The reason for a run on FTX is if you think that FTX loaned Alameda a bunch of customer assets and got back FTT in exchange. If that’s the case, then a crash in the price of FTT will destabilize FTX. If you’re worried about that, you should take your money out of FTX before the crash. If everyone is worried about that, they will all take their money out of FTX. But FTX doesn’t have their money; it has FTT, and a loan to Alameda. If they all take their money out, that’s a bank run.
All of which means it’s not a real “exchange.” The New York Stock Exchange could never go bankrupt like this. They make money just by small fees on transactions and by membership fees. But an “exchange”that gambles with customers’ assets by engaging in self-serving loans to sister corporations—well, that’s crazy, and it’s part of why humans invented financial regulation in the first place. Looks like Bankman-Fried has just been using new technology to reinvent old forms of fraud.
From what I have read, Bankman-Fried is claiming that he had an erroneous impression[*] of how much aggregate leverage FTX was offering to its customers. I think many people do not understand that an exchange like FTX does not necessarily make loans to its customers in the same way as a bank does—by depositing the full amount in their account. Rather, it extends a line of credit, which is subject to margin calls and/or collateral requirements, designed to protect FTX and ultimately its other customers. This was a normal practice offered to numerous customers and documented in their public documentation, it was not some special privilege accorded only to Alameda—though the terms may have been more generous for Alameda. Though note that Alameda had billions in assets so, proportionately to its size, it may not have been that generous after all.
The problem here seems to have been that, according to media reports, the line(s) of credit offered to Alameda were collateralised by FTT—FTX’s own exchange token—and shares in Robin Hood—neither of which are particularly high-quality assets compared to, say, US treasuries, especially FTT. But this is an assessment in hindsight, from the perspective of 12 Nov 2022 when FTT is essentially almost worthless—that was not the case earlier in the year!
Note that again, use of non-government bonds as collateral is hardly something unique to FTX—Tether, to take another example within the same industry, has held non-government bonds on its balance sheet to substitute for cash.
This is probably why Bankman-Fried said recently that FTX actually had sufficient assets to cover customer withdrawals, they were just very illiquid, so he needed to find someone to give him a liquidity injection (of some billion dollars!)
When Binance initiated the “controlled demolition” of FTT by selling off their FTT stash and loudly announcing they had done so, this of course brought down the whole precarious house of cards.
This fits with the idea that Bankman-Fried is a “hardcore utilitarian” (his own self-description) of the type who values high expected utility over risk-adjusted returns, rather than a deliberate fraudster. He presumably realised that a big holder of FTT could cause its price to crash by selling it, but he probably thought this was unlikely to happen because it would not be in that holder’s self-interest to do so. But I suspect that Binance’s CEO CZ got so angry about (what he perceived to be) SBF’s attacks on him, his business and even his children, that he was prepared to torpedo the whole thing, despite it hurting him financially as well in the short term, because in the long term it would take out a highly-competent competitor, which was valuable.
Furthermore, perhaps SBF calculated that it would be possible, or even easy to restart the whole shebang if the merry-go-round ever stopped, because FTT was sort of a representation of the money-printing machine that was FTX, so an injection of liquidity into FTX to restart it should have resurrected the value of FTT, enabling the loan to be repaid in the long term. But it turned out that was not the case, because of this little thing called “reputation”, which formed a key part of FTX’s intangible equity, and which was lost during this whole debacle. No-one wanted to go near the now-radioactive company that was FTX, not even CZ or Elon Musk. Elon didn’t trust SBF, and CZ may have had obvious personal reasons (see previous paragraph) to pretend to buy FTX and then thrown up his hands in mock horror and say that it was not something he wanted to be involved in, “pour encourager les autres”. I think it is a testament to Bankman-Fried’s lack of ego that he went cap in hand to his adversary to see if he would buy FTX out. But it was perhaps not a wise move because I think CZ kind of poisoned the well.
