November 20, 2022

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Everything You Need to Know About the FTX Meltdown

Well, last week didn’t go as we expected for the crypto markets. The surprise implosion of crypto exchange FTX caused a crypto crash when we were expecting a crypto breakout as stocks broke out this past week for their best week since June).

Much has been said about the FTX implosion, and the bears are crawling out of the woodwork to herald  the event as the dawn of an “ice age” for the crypto markets. But we think the event will ultimately prove to be much ado about nothing.

That is, we still expect cryptos to soar in 2023.

I’m sure that’s an odd take to hear given last week’s events. But let us explain why we feel this way.

There are four big things at play here.

1. Big bankruptcies are not uncommon to new tech industries or the financial sector. Cryptos exist in the overlap of those two spaces, and therefore, big bankruptcies like we’ve seen with FTX and Luna are historically quite normal.
2. Big bankruptcies did not end the automobile, PC, or internet revolutions. In fact, these bankruptcies tended to mark the bottoms of short-term pullbacks in those revolutions.
3. Ultimately, macroeconomic factors regarding the trajectory of inflation, the Fed, interest rates, yields, and the economy will overwhelm headline risks.
4. If this really is the second coming of the dot-com bubble, history says now is the time to buy as we’ve reached “max pain” and are due for two decades of significant returns from current levels in cryptos.

Before we explain each of these factors, let us first delve into the FTX issue and see what exactly went wrong at the crypto exchange.

In short, the world’s two largest crypto exchanges – FTX and Binance – got into an ego-driven tussle. This led Binance to withdraw its financial support for FTX, and that unearthed a financial maelstrom at FTX, ultimately spooking investors, causing the equivalent of a “bank run,” and bankrupting FTX.

Here is our play-by-play recap of the FTX fiasco:

• Binance (the No. 1 crypto exchange) was an early investor in FTX (the No. 2 exchange, until recently). When it exited FTX equity last year, it received a great deal of FTX Token (FTT-USD) (worth $2 billion).
• Changpeng Zhao (known as CZ) of Binance and Sam Bankman-Fried (known as SBF) of FTX began as friends. But FTX grew rapidly, and it soon became clear that CZ and SBF were growing less friendly and more competitive.
• In late October, SBF made a snarky comment about whether CZ would be allowed in Washington, D.C., to represent the industry: “uh, [CZ] is allowed to go to DC, right?” Many see this tweet as a catalyst in kicking off Binance’s complete exit from holding FTT.
• Then last Sunday, CZ announced that Binance would liquidate its FTT tokens as a form of risk-management “due to recent revelations that came to light.” CZ claimed that Binance didn’t want to be part of another LUNA incident and that it doesn’t support industry players lobbying behind their backs (allegedly referring to SBF). Binance initially planned to sell its FTT over the coming months to avoid having a large impact on the token’s price.
• Apparently Binance had a change of heart following things going on behind the scenes, and it began dumping its $2 billion worth of FTT on the market, despite SBF’s trading firm Alameda Research offering to buy the remaining crypto at $22 a token. Binance’s dumping freaked out other investors, so they followed suit and started dumping, too. FTX saw $5 billion in withdrawals on Sunday and even had to pause them at one point. Everyone was panicking and scrambling to get as far away from FTX and its token as possible.
• Other exchanges began announcing their lack of exposure to FTX to assure their own users they were safe.
• Binance dumping its token is obviously bad news for FTT, but if FTX were liquid, it could’ve processed withdrawals and found a way to do damage control for FTT.
• That wasn’t the case. Much like with LUNA, FTX was collateralizing its risk with its own faux tokens. Half of Alameda’s assets were in its FTT token, which was getting obliterated by the market.
• As it became clear that FTX had more liabilities than anyone imagined, Binance stepped in to save the day and (potentially) acquire FTX. However, Binance quickly changed course after a round of due diligence, leaving FTX desperate for funding. That funding never arrived. FTX declared bankruptcy.
• This led all cryptos to slump even lower, before equities came to the rescue yesterday (somewhat) with their face-melting rally following weaker-than-expected inflation numbers.

