FTX and SBF History

[Macrobius]

A Tunis Thread by my fellow physicist, Perk:

FTX and SBF history

Here's a fun articool already memory holed. It was on Sequoia Capital's page; they yesterday marked their $214m investment in FTX to 0. Archive: https://web.archive.org/web/20221110141739/https://www.sequoiacap.com/article/sam-bankman-fried-spotlight/ BY ADAM FISHER PHOTOGRAPHY: SASHA...

tunisbayclub.com

My response:

A relatively decent accounting/economic explanation of part of what might be going on here:

https://www.bloomberg.com/opinion/a...-a-death-spiral-before-binance-deal#xj4y7vzkg (H/T Brad Delong https://braddelong.substack.com/p/the-old-story-the-fall-of-sam-bankman )

Matt Levine: FTX Had a Death Spiral: FTX issues a token called FTT…. FTX periodically uses a portion of its profits to buy back FTT tokens. This makes FTT kind of like stock in FTX: The higher FTX’s profits are, the higher the price of FTT will be. It is not actually stock in FTX… but it is a lot like stock… a bet on FTX’s future profits. But it is also a crypto token, which means that a customer can come to you and post $100 worth of FTT as collateral and borrow $50 worth of Bitcoin, or dollars, or whatever, against that collateral, just as they would with any other token…. If you think of the token as “more or less stock,” and you think of a crypto exchange as a securities broker-dealer, this is completely insane. If you go to an investment bank and say “lend me $1 billion, and I will post $2 billion of your stock as collateral,” you are messing with very dark magic and they will say no. The problem with this is that it is wrong-way risk. (It is also, at least sometimes, illegal.) If people start to worry about the investment bank’s financial health, its stock will go down, which means that its collateral will be less valuable, which means that its financial health will get worse, which means that its stock will go down, etc. It is a death spiral. In general it should not be possible to bankrupt an investment bank by shorting its stock. If one of the bank’s main assets is… a leveraged bet on its own stock — then it is easy to bankrupt it by shorting its stock.

The worst case is something like: 1. You have 100 Customer As… each… [with] 1 Bitcoin in their accounts and ow[ing] you $10,000. 2 You have 100 Customer Bs who… each have $20,000 in their account and owe you 0.5 Bitcoin. 3. You have loaned 50 of the Customer As’ Bitcoins to the Customer Bs, and $1 million of the Customer Bs’ dollars to the Customer As. You keep the other 50 Bitcoins and $1 million as collateral. 4…. You owe clients 100 Bitcoins and $2 million, and that they owe you back 50 Bitcoins and $1 million, and you have 50 Bitcoins and $1 million on hand, so everything balances.

5. You have one Customer C who says “hi I would like to borrow 50 Bitcoins and $1 million, I will secure that loan with 150,000 FTT, each of which is worth $20.” 6. You say “sure, sounds good”…. 7. Now you have 150,000 of FTT, worth $3 million, as collateral (and no Bitcoins or dollars). 8. Your accounts show that you owe clients 100 Bitcoins and $2 million and 150,000 FTT, and they owe you back 100 Bitcoins and $2 million, and you have 150,000 FTT of collateral [on hand], so everything balances. But then if the value of FTT drops to zero, you have nothing….

You just have to call up Customer C and say “hey we need all those dollars and Bitcoins back.” But Customer C will not want to give you back all those valuable dollars and Bitcoins in exchange for now-worthless FTT. Also… Customer C… is an FTT whale, and FTT is now worthless. Has it been borrowing elsewhere against FTT? Are all those debts coming due?…

The reason for a run on FTX is that you think that Alameda is, in my terminology, Customer C. The reason for a run on FTX is if you think that FTX loaned Alameda a bunch of customer assets and got back FTT in exchange. If that’s the case, then a crash in the price of FTT will destabilize FTX. If you’re worried about that, you should take your money out of FTX before the crash. If everyone is worried about that, they will all take their money out of FTX. But FTX doesn’t have their money; it has FTT, and a loan to Alameda…. If, say, the operator of the biggest crypto exchange gently raises one eyebrow and says “FTT, eh?” that can be enough to topple FTX. FTT goes down, leaving FTX undercapitalized, leading to customer withdrawals, leading to ruin….

