The cryptoverse doesn’t stay boring for a long time, that’s for sure!

Back in July, I wrote a long piece about the Luna & Terra Implosion and at that point it was not sure, whether there would be further dominos to fall, or if all the naked swimmers had been exposed.

Over the last months, it seemed like the contagion was over, with the crypto markets surprisingly stable and Bitcoin prices even holding up pretty well in comparison to all the other crazy stuff that has been going on in the TradFi markets. Bitcoin’s volatility was even falling below the Nasdaq and S&P 500’s. But over the last few days, a new story unfolded rapidly, sending the cryptomarkets tumbling down with Bitcoin making new lows in this cycle (at around $16,000 at the time of writing).

One thing is certain, the stories in this industry are always colorful and fascinating!

Let’s first take a quick glance at the current crypto casino industry.

There are (or rather were) three major crypto exchanges that have emerged over the last years and months:

1. Coinbase: Founded in 2012, it is one of the oldest and most mature crypto exchanges. For a long time it was also by far the largest exchange. It went public April 2021 and became the first crypto exchange that can also be traded on a traditional stock exchange.
2. Binance: Binance was founded in 2017 in China and was often in the press as it changed its headquarters several times due to changing regulatory environments. It’s own token (self-printed money) currently holds rank 4 on Coinmarketcap.com and it also issues the 3rd largest stablecoin (BUSD) ranked 6th overall. Moreover, it recently overtook Coinbase as the largest crypto exchange.
3. FTX: Founded in May 2019, it quickly emerged as the upcoming exchange. Particularly in the months succeeding the Luna implosion, it gained a lot and was rapidly making up ground in comparison to its competitors, even becoming the second largest exchange by some measures.

The Story of Sam Bankman-Fried FTX

Sam Bankman-Fried has been the rising and booming character over the last months, appearing on countless popular podcasts and TV shows.

After the Luna & Terra Implosion, he stepped up to (seemingly) generously bailing out troubled crypto firms such as BlockFi and Voyager Digital.

Therefore, he has often been described as the ‘Crypto Savior’.

Some also referred to him as ‘Crypto King’.

Even Fortune Magazine had Bankman-Fried’s picture on its August/September cover, with the headline: “The Next Warren Buffett?”

With Bankman-Fried acquiring substantial stakes in Robinhood, there were some rumors, that FTX might acquire the trading platform in the future. While he denied this, it was repeatedly stated, that FTX had plans to also provide access to traditional stocks. In addition, Bankman-Fried promoted — and was passionately engaged in — tight cooperation with regulatory authorities. Along these lines, the FTX exchange was marketed as the place that would put TradFi and DeFi together in one spot, to bridge the two worlds so to speak.

Some biographical facts about Sam Bankman-Fried:

• He was born in a rich family in 1992.
  • His parents (Mr. Bankman and Ms. Fried) were both professors at Stanford Law School.
• He grew up in the Bay area throughout the Dot-com bubble and also throughout the whole time in which housing prices in this region were skyrocketing.
• He graduated from MIT in 2014 with a degree in physics and a minor in mathematics.
  • apparently, he was quite talented in mathematics.
• In 2013, he went on to Wall Street to work for Jane Street Capital trading ETFs.
• At the age of 25, he founded the cryptocurrency trading firm Alameda Research in October 2017.
  • He made huge gains in Bitcoin arbitrage trades.
• in May 2019, he founded the FTX crypto exchange.
• Before turning 30, he was worth over $24 billion.
• He had strong political relations and made huge donations to several political campaigns.
  • He was the second largest single contributor to Joe Biden in the 2020 election.

In other words, he was exactly the guy who you better stay far away from.

However, the key issue here was, that while being obviously smart and a genius in some areas, in my opinion he didn’t understand the fundamental value proposition behind blockchain technology.

I had listened to him in a few podcasts before and — beside the fact that I disliked his character and regulatory views right away — it was always obvious to me, that he didn’t really have an idea of what makes Bitcoin such a valuable asset. Instead, he talked about all the opportunities that DeFi offers and all the promising projects that are being developed and investors could take advantage of — so he built a crypto casino!

Moreover, being very politically engaged, he was always the one pushing for more government oversight and a more strict regulatory framework for the crypto industry. He was the poster-child for all politicians and people who envision the crypto world to become more institutionalized (which becomes quite interesting and laughable in light of all the news which are being revealed, read on).