Quick Thoughts

• FTX’s collapse was likely caused by LUNA/3AC, as FTX attempted to recover its losses behind closed doors via high-risk strategies? (Alameda’s CEO previously stated that “stop losses are unnecessary.”) Due to a lack of transparency, we didn’t find out for a few months that FTX was insolvent (by a longshot). Ironically, blockchains are super transparent. But centralized exchanges can still hide things.
• Many have/had exposure to FTX/Alameda (and also LUNA/3AC). Many projects have stated they’re either minorly affected or not at all, but everyone also thought FTX was fine after LUNA’s fallout. It could be a while until we see the scope of the damage from this.
• Crypto regulators seem to be licking their lips. However, FTX was based in the Bahamas, and U.S. customers weren’t even allowed to use the platform. The issue was FTX US’ exposure via shared ownership/investors.
• DeFi is still going strong and saw a huge uptick in usage & volume as a result of FTX’s downfall. This collapse is a net positive when it comes to increasing focus on decentralization and asset self-custody.
• Bad actors being ousted from the crypto space is always a good thing, although the pain being felt by institutional and retail investors is also very real.
• Many exchanges either already have or will begin publishing proof of reserves. This is obviously a positive as well and would have prevented the FTX fiasco, or at least led to its insolvency being known earlier (potentially right after LUNA’s collapse).

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Additional Backstory

• April 2019: SBF & Binance among the largest crypto investors.
• Sam’s role at Alameda following FTX’s founding is unclear.
• Twenty percent of initial FTT supply was sold to investors in three private sales – Alameda, Binance, Coinbase, Multicoin Capital, etc.

• Over 50% allocated to the company and team. This portion of the supply finished vesting earlier this year. 

  ◦ About 60% of the company’s tokens weren’t sold. These were reserved for different funds and to reward certain parties

• Alameda had $14.6 billion in assets as of June 30, but much of this was in FTX’s FTT token – $3.66 billion of FTT, $2.16 billion of “FTT collateral,” and $292 million of locked FTT. 

  ◦ On Nov. 2, CoinDesk published an article about this, declaring to its wide audience that FTX was backed by its own centralized token that it could freely print from thin air.

• Between Nov. 2 and FTX’s collapse on Nov. 6, speculation and rumors spread that FTX was missing a large amount of customer funds. With recent collapses on their mind (Celsius, BlockFi, LUNA), users began to withdraw their funds from FTX en masse, causing a bank run.
• On-chain data shows that FTX’s reserves were quickly dwindling. To make matters worse, Alameda began withdrawing funds from other exchanges and sending it to FTX, confirming that FTX’s issues were more far-reaching than it was letting on. FTX and Alameda continued to tell everyone that everything was “fine” up until the last possible moment.

FTX Fallout

• Justin Sun announced he would help holders of Tron-based tokens on FTX by depositing funds to the exchange in order to let individuals withdraw their tokens.
• USDD depegged to ~$0.97
• BlockFi and Voyager, which were going to be saved from bankruptcy by FTX, are now without a savior.

• Investors/firms/projects affected – Solana (FTX-affiliated entities reportedly held 10% of SOL market cap but “locked”), Tiger Global Management, the Ontario Teachers’ Pension Plan, SoftBank Group, Sequoia Capital, BlackRock, Galaxy Digital ($77m), Circle, Ribbit, Alan Howard, Multicoin (10% of assets under management), VanEck, TruFiDAO ($12m), Bybit (FTX had 100m BIT tokens), Temasek, Amber Group, Lightspeed Ventures, Insight Partners, Genesis Trading ($175m), NEA, Paxos, NEAR Protocol, Nova Labs, Messari, Polygon, Immutable, 1inch, and many more. 

  ◦ Sequoia wrote down its $150 million equity in FTX to $0.

