“It’s only when the tide goes out that you find out who was swimming naked,” said Warren Buffett during the 2008 financial crisis. This time, investors are caught naked by the collapse of the FTX platform, star of the crypto universe.
Well-known institutions lost $1.9 billion in FTX capital, including Ontario Teachers, BlackRock, SoftBank, Temasek and Sequoia. The Caisse, which burned 150 million in Celsius, is in good company.
Worse is the fate of a million customers caught in an $8 billion cash hole. The bankruptcy of the second largest crypto platform sends a shock wave that will make other victims.
This is the story of Sam Bankman-Fried, SBF for short, bright and likeable 30-year-old American in shorts, philanthropist and Democratic donor. His fortune of 24 billion has gone up in smoke.
His $32 billion empire includes FTX Trading, a platform where cryptocurrencies are traded, and Alameda Research, a hedge fund that conducts arbitrage trading. SBF and a dozen friends (and lovers) live together and run these businesses in a condo in the Bahamas, with no regard for governance.
FTX and Alameda have multiplied acquisitions and private placements in 500 crypto companies and 40 venture capital funds, financed by short-term debt. FTX was close to completing the purchase of Canadian platform Bitvo.
Tide withdrawal
The pullback of the tide that was supporting the markets came this spring, with rising interest rates. Bitcoin and other cryptocurrencies plunged, causing hedge fund Three Arrows Capital to go bankrupt.
Scalded, Alameda’s creditors called back their loans, secured by depreciated cryptocurrencies. Cash-strapped Alameda “borrowed” $10 billion from FTX clients — without their consent!
CoinDesk, a specialized news site, sounded the alarm, noting that Alameda’s balance sheet had a high proportion of FTT, the token issued by FTX.
Then everything falls apart in a week. The great rival and king of cryptos, Changpeng Zhao, boss of Binance, announces his desire to liquidate the 500 million in FTT obtained against the sale of a stake in FTX. Frightened, customers rush to take out 6 billion; Zhao offers to save FTX, then withdraws his offer. The run on deposits ends with the filing for bankruptcy.
US and Bahamian authorities have frozen the assets and are investigating. Civil and criminal proceedings are in sight.
As misfortune never comes alone, a hacker stole 600 million in cryptos, despite the freezing of operations.
String of errors
The dust has not settled, but classic vulnerabilities are apparent.
First, the opacity of the balance sheet, which does not allow the quality of the assets guaranteeing customer deposits to be assessed. Then, the absence of the lender of last resort, the central banks, which support the banks going through a liquidity crisis.
Rapid growth through acquisitions, financed by short-term debt, as well as the leverage pushed to the limit to generate generous returns on arbitrages of a few cents.
The concentration of power in the hands of a person with an inflated ego, without internal controls or rules on conflicts of interest. SBF and two colleagues formed the board of directors, without an institutional investor as a counterweight to the visionary entrepreneur.
Above all, the criminal attempt to save the company by embezzling from the customers’ accounts, a risk that would have been eliminated by custody of the values by an independent institution.
Faced with this failure, Chanpeng Zhao (known by his initials CZ) is committed to more transparency in the composition of the balance sheet and offers a fund to rescue platforms in liquidity crisis.
Ironically, SBF was the “good guy” who engaged with US regulators and legislators, and supported light industry oversight. CZ, the “bad boy”, strongly opposed it and argued with the regulators. Binance is not licensed in Canada nor was FTX.
CZ, a Chinese-Canadian living in Dubai, eliminated Binance’s headquarters to evade authorities. Today, this libertarian says he is open to regulation and promises careful management of the largest crypto platform in the world. Have.
The ball is now in the court of the regulators who must take up the challenge of international coordination. How to frame a stateless industry that can easily operate on the internet from a complacent jurisdiction?
Hopefully investors will insist on trading on platforms that are supervised by competent authorities in the future. Otherwise, the current crypto winter could turn ice age.