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Last week the cryptocurrency exchange FTX, which was recently valued at $32 billion, imploded.
While the tragedy continues to play out, let’s summarize what has happened so far:
- FTX is a cryptocurrency exchange, co-founded by Sam “SBF” Bankman-Fried. FTX enables customers to make leveraged bets (as high as 20 to 1) on cryptocurrencies.
- More often than not, it takes loans to make loans. FTX would make these loans to customers with borrowed money from various counterparties, one of them was a sister company, Alameda Research, which was purportedly created for the purpose of “arbitrage and market making” activities.
- When you lend money out, you want to have good collateral. The best collateral is cash (USD), but in the cryptoverse, stablecoins count, as do many cryptocurrencies themselves. The problem is that stablecoins have been shown to be, um, not so stable? And cryptocurrencies are inherently volatile, which makes them risky as collateral.
- FTX has its own crypto token, FTT. Like all crypto tokens, FTT has a price. Also like all crypto tokens, no one really knows what it’s worth, other than a great way to gamble on the number go up “technology.”
- At some point, FTX started accepting FTT as collateral. In the apt words of Matt Levine, accepting your own self-issued token as collateral is “very dark magic” and is almost certain to end badly.
- Turns out they didn’t just dabble in the dark arts; they swam in them. FTX started accepting lots and lots of FTT as collateral. Coindesk reported that FTT composed a large-ish amount (over 30%!) of Alameda Research’s balance sheet. Remember Alameda was a sister company of FTX, and one of the counterparties who enabled the loans to FTX depositors.
- And ended badly, it has. A competitor of FTX started dumping FTT, which caused its price to fall, along with other cryptocurrencies, including Bitcoin. The falling price of FTT cast a shadow on FTX’s reliability. Customers panicked and started withdrawing funds from FTX in record numbers.
- It has since come to light that FTX took customer funds and engaged in duration mismatch, making bets on venture capital, among other “risky bets.” This exposed FTX to a potential “run on the bank.” When customers came to withdraw their funds, the funds weren’t there. They were invested in some other venture.
- This meant FTX was faced with massive client withdrawals and rapidly falling prices of the collateral sitting on their balance sheet (namely FTT) at the same time.
- The CEO called it a “liquidity crunch” (euphemism). A more accurate description would be sudden death capital implosion (they were likely insolvent before they were illiquid, and likely within 24 hours). After a possible rescue from its competitor failed to materialize, FTX announced on Friday that it was filing for Chapter 11 bankruptcy.
- Everyone from retail clients, to celebrities like Tom Brady, to notable institutional investors like Sequoia Capital are likely to lose 100% of their investments. Regulators are circling the wagon and looking to investigate more.