What FTX’s collapse means for crypto

This is an audio transcript of the Behind the Money podcast episode: ‘What FTX’s collapse means for crypto’

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Michela Tindera
Right now in the world of crypto, there’s one story and one story only: the collapse of FTX.

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The world’s largest cryptocurrency firm, Binance, backed out of plans to buy its rival, FTX.

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FTX, one of the biggest players in the digital money markets, once valued at $32bn, is now on the verge of bankruptcy.

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FTX shocked investors by declaring bankruptcy this week.

Joshua Oliver
This is one of those stories that breaks out of the crypto sphere into the regular news.

Michela Tindera
That’s the FT’s asset management reporter, Josh Oliver. Josh has been following FTX’s dramatic fall. This was a business that’s had celebrity spokespeople like Steph Curry and Tom Brady. Its name was splashed on the Miami Heat’s basketball arena and on Formula One race cars. It was a crypto company building a path to going mainstream.

Joshua Oliver
They had spent a ton of money on promoting themselves directly to consumers and trying to kind of make their name. And I think that was a strategy on their part to try and become a household name. I think that they felt that if they were a household name, then they would have more credibility and they would be listened to more.

Michela Tindera
And its founder and CEO, 30-year-old Sam Bankman-Fried, was flying high, fashioning himself as a billionaire, major Democratic party donor and a philanthropist. Some even described him as the John Pierpont Morgan of digital finance.

Joshua Oliver
He was someone that people found compelling. He kind of spoke the language of financial regulators, of big investors, of lawmakers. So he was making himself the kind of acceptable face of crypto and trying to influence the shape of, you know, the future US regulatory approach to this whole digital asset world.

Michela Tindera
But now, after a whirlwind set of events over the last several days, FTX and Sam Bankman-Fried are facing scrutiny from authorities and regulators around the globe.

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I’m Michela Tindera from the Financial Times. On today’s episode of Behind the Money, we’re gonna do something a little different here. You’ll hear from two conversations I had with FT reporters as we try to understand: what does the collapse of FTX mean for the future of crypto?

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Hi, Josh. Thanks for being on the show today.

Joshua Oliver
My pleasure.

Michela Tindera
So, Josh, FTX underwent this really dramatic collapse resulting in the company filing for bankruptcy last week. Can you explain what causes this to happen and what does it have to do with FTX’s sister company called Alameda Research?

Joshua Oliver
So if you had to identify one thing that started the domino effect that ended up with FTX going bankrupt, it would be this leak of kind of snapshot of Alameda Research’s balance sheet to CoinDesk, which is a crypto-focused publication. Alameda Research was, it’s like a private trading shop. It was just taking any different opportunity that came to them in the crypto world. But it appears that over time, some of that was going quite badly wrong and they ended up actually in a bit of a financial hole, which was kind of where things started to go wrong for the Sam Bankman-Fried empire.

Michela Tindera
So the thing that right away grabbed people’s attention has to do with this crypto token that FTX was issuing, called FTT.

Joshua Oliver
It’s a bit kind of like reward points or something like that. It does not represent equity in FTX, but it was this kind of token that they controlled and they could issue it as much as they wanted. So it wasn’t like a real, you know, a full-on liquid asset in any stretch of the imagination.

Michela Tindera
OK. And so apparently on the balance sheet for Alameda Research, there was a very large holding of that FTT token. So what did that mean for Alameda to have that?

Joshua Oliver
One person I spoke to said you could draw an analogy — it’s not exactly accurate, but you could draw an analogy to using equity in your own company as collateral for a loan. And, you know, the problem with doing that is if your company’s in trouble and you need that collateral to do its job and back you up, it’s also gonna be plummeting in value at the same time because your equity is gonna be falling. So FTT was a little bit similar to that, which is why people got nervous.

Michela Tindera
So these events basically led to a bank-run scenario, and after learning about what was really going on, people wanted their money out of this thing ASAP. But you and our colleagues, Josh, recently figured out that this wasn’t possible, right?

Joshua Oliver
We reported over the weekend, based on a copy of some FTX financial records that we obtained, basically showed just how bad their financial position had gotten in the days before the company had to file for bankruptcy. The topline finding was that they had around $900mn in liquid assets, you know, assets that they can actually pay out today in order to meet their customer withdrawals. And they were facing withdrawals that were many, many times larger than that.

Michela Tindera
Now, what’s been the immediate fallout so far?

Joshua Oliver
The most direct impact, obviously, is for customers who had their money on FTX and didn’t manage to get it off before withdrawals were frozen. Now that the company is in bankruptcy proceedings, that will be a long and drawn-out process for them to recover their assets and it probably won’t be that they get everything back. We had a story over the weekend from my colleague Laurence Fletcher reporting on a hedge fund that had, you know, a big chunk of its crypto assets sitting on FTX. They didn’t get them off in time and they had to kind of come out and apologise to their investors. And the money is, at the very least, locked up. Very possibly a good chunk of it is gonna be gone.

