Years of triple-digit gains had transformed cryptocurrency into a multitrillion-dollar market. By late 2021, there were about 100 crypto assets valued at a billion dollars or more. This asset class was like a vortex, sucking in capital and talent from everyone, everywhere.
The prevailing bet was that sooner or later, a new killer app would emerge. It would be the next Facebook, or even Google.
Enter Sam Bankman-Fried, a former Wall Street trader who launched crypto exchange FTX in 2019. Despite being a relatively new player, FTX swiftly became the second-biggest trading venue, thanks to its popular and exotic leveraged financial instruments.
In May, as the bear market set in, Korean crypto developer Do Kwon declared that 95% of cryptocurrency projects were “going to die”. Barely a week later, his brainchild — the Terra protocol — collapsed, wiping out US$40 billion of market value.
If there was someone who couldn’t take a hint, it was Bankman-Fried. Days after Kwon’s ill-timed interview, he told the Financial Times (FT) that “the Bitcoin network is not a payments network and it is not a scaling network”.
If Bitcoin had no future as a payments network, which cryptocurrency did?
From ‘killer app’ to ‘Bitcoin killer’
What the FT story failed to mention was that Bankman-Fried had made massive investments in Solana, a new blockchain protocol. “It is one of the only chains that has a real plausible path forward,” he had said in an earlier interview with crypto news website Decrypt.
Bankman-Fried’s comments sparked outrage, particularly among Bitcoin’s most ardent fans. After all, he was said to have made his fortune by riding the decade-long surge in global Bitcoin demand.
But for nearly everyone else, Bankman-Fried was a one-way rocket ship to the proverbial “moon”. Solana was founded in 2020. In less than two years, its market value crossed US$80 billion. If it was on the path to hit a trillion dollars in market capitalisation, it was going to get there in a fraction of the time it took Bitcoin.
Effectively, some industry players came to view crypto as a zero-sum game. The grand prize was no longer merely a “killer app” — it would be an “Ethereum killer” or “Bitcoin killer”.
Bankman-Fried was involved with Solana from the very beginning. His investment fund, Alameda Research, was an early backer of the start-up that launched the blockchain protocol. He built Serum, a crypto exchange, on the Solana blockchain. Buyers of the Serum token could get a discount on trading fees. FTX listed Serum and Solana tokens on its exchange, giving both projects credibility and access to the increasingly vibrant crypto market.
Solana’s developers also sold their tokens to Alameda and FTX. Some reports peg Alameda and FTX’s share of Solana’s tokens at about 11% — a stake worth billions of dollars at one point.
But for Bankman-Fried, Solana was only the first rodeo. He backed and created numerous other tokens across the crypto ecosystem. Key among them was FTT, most widely used on FTX’s crypto exchange. As was the case with Serum, holding FTTs unlocked a discount for trading on FTX.
But Bankman-Fried had bigger plans for FTT. Reportedly, FTT was meant to underpin an entire “ecosystem”, including a bank and stock-trading app.
So, when FTX invested in other companies, it gave them FTTs. And as the story goes, Alameda used FTTs as collateral — borrowing money against FTTs to use for its own trading activities.
The kicker was that Alameda just so happened to be the market maker for FTT. That meant, as per The New York Times article, Alameda “had the ability to set the price of the token”. Incredible as it sounds, it worked. Until it didn’t.
When the bear market hit crypto, Bitcoin’s newest rivals were hit hard. The biggest blow-up was the Terra protocol, launched in 2019. Terra’s going bust took down major crypto hedge funds, including Three Arrows Capital. Companies such as BlockFi and Voyager Digital, which had lent money to the hedge funds, went under.
Alameda emerged from the rubble seemingly unscathed. Bankman-Fried positioned it and FTX as white knights, promising to swoop in to rescue BlockFi and Voyager.
Surviving on customers’ deposits during crypto winter
But Arthur Hayes, founder of crypto exchange Bitmex, suggests that Alameda escaped the carnage precisely because it had access to FTX’s customer deposits. He believes that Alameda had bet heavily on “shitcoins” — a term used to describe crypto currencies with low liquidity and speculative asset valuations.
These “shitcoins” were used, presumably alongside FTTs, as collateral for loans. Unfortunately, the prolonged market downturn meant that the value of Alameda’s “shitcoins” were increasingly worthless.
So, when crypto lenders tried to recall their loans to Alameda, the latter used FTX customer funds to make the payments, as reported by The New York Times. “The only reason we believed that Alameda was a sound entity was that credit always flowed from FTX depositors,” says Hayes.
Desperate times led to desperate measures. Many in the crypto space allege that at some point in recent history, Bankman-Fried started using his political influence to attack rival trading platforms — a group that included decentralised crypto exchanges (DEXs) and Binance, the biggest crypto exchange.
Analysts at Citi peg the global market share of DEXs at 18.5%. Binance, a centralised exchange, controls about half of the global volume. FTX’s share was about 10%.
Clearly for FTX, “taking out” the competition would boost its chances of survival.
For Binance CEO Changpeng Zhao, this was the final straw. The exchange said it would sell its entire stash of FTT, some of which it received when it invested in FTX in 2019. “We are not against anyone. But we won’t support people who lobby against other industry players behind their backs,” said Zhao.
Money only works when there is demand for it. The reverse is also true. Once Binance started dumping FTTs, Bankman-Fried’s empire toppled like a house of cards.
Soon, it emerged that FTX had indeed dipped into customer funds — to the tune of US$10 billion — to prop up Alameda. Reportedly, just four people at FTX knew about this. One of Bankman-Fried’s close aides had tweaked FTX’s accounting software, hiding the transfer of customer money from FTX to Alameda.
Conflict of interest
What happened at FTX had little to do with crypto. It had everything to do with a conflict of interest and the failure of a centralised exchange to perform its role as custodian of user funds.
Recall MF Global, the derivatives brokerage spun out of global investment manager Man Group. In 2011, MF Global declared bankruptcy days after experiencing a nearly 50% collapse in its share price.
Like FTX and Alameda, MF Global had an investment arm that made risky bets, spooking the market. When investor sentiment turned sour, the brokerage swiftly imploded.
And like FTX, MF Global was accused of dipping into customer funds — over US$1.2 billion — to pay creditors and stave off a potential bankruptcy.
Questioned by a congressional panel in 2011, CEO Jon Corzine said, “I simply do not know where the money is.” In recent weeks, Bankman-Fried has struck a similar chord. “I wasn’t running Alameda, I didn’t know exactly what [was] going on,” he said in an interview. If he didn’t know, who would?
The irony is that with Bankman-Fried, investors thought they were backing the creator of the next Bitcoin. Instead, they had bought into the complete opposite of everything the cryptocurrency stood for.
Bitcoin was created to replace trust in a central authority. FTX? It was the “personal fiefdom of Bankman-Fried”, says James Bromley, a lawyer brought in to help oversee its legal troubles.
It should come as no surprise then, that since the implosion of FTX, DEX trading volumes have surged. Moreover, crypto investors are yanking their assets from centralised exchanges and placing them on “cold” wallets, where users — not third parties — control their funds.
“No wonder Bankman-Fried didn’t like Bitcoin,” said Catherine Wood, a long-time decentralised finance (DeFi) proponent and the first exchange-traded fund (ETF) manager to invest in Bitcoin. “It’s transparent and decentralised. He couldn’t control it.”
Andrew Vong is chief future officer at EquitiesTracker Holdings Bhd