#44 The Context: FTX: what does it all mean?
The collapse of FTX has raised many more questions than answers. We ask some
Hi, it’s been a turbulent week, so we’re concentrating our efforts on the main story. FTX, one of the world’s biggest cryptocurrency exchanges, imploded after rival (and one-time investor) Binance decided to liquidate all its holdings of FTX’s FTT token, sparking panic withdrawals by FTX users and sales of FTT. Binance agreed and then declined, to rescue FTX. We’ve dedicated most of this newsletter to collecting questions that don’t, as of yet, have answers.
We wanted to thank all the journalists that have helped cover this story, upon whom we all depend to find out what happened. We’ve tried to list all those whose work has been quoted in this newsletter, but we may well have missed some - for which our apologies.
The usual disclaimer: This newsletter collates the main themes and headlines of the week in DeFi/crypto/metaverse/web3/NFT land and tries to provide unbiased context. It’s aimed at anyone who wants to keep an eye on the space but isn’t following it too closely, or is on the hunt for story ideas and angles. It’s put together by a team at YAP and doesn’t contain any promotion of our clients (if one is mentioned, we’ll flag that).
This was put together by a team led by founder Samantha Yap, and Jeremy Wagstaff, formerly of the journalism parish. Thanks to Ruby Wu, Becky Corbel, Delon Chan and Ewan Brewster for their contributions. Your feedback is as always welcome. Ping us at thecontext@yapglobal.com. Old newsletters can be found here.
[Elephants on the grass]
When elephants clash, it is the grass that suffers. (African proverb)
The near collapse of FTX and its aborted takeover by Binance, two of the biggest crypto exchanges outside the U.S., has sent everyone scurrying to find out what happened, what it means and why the underlying issues weren't noticed before. Both are led by charismatic characters — Sam Bankman-Fried and Changpeng Zhao respectively, with the former a darling of mainstream media and beyond.
A Twitter-based spat between the two quickly evolved from the latter beginning to sell off its holdings of FTX’s token, FTT, to panic selling and a sharp fall in the token's value. Investors withdrew more than $600 million of their tokens from the FTX exchange, pushing FTX's Bitcoin balance into negative territory. Bankman-Fried was forced to deny rumours of insolvency, until, after a few hours of deafening silence on Tuesday, the two men (separately) announced that, effectively, Binance was bailing out FTX, agreeing — with lots of caveats — to buy it. Whatever happens next, it’s clear that Bankman-Fried, and FTX, have lost, leaving a lot of questions about what just happened, and what it means — for other players in DeFi, for regulators, and for DeFi as a whole.
What prompted this? Zhao hinted that he was not happy with Bankman-Fried's recent statements about regulating the industry, but the speed and the sale of FTX’s collapse has prompted talk that the rapid steps amounted to a "stone cold hostile takeover" or “a mob boss move." A Reuters story suggests that the relationship had gone bad in June 2021 when Binance still owned 20% of FTX.
What, exactly, did Binance do, and what will it do? As we go to press Binance has backed out of its earlier conditional agreement to acquire FTX, saying due diligence, reports of mishandled customer funds and possible US agency investigations had led to the decision. Seeing most of FTX’s legal team depart can’t have helped.
Who, if anyone, might save FTX, and what might that mean? Justin Sun, founder of Tron, offered a ‘way forward’ for FTX, arguing the ongoing liquidity crunch was harmful to the industry and investors. SBF, according to Reuters, had spoken to Sun and would conduct a fund-raiser next week.
How did this happen? Questions have been asked about why FTX, supposedly a crypto exchange, should not be overwhelmed by volatility in the price of a cryptocurrency.
How did Sam Bankman-Fried's fortunes collapse so quickly? A few months ago he was “hosting world leaders on stage, talking about spending gazillions on elections, offering billions to Elon for a Twitter stake. Now being bailed out by Chinese crypto co,” in the words of Peter Kafka of Recode. Others wondered whether journalists had fallen for “the good liberal intellectual of crypto.”
What does this mean for SBF himself? His prospects don’t look good. Kraken founder Jesse Powell equated SBF’s actions as ‘sociopathic behaviour’ and said he was trying to control his ‘rage’ about the situation.
What does that mean for regulation? SBF was crypto's most regulator-friendly player. He may still be active, but what credibility does he bring to the table -- especially as CZ's comments suggest SBF was not speaking for him. And more broadly, what does it tell regulators that their most credible interlocutor has imploded so quickly. Indeed, CZ appears to have taken the whole stage for himself, making it less likely, at least for now, that TradFi might be on course to merge with DeFi. What is clear is that U.S. officials, at least, are launching probes.
