The collapse in the making of FTX and Almeda is taking a toll on cryptocurrency markets. However, we believe it is worth viewing the debacle as yet another great case study of sound business practices, or the lack thereof.
Of course, the story involves major players in the cryptocurrency world. But in our view, this has much more to do with the age-old game of fragile and/or self-referencing balance sheets, sustained by reputation instead of a sound capital structure. This feels like a Frankenstein of Enron and Lehman, only in part aided by the unregulated nature of crypto markets, the decentralised structure of its players and the lack of safety that comes with the sort of laws and regulations to which most of finance is subject.
So, who are the key parties in the current situation and their relations?
FTX is an exchange for cryptocurrencies. They make money by people trading on their platform. As is usual in crypto, assets on the exchange, be they crypto or fiat currency such as USD, are not segregated. That means that if FTX does go bankrupt, the users on the exchange will enjoy no protection of their assets.
The other major player is Alameda Research, a trading firm. Its business is to trade crypto currencies for its own profit (i.e. as principal).
Both FTX and Alameda are owned by Sam Bankman-Fried (or SBF), who emerged as the “white knight” in this summer’s near-death experiences of various crypto-players. His bailout of imploding crypto companies led to some calling him the ‘central bank’ of cryptocurrencies. For many traders, FTX and Alameda seemed to be the more robust counterparty due to the balance sheets and reputation they have/had. Now, it is SBF seemingly in need of bailout.
What led to the current crisis?
According to reports in the press, Alameda apparently took out loans (cash) and collateralised these with its assets that it held on its balance sheet (cryptocurrencies). The cash seemed to have been redeployed back into the FTX exchange. By traditional finance standards, it didn’t seem to be overly leveraged with liabilities of $8bn against assets of $14.6bn.
According to reports, the balance sheet from Alameda was not as strong and diversified as many had initially thought – concentration risk loomed high. The loans were in large parts collateralised by FTT, the FTX’s native token. If the collateral value fell, Alameda faced margin calls or could have been forced to repay the loans – and that is exactly what happened. The price of FTT came under pressure, in part due to a competing exchange (Binance, who held $530 million worth of FTT) voicing concerns about its value.
This triggered two responses. First, clients who had assets on FTX started to withdraw cash from the exchange – a non-bank bank run.
Second, FTT prices came under pressure as the market expected Binance to sell its FTT holdings. Alameda offered to buy the coins at the then market price of $22, but this offer was rejected by Binance. As a result, FTT slid from $26 at the start of November to $2.8 at the time of writing. FTX is now trying to sell its business or raise capital (both up until now unsuccessfully) to repay its loans and service withdrawal requests.
What can we expect from here?
Unfortunately, this episode has led to further erosion of trust in crypto. As we know, trust takes years to build and seconds to lose. And when you are actively looking for flaws, you will find them.
There will be more questions around the balance sheets of stablecoins and other lending counterparties. We suspect this will make the market less liquid and lending terms less favourable.
These seems like another case of the “smartest guys in the room” blinded by the light.
Cryptocurrencies are highly volatile. When you invest in ETFs and ETCs your capital is at risk.