Michela Tindera
And has the founder, Sam Bankman-Fried, made any kind of comment on all of this yet?

Joshua Oliver
He’s made a few statements on Twitter, including one very long thread where he kind of seemed to be trying to explain himself, trying to apologise, I think. You know, most people find those explanations incomplete. He has certainly said, you know, it was all my fault. I screwed this up. He said he’s sorry and his explanation, as best he could put it together, was they did not have an accurate picture internally of the liquidity and leverage on the exchange — that basically, their internal bookkeeping was not such that they really knew their financial position. That’s a really remarkable admission, right, for a company that’s supposed to be running on the blockchain where everything should be automated and is seen as being super high-tech and competent.

Michela Tindera
Now, Josh, there have been a number of crypto collapses during the last year, so why is this one any different? I mean, why were regulators and investors taking FTX and Sam Bankman-Fried so much more seriously compared to others in the space that have collapsed?

Joshua Oliver
I mean, I think one thing is scale. They were one of the bigger players in the world in terms of the exchange space. Another thing is the kind of relatively establishment background that Sam Bankman-Fried came from. You know, he had experience in traditional finance. He had political connections. They presented themselves in a way, kind of speaking the language of regulators and financial institutions. They weren’t oppositional, right? And a lot of crypto is really against banks and against regulation. And I think people found Sam Bankman-Fried as someone who they could work with because he wasn’t taking that contrary stance. He was sort of talking about, OK, how can we regulate this? We need regulation. You know, he seemed like the reasonable person in the room. And also he, through that salesmanship and the apparent success of the business in the early stages, he attracted a lot of very big-name investors. And so that is what really, I think, added to it, clinched the credibility is that, you know, when you have BlackRock as an investor, when you have Sequoia, when you have Canadian teacher pension plans invested in your company — that is just big ticks in people’s mind that, OK, this is a reputable company because we trust these investors to have done their homework before they invest major sums of money into a company. Clearly, you know that homework needs to be looked at again.

Michela Tindera
Josh, what might happen to Sam Bankman-Fried and his colleagues from a legal standpoint?

Joshua Oliver
You know, I’m not a regulatory or enforcement expert, but, you know . . . so the things we know about, there is a bankruptcy proceeding. Sam said in one of his statements he’s no longer the CEO of FTX, but he will continue to stick around and try and help with the bankruptcy. We know that there is an SEC investigation that has been accelerated in recent days in light of the events. So, that is kind of another shoe that could drop. What are the US authorities looking at? You know, the US has very long arms and is quite comfortable exerting jurisdiction seemingly rather far away from the US. And then there’s also the Bahamas authorities. You know, that’s where the FTX international exchange was based, it’s where Sam lived. And the police in the Bahamas have said that they are investigating, as have the securities regulator in the Bahamas. So, you know, those are investigations that we will kind of learn more about as time goes on.

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Michela Tindera
All right. Well, thanks for all this insight, Josh. We’ll continue to watch your and the rest of our FT colleagues’ reporting on what happens next.

Joshua Oliver
My pleasure.

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Michela Tindera
OK. And now we’re gonna talk with the FT’s markets editor, Katie Martin, who’s gonna help us take a step back and really look at the big picture here to understand what all of this means for crypto and for the rest of the financial world. So thanks so much for joining us, Katie.

Katie Martin
Pleasure.

Michela Tindera
When I first heard this news, I guess maybe my first question was, is crypto dead? Again?

Katie Martin
Yeah. I mean, I personally have declared crypto to be dead on at least half a dozen occasions previously and it is an incredibly resilient asset class, you know, for want of a better word. People stick with this thing. The whole kind of mindset around crypto is just hold on, you know, it’s us against the system. You’ve got to hold on to your coins no matter what happens. And that is a really important mindset in this market and a lot of people will cling on to the bitter end. These are people with high risk appetite. Something like 40 per cent of holders of crypto are young men, very high tolerance for risk. But this is very much, it’s a young man’s game. It’s very much about holding your nerve. So I think bitcoin is not dead. It has been severely compromised in terms of the extent to which normal bits of the financial system are going to be prepared to work with crypto firms. I can’t see that recovering anytime soon, but in terms of nuking the price of the coins itself, this doesn’t appear to be enough to, to put people off.

Michela Tindera
To what degree would you say that this is impacting the larger financial industry, this collapse of FTX?