On top of it, FTX was printing its own money by creating its own FTT token.

Note: Here is a general base rule that I encourage every ‘crypto investor’ to consider before making any investment: Does the project or platform have an own token that they are promoting? If yes, it might likely be a scam. Or, even if it is not a scam, it will most likely not be successful in the long-run.

Or, an even better base rule: Just allocate some portion of your portfolio in Bitcoin, which is the real revolutionary asset. Put it in self-custody and stay away from all of the crypto circus around it.

Back to the story.

Cory Klippsten, the CEO of investment platform Swan Bitcoin, had been warning that saving other entities, such as BlockFi and Voyager Digital, was not an altruistic move by FTX, but that they are doing it essentially to safe their own exposure to these entities.

But FTX own liabilities were not the only problem.

As mentioned above, Bankman-Fried not only runs the FTX, but also the cryptocurrency trading firm Alameda Research. These two companies are legally two different entities, but basically were working together quite closely.

Real problems started to arise, when Alameda’s balance sheet was leaked on a Coindesk piece on November 2nd. It revealed that a huge portion of their $14.6 billion assets consisted of different classifications of FTT tokens:

• $3.66 billion → Unlocked FTT
• $2.16 billion → FTT Collateral
• $292 million → Locked FTT

Furthermore, another $3.37 billion of “crypto held” assets and huge Solana holdings also revealed huge exposure to other cryptocurrencies that would probably have low liquidity in case of huge selling pressure.

This stood against the liabilities of Alemada Resarch, which amounted to about $8 trillion.

The basic problem here is, that having huge liabilities on the right side of the balance sheet, requires to have sufficient stable assets on the left side.

However, if all you have are blown-up, illiquid (and most of them self-printed) assets with high volatility, then you can run into problems, as the air comes out and the value in these assets rapidly evaporates.

Traders (rightly) started to doubt whether FTX would be able to honor all of their liabilities in case of a liquidity crunch. Thus, they started to take short-positions in the assets held by FTX and Alameda accordingly.

At that point, Binance — another huge holder of FTT tokens — announced to be selling its position.

…which brings us to Binance and CZ

The Story of Binance and CZ

Compared to Bankman-Friend, Binance Chief Executive Changpeng Zhao (commonly known as “CZ”), is a crypto veteran.

He was in the team that developed Blockchain.info (now Blockchain.com), back in 2013, which became a major blockchain data provider and the largest non-custodial wallet.

In 2017, he founded Binance, which has become the largest crypto exchange in terms of trading volume and Bitcoins held in custody.

Upon the leakage of Alameda’s balance sheet, Binance came out with the following statement:

“As part of Binance’s exit from FTX equity last year, Binance received roughly $2.1 billion USD equivalent in cash (BUSD and FTT). Due to recent revelations that have came to light, we have decided to liquidate any remaining FTT on our books. We will try to do so in a way that minimizes market impact. Due to market conditions and limited liquidity, we expect this will take a few months to complete.”

It was quite obvious at this point, that CZ was smelling blood.

And who would be surprised — FTX is (or rather was) their largest competitor.

If Binance would be a friendly economic actor, who just sees risks in their own holdings, they would have tried to secretly sell their assets over the counter.

In contrast, they choose to make it public, so that everyone would see their intention of selling a huge portion (up to $2.1 billion) of FTT.

In other words, they were seeing a wounded animal running and made a pronounced attempt to dump the price in order to give it the final blow.

In order to curb the looming disaster, Caroline Ellison, Alameda’s CEO was quick to reply:

CZ of course didn’t take the deal.

He was not interested in an OTC-deal, which would have had the least possible impact on Alameda and FTX. His goal was exactly the opposite — to have a massive negative impact!

And he succeeded:

At this point (As Dylan LeClair had already pointed out in reply to the above tweet), FTX and Alameda were the only buyers and increasingly also the only holders of the FTT tokens.

The price rapidly fell below the offered $22 and with all the building selling pressure from other holders, the FTT price totally collapsed within a few hours.

The next chart shows FTX crypto balances during the sell-off. Their main asset was their self-created token, which nobody wanted to possess anymore:

At that time, it was reported, that the crypto exchange was facing a shortfall of up to $8 billion and needed $4 billion to avoid bankruptcy. Apparently, Bankman-Fried was desperately trying to get a liquidity injection from multiple potential investors, but with no success.