Why wasn’t this flagged earlier? Hindsight is 20/20, but only a handful of people wrote down their concerns that something was afoot: Is Alameda Research Insolvent? by Dirty Bubble Media was published on November 4, two days after the first report apparently showing that two pillars of SBF's empire leaned heavily on each other. And Jay Pinho highlighted problems with FTX US back in August. Amy Castor argues that the 'flywheel’ model adopted by FTX/Alameda was surprisingly similar to that run by Celsius.
Who else within FTX’s immediate orbit might be immediately affected? Who are Alameda's other counter-parties? And who is lending to those parties? This is the most likely vector of contagion, given the experience with Three Arrows Capital, where attempts to cover sudden holes in balance sheets prompted a chain reaction of lender failures, in the words of Amy Castor. A case in point is the stablecoin Tether, whose dollar peg sank in part on reports that Alameda had significant holdings, raising fears of major redemptions under forced liquidation.
..and more broadly? Solana is feeling the heat, with the SOL token falling 50%. in the past week. It has since postponed a token unlock for non-developers, prompting criticism from some holders.
How, if at all, is this connected to the earlier collapse of Three Arrows Capital? Lots argued a piece by Reuters, which said the seeds of FTX’s downfall were sown after SBF’s decision to save failed crypto lender Voyager Digital.
Is this another example of CeFi ruining DeFi’s good name? There are plenty who argue just that, but others might argue that the reason centralised exchanges are so popular is in part down to the complexity of self-custody.
What does this mean for FTX’s investors, some of whom appear to have been kept in the dark? “FTX investor tells me that the company has not yet sent them any information on the deal. Says all he knows is what he's seeing on Twitter.” Sequoia Capital has written down its investment to zero. SoftBank has not said anything yet, but it participated in a $900 million That does this tell us about VC investment in FTX — and other crypto players? Eric Newcomer pointed out that Sequoia invested in a $420m round in FTX at a $25B valuation in October 2021 and a consortium with Paradigm invested $400M at $32B in January 2022. And now it's selling in a fire sale? This is a truly crazy event in the startup world. Dot-com bust level event". More searchingly, Arthur Hayes points out that VCs must have known about the co-dependent reliance on FTT tokens, although it’s hard to judge which is worse: knowing and investing anyway, or not knowing.
What will the wider fallout be for crypto? Prices are falling and may continue to do so. At the time of writing Bitcoin had steadied around 17,000 USD, according to Bloomberg, but in an analyst’s note, JPMorgan has warned that Bitcoin could fall to 13,000 in a 'cascade' based on the argument that the number of entities with strong enough balance sheets able to rescue others is shrinking.
Who else might fall? FTX was seen as “untouchable.” No one is too big to fail. (Inside FTX’s $32bn collapse) Most parties are rushing to reassure investors and users.
What are the lessons for DeFi? The most obvious one is that account holders had little visibility into the balance sheet and operations of FTX, and that qualms about the relationship between FTX and Alameda were justified. It’s telling that Binance has released the wallet addresses of its $69B crypto reserve. The call for such transparency will only grow.
How did this story play out in the media? If you include Twitter as the media, it was a battle waged in front of anyone who wanted to watch. But there were also a lot of leaks and rumours, which hindsight might conclude poured fuel on the fire.
(Stories by Oliver Knight of CoinDesk; Ryan Weeks of The Block; Tom Westbrook, Georgina Lee, Angus Berwick and Tom Wilson of Reuters; Annie Massa, Lydia Beyoud, Min Jeong Lee and Anna Irrera of Bloomberg; Ezra Reguerra and Jesse Coghlan of Cointelegraph; Alex Hern of The Guardian; Saptak Bardhan of Entrepreneur; Sead Fadilpašić of Cryptonews; Zeynep Geylan and Samuel Wan of CryptoSlate; James Warrington of The Telegraph)
[Politics and tokens]
The U.S. midterm elections are upon us and while crypto isn’t the main focus, it’s certainly becoming an issue politicians can't afford to ignore. The fall of FTX and Sam Bankman-Fried not only adds to the urgency, but also will raise suspicions that even the most ‘regulator-friendly’ faces in crypto cannot be trusted. (It’ll also make them wonder who, exactly, they should be talking to, if anyone.)
Here's a good summary of what’s being reported, a summary of implications about who gets in and who gets kicked out, and why all this is important for crypto (in a nutshell: failure to agree on crypto policy this year means the debate will kick into 2023.)