Katie Martin
The good news is that this absolutely incredible collapse of FTX appears to have left the rest of the financial system pretty much unscathed. This has always been the big concern for central banks and for regulators is: how enmeshed is crypto with the rest of the financial system? What are the potential ramifications if something goes horribly wrong? Is it a risk to financial stability more broadly? And making predictions is a mug’s game, but right now it looks like the answer is no. It looks like the rest of the system can cope just fine. That is good news for regulators everywhere.

Michela Tindera
How or why could this type of FTX collapse happen?

Katie Martin
This kind of collapse can happen because there are lots of organisations out there in the crypto space that have got their own coins and they vary by supposed utility and they come in lots of different flavours. As soon as somebody calls into question how those coins work and what they’re actually worth, what we’ve seen with the experience of FTX is that the coins can fall very, very fast and it looks like they can effectively take down an organisation with them.

Michela Tindera
The crypto industry makes these claims that it’s, you know, different and maybe superior to the traditional financial industry . . . 

Katie Martin
Yeah.

Michela Tindera
 . . . because everything is, quote unquote, “decentralised”. What does what happened here with FTX say about that ideology?

Katie Martin
Yeah, the notion that crypto is decentralised is just farcical. There’s actually a really small number of individuals who really matter in this space and their actions and motivations and levels of transparency really matter. And ironically, one of the people who was seen as absolutely essential to the functioning of this market until very recently was Sam Bankman-Fried. This industry was already incredibly centralised. It’s becoming even more centralised in a small group of not always terribly transparent individuals. Again, this is effectively one guy who made a set of promises and came up with an algorithm and said “you can trust my coin”, and you couldn’t trust his coin. It just evaporated.

Michela Tindera
Sam Bankman-Fried was seen as having this positive relationship with regulators in the US. Now that he’s probably gonna be out of the picture, how do you see the relationship between crypto and regulators going in the future?

Katie Martin
Yeah. This will definitely reshape how people think about the kind of big names, the big personalities in crypto, but also how they think about organisations in crypto, because what’s becoming increasingly clear is that FTX was Sam and Sam was FTX. And that the usual controls that you have in place — if you’re like a normal stock exchange or if you’re an investment bank, all of those kind of controls and checks and balances and, you know, lots and lots of highly qualified people who make sure that you don’t make huge mistakes — that just appears not to have been there. And so, lots of really big-name venture capital firms, lots of, lots of financiers effectively, were drawn into Sam’s vision and said very publicly, what a genius and a visionary he was — they’ve been shown to have been completely naive. And so I think that from now on, the sort of due diligence that venture capital firms and other financiers are going to be doing of crypto firms is going to be a whole different ballgame. There’s going to be much more detailed questions around what is the motivation of founders in this space, what are internal auditing processes, what does that all look like. I really feel like there’s just going to be for any traditional finance firm, as they like to call them, you know, any establishment of the financial system, if you’re going to interact with crypto firms, I think the questions are gonna be significantly more detailed and much more challenging from now on because Sam Bankman-Fried appears to have pulled wool over people’s eyes. They were wowed by his intellect and just didn’t ask the right questions.

Michela Tindera
It kind of just makes me wonder: are these VC firms just looking for the next kind of, like, bright young man, and they can say anything and (laughter) they’ll sign on to it?

Katie Martin
Yeah, I think this whole, this whole situation is very much a product of its age. For a lot of, you know, venture capital and private equity firms and other investors actually, you know, looking for the transformative crypto firm has been, you know, one of the kind of big pursuits, if you like. And it’s certainly looking like money has been put to work in organisations that simply don’t make sense. And I guess that the lesson from this whole episode, one of the lessons here is: if a crypto firm explains to you what they do and you don’t get it, it’s not you being an idiot, you know what I mean? Like, these firms should be able to explain to intelligent adults what it is that they do and leave those intelligent adults coming away thinking, “Huh, I get it now”. And not thinking, “Well, I’m sure they get it. They surely, surely they understand how this really works. I don’t really need to understand how all this really works”. There’s a lot of bamboozling that has happened that has drawn money and people into this, into this market. If anything good comes out of what is turning out to be a pretty ugly situation, then I hope it’ll be that the crypto community explains better how it works and what the risks and controls are.

Michela Tindera
Are there any discussions around governments protecting crypto investors’ money, like the way the Federal Deposit Insurance Corporation or FDIC works in the US?

Katie Martin
The reason that can’t work is that the only way you can get something like FDIC protection is if you play by the regulator’s rules and so crypto can’t have it both ways. They are either regulated like banks, which is an extremely onerous process, but you get that protection that kicks in for your users. Or you’re not, and you can do what you like (laughter). But then if something goes wrong, users can lose everything. You can’t have it both ways.

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Michela Tindera
Well, Katie, thank you so much for coming on the show.

Katie Martin
No problem. Good luck.

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Michela Tindera
Behind The Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week.

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