To understand the sudden downfall of the now-collapsed crypto exchange FTX, you have to go back to the beginning.
Here’s how founder Sam Bankman-Fried described it when he announced the now-called-off rescue by Binance, another crypto exchange:
“FTX.com’s first, and last, investors are the same: we have come to an agreement on a strategic transaction with Binance for http://FTX.com (pending DD etc.).”
That appended “etc.” turned out to be quite significant. Binance quickly pulled out of its planned bailout after a quick look at FTX’s books. “Sad day but we tried [crying emoji],” Binance’s CEO Changpeng Zhao said.
But it’s Bankman-Fried’s references to FTX’s first investor that’s the key to his exchange’s implosion – and the details of how that Binance investment unfolded are a great illustration of how crypto works, and falls apart.
FTX was founded in May of 2019 and later that year Binance, which is the world’s largest crypto exchange, invested in FTX.
An industry leader in an emerging business making an investment in an up-and-coming firm in order to boost demand, build out various kinds of support systems, and hopefully get a nice return in the process is a totally normal thing.
And indeed, the press release announcing Binance’s “strategic investment” in FTX in order to “work together to further develop the cryptocurrency ecosystem” sounds pretty much like any other press release announcing that kind of deal:
“The FTX team has built an innovative crypto trading platform with stunning growth. With their backgrounds as professional traders, we see quite a bit ourselves in the FTX team and believe in their potential in becoming a major player in the crypto derivatives markets.“ said Changpeng Zhao (CZ), Binance CEO. “We are pleased to have an excellent partner joining the Binance ecosystem and aim to grow the crypto market together.”
Swap a few of the nouns and this might as well be a press release about a deal between two industrial fasteners suppliers.
But then last year, Bankman-Fried decided he wanted to buy Binance out of its investment in FTX.
By this time, FTX was no longer a months-old exchange. It was a direct competitor to Binance and in Bankman-Fried’s telling, their investment relationship was getting a bit awkward. Again, this is not out of the ordinary for this kind of deal.
But because this is crypto, the actual buyout transaction gets weird fast. Bankman-Fried bought out Zhou for a total of $2 billion, Reuters reported, and part of that purchase was paid not in US dollars or another state-backed currency, but in the crypto coin that FTX itself had created, called FTT.
FTT was traded on FTX and was crucial to how the exchange functioned. And crucially, it is now clear that FTT was central to Bankman-Fried’s purported personal wealth of $16 billion.
Before he founded FTX, Bankman-Fried founded a hedge fund called Alameda Capital, which had an increasingly complex and important series of financial relationships with FTX as the exchange grew. A huge portion of Alameda’s claimed $14.6 billion in assets were FTT tokens.
And after crypto prices plummeted over the summer, Alameda took a series of big losses and Bankman-Fried transferred $4 billion from FTX to Alameda to prop up his hedge fund. That money was itself secured in part by FTT and included customer deposits, Reuters reported.
There’s a common saying that crypto’s function is “number go up,” meaning that the whole point is that it increases in value. This was particularly true for FTX and Alameda with respect to FTT: FTT needed to keep going up so that FTX and Alameda could borrow increasing amounts against its value. A price decline in FTT was a potentially fatal risk for FTX and Alameda.
And because of the structure of Bankman-Fried’s buyout, Binance’s Zhou owned about $580 million worth of FTT.
On November 6, Zhou stuck a knife in FTX, tweeting that Binance was selling its entire FTT stake “due to recent revelations that have came to light” [sic]. He didn’t go into any substantive detail and he didn’t need to. FTT’s price plummeted and customers withdrew $6 billion from their accounts. With its coin in free-fall and an old-fashioned bank run in process, FTX couldn’t survive. Two days later, Zhou announced that Binance would bail out FTX, pending due diligence. And then two days after the bailout was announced, Binance pulled out, citing unnamed regulatory investigations and issues with FTX’s books. And on Friday, FTX filed for bankruptcy and Bankman-Fried stepped down.
Sam Bankman-Fried once infamously described the crypto world as a series of black boxes that spit out tokens that go up in value, which is a pretty nihilistic, if accurate, view of what crypto is. But at its core, crypto is wild combination of contradictions. It’s nihilistic and idealistic; decentralised and dominated by a few mega-billionaires; trustless and faith-based; public and encrypted; transparent and inscrutable; and a utopian anarchist invention beloved by drug cartels, terrorists, and Kim Jong-Un.
Individually, delusion is an affliction; mass delusion is profitable.
FTX’s implosion shows us that the only thing that can resolve crypto’s roiling contradictions is a line that goes up. When the line goes down, like it did with FTT, none of it works.
This piece was originally published on Future Tense, a partnership between Slate magazine, Arizona State University, and New America.