Part of the problem for crypto has been that the ‘industry’, for want of a better word, is nowhere near a consensus about what it wants from policymakers. The FTX and Binance spat (see section below) may be rooted in differences over self-regulation and lobbying.
LBRY Inc’s lost SEC case may focus minds in that it “sets an extraordinarily dangerous precedent that makes every cryptocurrency in the US a security, including Ethereum,” LBRY wrote on Twitter. CEO Jeremy Kaufman has decided to run for Senate in New Hampshire, saying that getting into politics is the only way we can make blockchain legal." Web3 VC firm Paradigm has reached a similar conclusion: it has set up a Crypto Policy Council that includes Paul Ryan to advise it on “how to tell the story of web3 in Washington and around the world." (It denies this is a lobbying group.)
(Stories by Shraddha Sharma of BeInCrypto; Kate Irwin and Sander Lutz of Decrypt; Allyson Versprille of Bloomberg; Ben Schreckinger of POLITICO)
[Tidbits]
The world keeps turning.
Japan's NTT Docomo is partnering with Accenture, saying it will invest $4 billion in web3, according to Ledger Insights. DOCOMO, it says, has not been a major blockchain player, mainly participating in telecoms blockchain consortia such as the Carrier Blockchain Study Group. Fellow unit NTT Data has been involved in several projects, such as Italy’s Spunta for interbank reconciliations and TradeWaltz, a major Japanese supply chain blockchain platform.
Footy and NFTs: Interesting take on **Visa’s World Cup 2022 'Masters of Movement’ NFTs**. Conclusion: these aren't run-of-the-mill NFTs, but 'generative art’ where the artist uses an 'autonomous system' (think AI), in this case data of player movement in an iconic World Cup goal fed into an algorithm that creates the art. See below for more on footy and NFTs. (Story by Pet Berisha who writes the newsletter Sporting Crypto)
Teachers are using NFTs to earn money making educational content. Press release: TinyTap's first Publisher NFTs sold out, generating 138.926 ETH (~US$228,000) that is shared with 6 teachers
An interview with Ola Atose, founder of London-based digital assets exchange KoinKoin, explores the role of crypto in Africa. In particular he mentions the use of stablecoin by larger clients in energy, agriculture and food to transfer funds across the continent. Another piece, this one a commentary by Ray Youssef, CEO of Paxful and cofounder of the Built With Bitcoin Foundation: Bitcoin Will Empower Youth Of Nigeria
[Reading]
Good stocks and financial read on the crypto mining industry by analyst/Insight Provider Andrei Zakharov of Algosun Global who publishes on Smartkarma. Bottom line: some miners are in better shape than others, but expect to see further contagion in the next 3-6 months.
The New York Times’ David Yaffe-Bellany explores how crypto dudes bought an English football club.: What Happens When Crypto Meets Ted Lasso.
[Events]
Salt Asia | November 14th - 16th 2022 | Singapore, Singapore
Web3 Dubai | November 17th - 18th 2022 | Dubai, UAE
EthVietnam | November 25th - 27th 2022 | Ho Chi Minh City, Vietnam
Miami Web3 | November 28th - 30th 2022 | Miami, USA
DCentral Miami | November 28th - 29th 2022 | Miami, USA
[DeFi Definitions]
An occasional segment exploring one particular aspect of DeFi.
This Week: “AMM - Automated Market Maker” by Katherine Samson
An automated market maker (AMM) is a trading mechanism that provides liquidity to decentralised exchanges (DEXs), helping users to trade and exchange cryptocurrencies without a middleman.
AMMs bring traditional order books to the decentralised finance (DeFi) space to give agency to users to ideate and innovate solutions while engaging actively within this community. Through liquidity pools (a pile of pre-funded digital assets secured in smart contracts) traders no longer wait for order matching systems to proceed with their trade.
Instead, an AMM provides these traders with autonomy through its algorithm. This enables users to trade against their trading pair pool of choice. An example of this is Uniswap, an Ethereum-based DEX allowing users to supply liquidity and exchange with any pair of ERC-20 tokens.
AMMs play a pivotal role to avoid slippages in pools, enabling greater functionality of these DEXs through reduced transaction fees paid on each execution within the pool. Each pool typically uses a mathematical equation (x*y=k) to fulfil its balance function, causing either pairing token to rise and fall based on user purchase. For larger orders placed on an AMM, as a substantial amount of token is either added or removed, asset pricing can vary from its traded price (based on other exchanges), creating an arbitrage that incentivises traders.