What happened next, was a capitulation of FTX and a Letter of Intent by CZ to buy the FTX exchange.

At first, it seemed like the whole succession of events turned out to be an incredible 3D chess mastermind move by CZ, teaching Sam Bankman-Fried a painful lesson in ‘The Art-of-War’.

#SAFU.🙏

— CZ 🔶 Binance (@cz_binance) November” target=”_blank” rel=”noreferrer noopener”>

#SAFU.🙏

— CZ 🔶 Binance (@cz_binance) November” target=”_blank” rel=”noreferrer noopener”>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. Stay #SAFU.🙏announced, that he would buy FTX, it became clear that he had already backed out of the deal and that the deal was not going to happen:

November” target=”_blank” rel=”noreferrer noopener”>

November” target=”_blank” rel=”noreferrer noopener”>Sad day. Tried, but 😭report in the WSJ confirmed that the huge funds ($10 billion) that where loaned from FTX to Alameda in previous months, was at least to a significant extend taken right out of customers deposits.

Here are some of the FTX.com terms-of-service:

(A) Title to your Digital Assets shall at all times remain with you and shall not transfer to FTX Trading. 

(B) None of the Digital Assets in your Account are the property of, or shall or may be loaned to, FTX Trading; FTX Trading does not represent or treat Digital Assets in User’s Accounts as belonging to FTX Trading. 

(C) You control the Digital Assets held in your Account. At any time … you may withdraw your Digital Assets by sending them to a different blockchain address controlled by you or a third party.

It is no question that taking money out of the customers deposit is not just customer fraud, but also a clear violation of its own contract with customers.

He has good political connections in the democratic party, so it might be that he can avoid going to jail — but he definitely belongs there.

It is a sad story.

One final silver lining might be, that CZ stated, that he would implement a Proof-of-Reserve procedure in the Binance exchange. A few entities are already engaged in it, which allows to make use of the potential transparency of blockchains, one of its great features. Allowing for better options for customers to do their due diligence should lead to a more trustworthy operation of the business.

What to Think of It and What Is in the Cards For the Future Development of the Industry?

The whole story is still in the progress of unfolding and there are still many open questions remaining:

• The biggest question is, how huge the contagion effects are going to be:
  • Alameda was a huge player, as a key investment vehicle and market maker in the crypto industry. It is likely that there are many other entities entangled.
  • Since it is currently a huge bloodbath, there might be margin calls for investors and entities having exposure to loans which are collateralized by cryptocurrencies — especially those that were held by FTX and Alameda.
    • For instance, Solana was a main asset of Alameda and saw a tremendous decline.
    • But also BTC and ETH, which are the dominant assets used for collateralization, have declined substantially.
  • Lending platforms might see some more bankruptcies:
    • Blockfi, which was ‘saved’ by FTX a few months ago, has already stopped withdrawals.
    • Voyager, which was also previously saved by FTX, also seems to be in deep trouble.
    • Genesis has huge exposure to FTX.
    • ABRA has reported to have some exposure to FTX, but claims that it is small. So far, it remains in full operation.
    • Ledn has admitted to having had some exposure to FTX and Alameda, but claims that it is limited and will keep in full operation.
  • Other entities with high exposure:
    • The cross-chain protocol Stargate,
    • Tom Brady seed investments
    • Yuga Labs
• Will there be any other ‘saviors’ stepping in and buy out some of the companies that are on the brink of bankruptcy?
• Another question was, what really happened between the 3 main entities of the story: Glassnode revealed, that there have been significant flows of funds between not only FTX and Alameda, but also Binance had a lot of interaction with Alameda throughout the previous months.
  • Do they have more exposure than they let on?

It will for sure stay interesting how this story is going to continue unfolding.

My personal hope is, that it is really another wake-up call for implementing Proof-of-Reserve structures in crypto exchanges and entities.

Key Takeaways:

• All major players in the industry dearly need to implement Proof-of-Reserve as an operational business standard going forward.
• Stay away from institutions that don’t understand that Bitcoin is the real manifestation of the blockchain technology innovation, and instead keep focusing on promoting altcoins.
• Especially stay away from any entities that issue their own token (print their own money)!
• And again and again: Not your keys, not your coins!!!