Matt Levine seems to think it was the leveraged derivatives. I will quote him at length:
One question that might be too early to answer is: Why was there a liquidity crunch in the first place? A crypto exchange is a weird sort of business, in many ways more like a brokerage than a traditional exchange. The simplest way to run the business is to take deposits from customers, buy crypto for the customers, keep everything segregated, and make money on commissions. Coinbase Global Inc.’s balance sheets are public, and pretty simple: It has about $101 billion of customer cash and crypto assets, and about $101 billion of offsetting customer liabilities. If the customers asked for their $101 billion back, presumably Coinbase would just give it to them.
A more complicated way to do it is to provide leverage to customers: Instead of taking $100 of customer cash to buy $100 worth of Bitcoin, you take $100 of customer cash to buy $200 worth of Bitcoin. A lot of FTX’s business is in perpetual futures, a leveraged product, sometimes levered 20 to 1. If you are an exchange and you are in this sort of business, you will need to come up with the extra $100 to lend to your customer. Presumably that doesn’t come from your equity: You are doing some sort of borrowing, perhaps from other customers, perhaps from outside financing sources, perhaps from your affiliated hedge fund, etc. You will have some customers who owe you money, and others whom you owe money. You will be like a bank. If everyone to whom you owe money demands their money back at once, you will need to get the money back from the ones who owe you money, which might be hard. (You might not have a contractual right to demand the money back right away, or it might be rude and bad for business, or you might have to liquidate them to get the money back and that would blow up the value of your collateral.) In broad strokes this is a reasonable description of what happened to Bear Stearns, a brokerage that financed its customers’ positions. If you are a crypto exchange that provides leverage, then you are probably bank-like enough for a run on the bank.
Another complicated way to do it is that you take your customers’ assets and go invest them in whatever sounds good to you. You’re holding Solana tokens for a customer, you invest them in some yield-farming thing to make some extra cash, if the customer asks for the tokens back you don’t have them, etc. This is more or less what brought down the Celsiuses and Voyagers and BlockFis of the world, but I would not have expected it from FTX. “FTX has enough to cover all client holdings,” Bankman-Fried tweeted yesterday. “We don’t invest client assets (even in treasuries).”
I’m confused about this. This seems to explain why customers with invested assets can’t withdraw immediately. But if a customer has only cash in their account, why can’t they withdraw it if it’s not being invested? If customer A’s cash is being used to secure margin loans for customer B, then how is it true that customer A’s cash is “not invested”?
Without trying to make an affirmative statement about what happened at FTX or saying there wasn’t any other factors, it seems likely that the idea “that customer funds solely belong to the customer and don’t mix with other funds” is simplistic and effectively impossible in any leveraged trading system. In reality, what happens is governed by risk management/capital controls, that would almost always blow up in a bank run scenario of the magnitude that happened to FTX.
For example, Robinhood, which no one believes was speculating on customer funds, had a huge crisis in Jan 2021, that needed billions of dollars. This was just due to customer leverage (and probably bad risk management, the magnitudes seem much than what FTX faced this week).
Your comment is valid. This reply is getting into sort of low quality/twitter/reddit style speculation and I might stop writing after this:
Some factors that seem different:
That was Jan 2021, when I think the economy was still in one of the greatest bull runs in human history, money is tighter now for various reasons
At RH, the underlying problem was pretty well defined, and easy to communicate/verify
RH probably had more integration/acceptance in conventional finance. Crypto can be openly hostile, SBF was probably relying on less conventional backstops from his other entities and informal networks
It is possible SBF’s preparations and backstops were formidable, but at the critical moment when withdrawals surged, the separate crisis of defending FTT at >$20 drained all of Alameda and FTX’s resources, that would otherwise almost always be available to satisfy even chaotic customer withdrawals. No one expected both things to happen at the same time
The dual crisis of the withdrawal and FTT issue was spooky, this was two distinct issues. This looked like solvency, and made it a lot harder to get money
It’s not clear the RH FDIC crisis had any visible effects (and it’s not even clear the feds would act in a public way if a violation occurred) while yesterday’s FTX’s withdrawal suspension was blatant, highly damaging and public, by the time FTX was making its phone calls. If they made the calls on Sunday, this may have solved quietly.
RH didn’t give $2M to grantees with a lot cultivated online clout (that the very grant paid to enhance!) who then turn around to unfairly negatively speculate online about deception.
Some other potential factors, are really sort of sad, not SBF’s fault, and I don’t want to write it.
Matt Levine seems to think it was the leveraged derivatives. I will quote him at length:
Alas, the original tweets from SBF appear to be down now. Not sure whether that’s much of an update, though it does look very vaguely suspicious.
I’m confused about this. This seems to explain why customers with invested assets can’t withdraw immediately. But if a customer has only cash in their account, why can’t they withdraw it if it’s not being invested? If customer A’s cash is being used to secure margin loans for customer B, then how is it true that customer A’s cash is “not invested”?
Without trying to make an affirmative statement about what happened at FTX or saying there wasn’t any other factors, it seems likely that the idea “that customer funds solely belong to the customer and don’t mix with other funds” is simplistic and effectively impossible in any leveraged trading system. In reality, what happens is governed by risk management/capital controls, that would almost always blow up in a bank run scenario of the magnitude that happened to FTX.
For example, Robinhood, which no one believes was speculating on customer funds, had a huge crisis in Jan 2021, that needed billions of dollars. This was just due to customer leverage (and probably bad risk management, the magnitudes seem much than what FTX faced this week).
https://www.cnbc.com/2021/02/03/why-investors-were-willing-to-write-robinhood-a-3-billion-check-during-the-gamestop-chaos-.html
Is it not ominous that people were prepared to wriye Robinhood a check, but not FTX?
Your comment is valid. This reply is getting into sort of low quality/twitter/reddit style speculation and I might stop writing after this:
Some factors that seem different:
That was Jan 2021, when I think the economy was still in one of the greatest bull runs in human history, money is tighter now for various reasons
At RH, the underlying problem was pretty well defined, and easy to communicate/verify
RH probably had more integration/acceptance in conventional finance. Crypto can be openly hostile, SBF was probably relying on less conventional backstops from his other entities and informal networks
It is possible SBF’s preparations and backstops were formidable, but at the critical moment when withdrawals surged, the separate crisis of defending FTT at >$20 drained all of Alameda and FTX’s resources, that would otherwise almost always be available to satisfy even chaotic customer withdrawals. No one expected both things to happen at the same time
The dual crisis of the withdrawal and FTT issue was spooky, this was two distinct issues. This looked like solvency, and made it a lot harder to get money
It’s not clear the RH FDIC crisis had any visible effects (and it’s not even clear the feds would act in a public way if a violation occurred) while yesterday’s FTX’s withdrawal suspension was blatant, highly damaging and public, by the time FTX was making its phone calls. If they made the calls on Sunday, this may have solved quietly.
RH didn’t give $2M to grantees with a lot cultivated online clout (that the very grant paid to enhance!) who then turn around to unfairly negatively speculate online about deception.
Some other potential factors, are really sort of sad, not SBF’s fault, and I don’t want to write it.