  ◦ Ten percent of Multicoin Capital was on FTX

  ◦ Could be some sell pressure for various tokens that FTX holds, as they unlock. For example, FTX and Alameda hold some amount of NEAR that will gradually unlock.

  ◦ Many of the companies FTX invested in could be fine. Yuga Labs, for example, has no remaining exposure to FTX and moved the small amount of funds it had on FTX US to Coinbase before withdrawals were halted. Alameda also participated in a Polygon funding round, but that $50 million of MATIC is locked (and will likely remain locked for a long time, now that it’s filed for bankruptcy).

• Individuals affected – Steph Curry, Tom Brady, FTX’s 1+ million users, FTX US’ smaller user base.
• FTX has naming rights to Miami’s NBA stadium, an MLB partnership, a deal with Mercedes-AMG, and has sponsored a variety of other teams and events.
• Over 80k of BTC outflow from exchanges; 57,900 stablecoins withdrawals from exchanges too, up from slightly over 7,000 the week prior. (This is a good thing!)
• FTT market cap dropped from ~$3.4 billion at the start of November to a few hundred million after its collapse. (Its market cap is currently $500 million.)
• FTX had over one million users as of early 2022.
• Theories are circulating that FTX was impacted more by LUNA’s collapse than it let on and that this led to FTX’s eventual demise.
• DeFi continues to operate just fine. (Far more activity and volume, in fact.)

• Other market stats as of November 10:

  ◦ TVL in top 20 DeFi projects down 20% in 24 hours 

  ◦ MakerDAO TVL up 28%, surprisingly

  ◦ Market cap of top 20 dApps and blockchains down 12.7% 

  ◦ OP down most (26%), BNB down least (1.9%)

  ◦ MATIC only top 20 project in the green this last week

  ◦ Funds held in top five treasuries decreased 14%, from $6.82b to $5.84b

  ◦ DeFi activity up big 

  ◦ Perpetuals borrowing volume up big 

  ◦ Assets borrowed on dYdX up 380%

  ◦ Ninety-one percent increase in active users on top lending protocols

  ◦ DEX active users up 16%, from 54k to 62k

  ◦ Blockchain earnings also massively up due to increased activity 

  ◦ $5m for Ethereum in 24 hours

FTX & Alameda’s Investments:

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The Final Word on the FTX Meltdown

Things may seem rather bleak right now. After all, this event is terrible for everyone involved and will weigh down the industry moving forward. FTX had its tentacles across the whole crypto space, so the bankruptcy will be felt across the entire market.

But we’re still staunch believers in blockchain technology and its ability to reshape the fintech landscape over the years to come. The impact from FTX will likely be short-lived, and broadly, we remain very positive on cryptos going into 2023.

Why?

Because there are countless good actors creating products and services that are faster, fairer, and freer than incumbent processes. They will carry this space forward. 

We’ve seen catastrophic crashes in the crypto space before – some so severe that they ground the entire industry to a halt for days, even weeks. But out of the wreckage came the companies and projects that are thriving today. They were built out of bear markets, and they know how to weather the storm. 

When the grass is cut, the snakes come out. There will be a lot of snakes scurrying out because of FTX’s collapse – that’s to be expected. We saw the same with Lehman Brothers. That may sound spooky, but Lehman’s collapse was the eighth inning of the 2008 financial crisis. If the comparison holds true, we may find that the FTX crisis is the eighth inning of this crypto winter.

It’s not always wise to use history as an indicator of future performance. But while history doesn’t necessarily repeat, it often rhymes. And history tells us that it’s best to get aggressive about cryptocurrencies when they’re down 80% or 90% – just like they are right now. Volatility creates opportunity, and this time is no different. 

Over the coming weeks, we will continue to unpack the fallout from FTX and Sam Bankman-Fried in our crypto advisory, Crypto Investor Network . In fact, as a subscriber, you would have been able to watch this video days ago! Stop stalling and become a subscriber today to access every actionable recommendation we make in the wake of this momentous event in real-time.

Regards,

Luke Lango