It is still early and confusing but that seems to be the story of FTX. Coindesk reported on Alameda’s FTT exposure…. Changpeng “CZ” Zhao…raised eyebrows by tweeting that Binance would sell its FTT…. People worried that this would tank the price of FTT and put pressure on FTX, so they started withdrawing…. FTX didn’t have the money, and Bankman-Fried started calling around asking for a loan or a bailout. Eventually he called CZ himself, and they announced a non-binding letter of intent for Binance to acquire FTX and make customers whole. Bankman-Fried’s fortune basically vanished, as did his “ emperor aura.” Venture capital investors in FTX — which last raised money at a $32 billion valuation — are probably getting zeroed, the price of FTT collapsed, and now regulators are investigating….

The most informed view is probably that of CZ himself, who tweeted this morning: “Two big lessons: 1: Never use a token you created as collateral. 2: Don’t borrow if you run a crypto business. Don't use capital "efficiently". Have a large reserve. Binance has never used BNB for collateral, and we have never taken on debt.” “Never use a token you created as collateral” suggests, to me, that FTX accepted its FTT token as collateral, probably from Alameda, probably in exchange for borrowing assets that it owes to customers…. If this is the story, then it is not a liquidity crisis but a solvency one…. FTX took its customers’ money and traded it for a pile of magic beans, and now the beans are worthless and there’s a huge hole in the balance sheet….

It makes for a tricky decision for… CZ: Follow through with rescuing his onetime top rival and shoulder the financial and regulatory burdens, or let FTX crumble and sort through the potential wreckage?… His answer, at least for now, is that the financial hole appears too deep. Binance is unlikely to follow through on its takeover of FTX, according to the person familiar, who wasn’t authorized to publicly discuss the matter.

Seems bad.

My comment: there is actually a much deeper question here than this sort of (probably sound) surface analysis, which has to do with the fuzzy borderline in capital markets between 'real investment' (entrepreneurial) and passive investing (rent seeking)... it's the same 'border' that medieval Christendom or Islam have wrestled with, in trying to dilineate between 'usury' (passive 'investment' in a pyramid scheme with privileged but risk free 'return' -- the VIG) and perfectly acceptible risk sharing with your fellow human brothers.

*cough* rehypothecation of collateral *cough* ... the real problem with the above critique is not that it isn't sound... it is that it obviously applied at national scale to ANY fiat currency, which I think is the wrong conclusion to reach (but why?).[1][2][3][4][5]

The assets of the company in question have been frozen:

https://www.zerohedge.com/markets/ftx-assets-frozen-bahamas-regulator-liquidator-appointed

[1]: I forget the name of the case and will link if I remember it, but there was a very famous New Deal test of the SEC's regulatory power that was extended to offering 'passive investment' in real estate which was considered effectively issuing 'stock' without complying with the regulatory apparatus -- don't be surprised if this concept resurfaces. I first considered the possibility in an online advertising context, in 2010 @perkunos might remember my stories of Microsoft Advertising.

Relevant discussion though: https://www.sechistorical.org/museum/galleries/icr/icr02_rules_of_new_game.php

Also https://history.columbia.edu/wp-content/uploads/sites/20/2016/06/Jacobs-Final-Thesis.pdf The Investment Company Act of 1940: Democritizing Finance in the Fight Against Fascism (which the US didn't engage in until December 7, 1941 )

Final Statements – June 4, 1940 Senator Downey: “Do I understand that the representatives of the investment trusts and of the Securities and Exchange Commission are virtually in agreement now?”
Senator Wagner: “Not virtually but actually in agreement.”
Senator Downey: “This is a most amazing thing in this chaotic world right now.”
Senator Wagner: “I think it is.”

Senator Downey: “It is really the first encouraging thing I have heard in several weeks. How was this miracle brought about?”1

The Uniparty was forged in the 30s.

[2]: Not this one however: https://lawecommons.luc.edu/cgi/viewcontent.cgi?article=1260&context=facpubs unrelated brain food?

[3]: Investopedia: https://www.investopedia.com/terms/i/investmentcompanyact.asp

[4]: Interdasting (2010): https://en.wikipedia.org/wiki/Jones_v._Harris_Associates

The Supreme Court unanimously agreed with the plaintiffs and held the Seventh Circuit erred in holding that claims alleging mutual fund management's fees were too high is not cognizable under Section 36(b) of the Investment Company Act. Justice Alito wrote the majority opinion arguing the Seventh Circuit Court of Appeals erred in not applying the established standard from Gartenberg v. Merrill Lynch Asset Management, Inc.. The Court established that the ICA requires for a claim to be valid there must be a determination that the fee is "so disproportionately large it bears no reasonable relationship to the services rendered."

[5]: https://freemanlaw.com/regulated-investment-companies/