligences.
FTX marketed itself heavily. It got Larry David to do a Super Bowl ad this year in which his character’s skepticism turned out to be completely correct. Bankman-Fried bought a 7.6 percent share in popular day-trading brokerage Robinhood. FTX sports sponsorships included the Miami Heat’s FTX Arena, MLB umpire patches, the Mercedes-AMG Petronas Formula 1 racing team, and athletes such as quarterback Tom Brady. FTX even advertised in fortune cookies. FTX worked hard to paint itself as a trustworthy, fully capitalized institution run by smart and sensible people—even as it was operating almost entirely outside any regulation and was a hollow shell.
But Bankman-Fried was also keen to sell himself as a philanthropist. Bankman-Fried formed a super PAC, Protect Our Future, to lobby for political candidates in the 2022 U.S. midterm elections, spending over $39 million. Several million dollars went to sponsoring his fellow effective altruist Carrick Flynn in a Democratic primary for the House of Representatives, but Flynn lost his primary to Andrea Salinas.
Bankman-Fried aggressively lobbied in Washington, D.C., for the Commodity Futures Trading Commission to control crypto in the United States. He was photographed with its commissioner, Caroline Pham. Bankman-Fried’s policy proposals upset many of his fellow crypto institutions, most notably offshore crypto exchange Binance and its CEO, Changpeng Zhao, who felt that Bankman-Fried was setting the rest of the industry up for failure.
Bankman-Fried’s media promotion served to distract attention from what was going on inside FTX. Occasionally, warning signs would leak: His Forbes billionaire list entry included a cautionary note that most of his claimed wealth “was tied up in ownership of about half of FTX and a share of its FTT tokens”.
FTT was the internal trading token of FTX—like supermarket loyalty points for frequent traders, who could get discounted trading fees and free withdrawals. The token was also traded in the wider crypto market. On Nov. 2, a balance sheet was leaked showing that a third of Alameda’s claimed assets were a large volume of FTT. It was as if the Tesco supermarket chain was solvent only if you counted its own made-up Clubcard points as assets. Alameda had also used this pile of FTT as collateral for loans from outside companies.
Binance had been an early investor in FTX. It divested in July 2021; FTX paid Binance for its share in $2.1 billion of FTT and stablecoins. On Nov. 6, when FTT was at $25, Zhao started dumping Binance’s FTT holding on the open market. Alameda offered to buy Binance’s FTT at $22, but Binance continued dumping.
Bankman-Fried had always maintained that Alameda and FTX were separate entities, but the market considered them closely entwined. The possibility of trouble at Alameda led FTX users to withdraw funds as fast as possible—a bank run. FTX paused all withdrawals on Nov. 8.
A few hours later, Binance and FTX announced that Binance would buy FTX to resolve its “liquidity issues”—pending due diligence. Zhao announced the next day that FTX’s books showed that, rather than just a lack of liquidity, the exchange was insolvent by at least $6 billion. The Bahamas, where FTX is incorporated, has frozen all assets and has appointed a provisional liquidator.
Alameda’s liabilities included substantial loans from FTX. It came out later that FTX had lent over $10 billion in customer assets to Alameda and had accepted FTT—its own internal-trader loyalty points—as collateral. Alameda had been in a hole months before, when the crash in May of Terraform’s UST had quickly been followed by the collapse in June of Celsius Network and Three Arrows Capital. Bankman-Fried had bailed out Alameda with customer funds, secured by Alameda’s FTT holding. FTX and Alameda worked in tandem as a risky shadow bank, using customer funds.
Bankman-Fried was quick to reassure customers that FTX US was not affected and that it was “fully backed 1:1”. FTX US was also attempting to buy the remains of the bankrupt Voyager Digital—another victim of Three Arrows Capital—though the deal is on hold until the status of FTX US is sufficiently clear; withdrawals are operating, but deposits have been blocked. The Texas State Securities Board had previously wanted to stop FTX US’s purchase of Voyager on the grounds of problematic activity by the international branch of FTX.
It’s clear now that FTX and Alameda had been hollow shells for many months, even as Bankman-Fried was presenting himself to legislators as a serious regulation-minded crypto proprietor. But there is no reason to presume any other crypto institution is any healthier while the fresh dollars aren’t coming in. In May 2021, FTX’s erstwhile savior Binance appeared to be trading against its own customers. Binance was also used by Iran to evade sanctions with bitcoin. There was, after all, no regulator to stop the exchange from doing anything it felt like.
Legislators have occasionally proposed rules for sensible crypto trading in the United States. The problem for regulation is that the cryptocurrency industry is intrinsically all but unregulatable as long as the trading volume and price discovery happen in the unregulated offshore casinos and the U.S. entities in reach of the law are just the cashier’s desk for the casinos. This is how the crypto world likes it: a trash-fire trading environment, but being able to cash out with real dollars. This is why it bitterly fights the faintest regulation, every time.
This is not just a concern for consumers but a concern about broader financial stability. The Financial Stability Oversight Council’s 2022 Report on Digital Asset Financial Stability Risks and Regulation covers in detail the collapses of UST-Luna and Three Arrows Capital, as well as the cascade of failures that ensued.
The upside for regulators is that the collapse of cryptocurrency didn’t affect the wider economy. The consequences for retail investors in Celsius Network and Voyager Digital were horrifying, but the wider economy hasn’t been put at systemic risk—yet.
The cryptocurrency collapse will be easy to unwind: The crypto traders will go broke, and everyone in crypto will finally admit to their losses. Sequoia Capital has marked its FTX investment down to $0—and deleted from its website its previous hilarious paean to Bankman-Fried’s mysterious genius. The crash victims that FTX was going to bail out, such as BlockFi, have realized their rescuer is not coming.
The crypto bag-holders all actually lost their money long before, when they bought the bitcoins. In the time since, they’d been telling themselves and everyone else that their magic beans were worth money and never mind the lack of buyers. But this was not the case. The beans were always worthless, and the only way to make money from them was to sell them off before other people caught on.
David Gerard is the author of the book Attack of the 50 Foot Blockchain and the cryptocurrency and blockchain news blog of the same name. His new book is Libra Shrugged: How Facebook Tried to Take Over the Money.