What was FTX?

By: Reed Morris

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FTX Holdings was founded in May, 2019. It was one of the first large crypto exchange platforms that the world came to know. As it was founded right at the beginning of the crypto explosion, it proceeded to make absurd amounts of money off the back of it. FTX became a world renowned company, and in the 2022 Super Bowl, became an American household name with one of the most popular and successful Super Bowl ads in recent years. 

Larry David in the FTX Super Bowl ad Image taken from: https://www.nbcsports.com/video/super-bowl-2022-ad-ftx?scrlybrkr=8fa11097

This sounds like the setup to a story about an extremely successful company on the forefront of cryptocurrency technology, right? Like many people that believed in this company, including celebrity endorsements such as Larry David, Steph Curry, and Tom Brady, you would be wrong. 

On November 11, 2022, FTX Holdings filed for bankruptcy, and in the process, close to $11 Billion has gone up in smoke. 

Humble Beginnings

FTX was founded by Sam Bankman-Fried (SBF) in May of 2019. Before SBF founded FTX, he founded an investment and trading firm called Alameda Research. Alameda consisted of SBF and roughly 10 of his friends, making random crypto trades for a pretty decent profit. When the company was at its height in 2017-2018, it made a respectable profit month after month. 

Sam Bankman-Fried, Founder and CEO of FTX Image taken from: https://watcher.guru/news/insider-reveals-how-sam-bankman-fried-tricked-washington

When the crypto scene started to grow and gain more public attention, larger trading firms got into the scene and made it harder for little companies like Alameda, to make as much money. This is when SBF pivoted his business model and decided to go from exchanging crypto, to being the exchange himself. This pivot birthed the FTX crypto exchange. 

The FTX Business Model

Before we dig into why FTX’s business model failed so catastrophically, we should look at what model DOES work for exchanges. The ideal business model for the average person putting money into a bank or exchange is where the organization holds your money and gives it back when you want it. While it is a good form of banking, it doesn’t make much money. Crypto exchange “Coinbase” uses this model, and only makes money by charging fees on substantial transactions. 

What MOST banks will do is they’ll take your money, and invest it in physical assets such as real estate and long term stock options. This allows banks to be a better investor than you, and make a bit of money off the back end. This also allows banks to give their customers interest on their holdings, so everyone makes a little money. As long as real estate and other investments don’t crumble all at once, everyone’s happy. They still have enough money to pay people out if they want to withdraw some, or all, of their money. 

Something very important to note about real banks, is that NO MATTER WHAT they are required to pay out customers up to $250,000. This is called FDIC insurance, and makes sure that even if a bank goes completely under, people can still make it out with a decent amount of money. 

Where we run into major problems with crypto exchanges (cryptobanks) is the FDIC does not apply to them whatsoever. 

Here’s a unique scenario to think about. Imagine that you give a bank $100,000, and instead of investing that money into something stable such as real estate, they take the money and buy a high quality Babe Ruth rookie card. The money you gave them is technically still there, but it’s no longer liquid. Now, take this scenario and multiply it by thousands of customers. For every $100,000 dollars put into the bank, a new rookie card is acquired. Now, uh oh, someone wants their money back, so the exchange has to sell one of the cards, no big deal, the card is sold for more than it was bought, you get your money back and the bank keeps a little.

Now the real problem occurs when a whole lot of people want their money back, all at once, and you need to sell a whole lot of these Babe Ruth rookie cards to be able to do that. If you sell all of these cards, they will end up having very very little value, and you’ll never get the money to pay back your customers. Take this scenario, and instead of a Babe Ruth rookie card, the exchange is investing in a worthless, self minted, crypto coin. That’s FTX.