[*] I’m not going to go into how I suspect this erroneous impression came about, because it’s a technical detail that’s not really relevant to the above points, and my theory looks on its face to be so implausible that I don’t think you would believe it—and anyway, SBF has promised to publish a full account of the affair so hopefully we’ll know soon anyway.
The key paragraph:
All of which means it’s not a real “exchange.” The New York Stock Exchange could never go bankrupt like this. They make money just by small fees on transactions and by membership fees. But an “exchange”that gambles with customers’ assets by engaging in self-serving loans to sister corporations—well, that’s crazy, and it’s part of why humans invented financial regulation in the first place. Looks like Bankman-Fried has just been using new technology to reinvent old forms of fraud.
From what I have read, Bankman-Fried is claiming that he had an erroneous impression[*] of how much aggregate leverage FTX was offering to its customers. I think many people do not understand that an exchange like FTX does not necessarily make loans to its customers in the same way as a bank does—by depositing the full amount in their account. Rather, it extends a line of credit, which is subject to margin calls and/or collateral requirements, designed to protect FTX and ultimately its other customers. This was a normal practice offered to numerous customers and documented in their public documentation, it was not some special privilege accorded only to Alameda—though the terms may have been more generous for Alameda. Though note that Alameda had billions in assets so, proportionately to its size, it may not have been that generous after all.
The problem here seems to have been that, according to media reports, the line(s) of credit offered to Alameda were collateralised by FTT—FTX’s own exchange token—and shares in Robin Hood—neither of which are particularly high-quality assets compared to, say, US treasuries, especially FTT. But this is an assessment in hindsight, from the perspective of 12 Nov 2022 when FTT is essentially almost worthless—that was not the case earlier in the year!
Note that again, use of non-government bonds as collateral is hardly something unique to FTX—Tether, to take another example within the same industry, has held non-government bonds on its balance sheet to substitute for cash.
This is probably why Bankman-Fried said recently that FTX actually had sufficient assets to cover customer withdrawals, they were just very illiquid, so he needed to find someone to give him a liquidity injection (of some billion dollars!)
When Binance initiated the “controlled demolition” of FTT by selling off their FTT stash and loudly announcing they had done so, this of course brought down the whole precarious house of cards.
This fits with the idea that Bankman-Fried is a “hardcore utilitarian” (his own self-description) of the type who values high expected utility over risk-adjusted returns, rather than a deliberate fraudster. He presumably realised that a big holder of FTT could cause its price to crash by selling it, but he probably thought this was unlikely to happen because it would not be in that holder’s self-interest to do so. But I suspect that Binance’s CEO CZ got so angry about (what he perceived to be) SBF’s attacks on him, his business and even his children, that he was prepared to torpedo the whole thing, despite it hurting him financially as well in the short term, because in the long term it would take out a highly-competent competitor, which was valuable.
Furthermore, perhaps SBF calculated that it would be possible, or even easy to restart the whole shebang if the merry-go-round ever stopped, because FTT was sort of a representation of the money-printing machine that was FTX, so an injection of liquidity into FTX to restart it should have resurrected the value of FTT, enabling the loan to be repaid in the long term. But it turned out that was not the case, because of this little thing called “reputation”, which formed a key part of FTX’s intangible equity, and which was lost during this whole debacle. No-one wanted to go near the now-radioactive company that was FTX, not even CZ or Elon Musk. Elon didn’t trust SBF, and CZ may have had obvious personal reasons (see previous paragraph) to pretend to buy FTX and then thrown up his hands in mock horror and say that it was not something he wanted to be involved in, “pour encourager les autres”. I think it is a testament to Bankman-Fried’s lack of ego that he went cap in hand to his adversary to see if he would buy FTX out. But it was perhaps not a wise move because I think CZ kind of poisoned the well.
[*] I’m not going to go into how I suspect this erroneous impression came about, because it’s a technical detail that’s not really relevant to the above points, and my theory looks on its face to be so implausible that I don’t think you would believe it—and anyway, SBF has promised to publish a full account of the affair so hopefully we’ll know soon anyway.