Going criminal

While SBF was somehow keeping FTX afloat, his first company, Alameda Research, was making a large amount of terrible crypto investments. It was being run by the 28-year-old girlfriend of SBF, who was having an extremely hard time making good investments for Alameda. In referencing her direction and methodology around making massive crypto bets, she said, “’Ya know [I] adjusted myself to you know, okay we’re farming comp, uh and then it’s like oh were farming these things that are like foods, and now we’re farming these whatever weird, like meta food things, I don’t know.’ She goes on to say,‘Yeah I feel like I did manage to get, yeah, get away from my initial skepticism and end up embracing the mindset of like great, gonna go out and look for like, whatever like the weirdest, dumbest thing people are talking about today and like that’s gonna be the thing I’m working on today.’” Through this interview, it becomes pretty apparent that she has little to no idea what she’s doing regarding handling multi billion dollar cryptocurrency bets. 

Caroline Ellison, head of Alameda Research, at her offices in Hong Kong Image taken from: https://www.the-sun.com/tech/6678424/who-is-caroline-ellison/

As Alameda was losing obscene amounts of money hand over fist, SBF started taking money directly from FTX’s accounts and secretly fueling the dumpster fire, Alameda Research. While on the surface this seems sketchy at worst, this is a 100% illegal way to conduct business. This is the point at which FTX and SBF start to resemble Enron. What was going on behind the scenes here was completely illegal and SBF should face criminal punishment. 

The collapse

In early November, 2022, a leak was made of FTX’s finances. The leak showed that FTX was “loaning” money to Alameda to keep up its failing bets, and in return, Alameda was giving them FTT Tokens. FTT Tokens are the tokens minted and sold by FTX as mentioned in its business model. The FTT Token was only being propped up by FTX’s profits. As more people invested into FTX, these FTT Tokens gained more “value” even though there was literally no solid financial support behind that said value. FTX would continuously buy the FTT Token to keep its value up. The leak brought to light that almost ALL of the money on FTX’s books was being held in this made up, completely valueless FTT Token. So, instead of having people’s real money in their vaults, FTX was filling it with these worthless crypto tokens. People started to realize that this was a major red flag, and decided to start pulling money out. 

Very shortly after this leak was published, the CEO of a similar crypto exchange, Binance, said publicly that he had a large amount of this FTT Token and was scared for its stability. Instantly, he announced that he had decided to dump it all. With the CEO of Binance dumping all of his FTT Token, the value plummeted and everyone who had money in FTX also started to pull their money out of the business. 

The house of cards that was FTX fell apart and literally overnight, the company went from the largest and most valuable Crypto Exchange, to worth absolutely nothing. FTX collapses and as a financial powerhouse, simply ceases to exist. 

The aftermath

There will be a lot of changes in the wake of this catastrophic financial oversight. The company that Wall Street counted on to do accurate accounting for FTX, Prager Metis, is facing serious consequences as it was their responsibility to notice a fault this large in the company. The people involved in FTX and Alameda all should also be facing serious jail time. 

Several other things were noticed as well. As I mentioned Binance earlier, it would be good to note that after FTX collapsed, people were rightfully skeptical and decided to look deeper into Binance’s finances (sick rhyme). What they found was that almost 50% of THEIR reserve is also in their own Crypto Token. In the Crypto world, this has immediately popped up as a huge issue, all over the place, and is an extremely dangerous balancing act to keep up. 

As mentioned earlier, this situation is very reminiscent of that of the Enron collapse, which I have covered in a previous article. While the similarities between the two fraudulent companies are deeply woven, it brings me great joy to announce that the new CEO of FTX, whose job it is to oversee the company’s liquidation, is none other than John J. Ray, the same guy that liquidated Enron 20 years ago. 

John J. Ray, liquidated Enron in 2002, and is set to liquidate FTX in 2022 Image taken from: https://www.bloomberg.com/news/articles/2022-11-11/enron-s-liquidator-to-oversee-ftx-s-massive-crypto-bankruptcy?scrlybrkr=8fa11097

What can we learn?

What I have taken away from this incident, is to not blindly trust companies with your money. You never know who is up to what kinds of shady business, and who will hang you out to dry whenever they want. While keeping your money in banks is a decently safe way to operate, nothing will ever be safer than a big treasure chest full of money buried in your backyard. 

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