Binance and FTX: Breaking down the chaotic week in crypto

Sascha: [00:00:03] This is The Dive. I'm your host, Sascha Kelly. The cryptocurrency market is in meltdown after the collapse of one of the world's largest crypto exchanges. This year, it felt like the worst had passed already for crypto. 

Audio Clip: [00:00:17] Look, I think the industry needs to grow up. I think this week highlights the virtues of Bitcoin as much as it exposes the fragility of the crypto ecosystem. 

Sascha: [00:00:25] Several companies went bankrupt in the first half of the year, and after months of subsequent price falls, it felt like stability had returned to the market. But now this has all been shattered. The collapse of FTX has even been described as Crypto's Lehman Brothers moment. In the aftermath, bitcoin was down 25% and Aether 33%. It's Friday, the 11th of November. And today I want to know, is this collapse going to change the future of crypto? Has the bubble finally bust? To talk about this today? I'm joined by my colleague, the co-founder of Equity Mates. It's Alec Renehan. Alec, welcome to The Dive. 

Alec: [00:01:04] Hi, Sascha. Good to be back. I was out for a week with COVID and it feels like I've come back to a big story. 

Sascha: [00:01:10] You go away and the whole crypto market seems to collapse, so please don't get sick again. 

Alec: [00:01:15] Not the first time we've heard a headline. The crypto market is collapsing though.

Sascha: [00:01:19] That's true. It's a particularly volatile market. I thought I was well versed in crypto, but even I have felt like I need some guidance through the headlines lately. So let's go back to the beginning and start with the basics. FTX and Binance are two of the biggest cryptocurrency exchanges. What does one need to know about them? 

Alec: [00:01:37] If you want to buy or sell crypto. You need an exchange to do it in the same way. You need an exchange to buy or sell stocks. With stocks we go to Robinhood eToro or CMC, IG Stake, CommSec, wherever you are in the world. Some of the names you might be familiar with in the world of crypto. You go to an exchange like Coin Spot, Coinbase, Binance or FTX Binance above two X or two of the most popular exchanges. Binance is the bigger of the two, with a valuation of over $300 billion. In 2021, the company reported revenue of $20 billion. So a massive company. It's led by its founder, Changpeng Zhao, who goes by the abbreviation, say, Z. He's the 19th richest person in the world with a net worth of $65 billion, according to Forbes. FTX, on the other hand, was valued at $32 billion in January this year, so about a 10th of Binance, and it made just over $1 billion revenue in 2021. So a 20th of what Binance made FTX is led by its founder, 30 year old Sam Bankman-Fried, and before this week, his net worth peaked at $26 billion. 

Audio Clip: [00:02:50] Sam Big Winfried has really played a key role in the crypto industries, just the role in the industry this year in general, after he spent hundreds of millions of dollars, the Michael Jordan of crypto, if you will. 

Sascha: [00:03:02] And I've seen a lot of profiles on Sam Bankman-Fried. He seems to be in the media a lot and in the past couple of years he's become somewhat of a white knight in the crypto community. 

Alec: [00:03:14] Yeah, he became a bit of a white knight after rescuing several distressed crypto businesses earlier this year that included Voyager and Blockfi, two companies that most people may not be familiar with, but they're well known in the world of crypto for.

Audio Clip: [00:03:29] Pain in the world of crypto. Voyager Digital Files for Chapter 11 Bankruptcy Protection just days after the broker suspended withdrawals on the platform. 

Alec: [00:03:36] But outside of the world of crypto, he was also building a reputation. He's a big proponent of the effective altruism movement and actually planned to work for an animal rights charity after university before they told him they would rather have his money than his time. Sam back then, Freed also was building a reputation as a massive political donor in this year's midterm elections in the US, the ones that we've just seen this week. He was the second biggest individual donor to the Democratic Party after George Soros. 

Sascha: [00:04:07] Wow, that's significant. So these are the two companies that are at the centre of this story. Let's unpick exactly what happened this week. FTX has collapsed and Binance had a big part to play in that. 

Alec: [00:04:21] Yes. So let's go for a quick timeline of the week. Starting on Monday, Caesar tweeted that finance would be dumping the FTT token, which is FTX X's own cryptocurrency. 

Sascha: [00:04:33] Over the weekend, the CEO of Binance said he would start selling the FTT tokens that he owned, and that. 

Audio Clip: [00:04:38] Was about a half a billion dollars worth. 

Alec: [00:04:40] Finance suggested, although they never explicitly said that something was wrong with FTT. But that was enough for the market and it caused a panic from other FTT holders. And that caused a run on FTT similar to a run on the bank when thousands or hundreds of thousands of customers want a. Sell their assets at the same time and pull their money out of a bank or in this case, out of FTX. It requires a lot of liquidity for us to be able to fulfil those demands. Basically, they need a lot of cash on hand to be able to give it to customers when they want it. Investors reportedly pulled 650 million USD from FTX on Monday and that threw it into a liquidity crisis. Basically, they didn't have enough cash to make the demands. This effectively forced FTX into bankruptcy and they're looking to be bailed out by another buyer. And the only buyer that was willing to talk was by now, CC said on Wednesday. I remember two days after the original tweet on Wednesday, he said that finance would be acquiring FTX that can't run for 24 hours. But on Thursday, just one day later, finance pulled out of the deal. 

Sascha: [00:05:53] Well, Alec, who needs drama on television when you've got the world of crypto? That is a wild timeline. I do have one headline question from that, though. Was it anything actually wrong with the FTT token or is this all just a wild rumor that got out of hand? 

Alec: [00:06:08] This is the million. Well, that's the million dollar question. But I guess a billion dollar multibillion dollar question. It didn't look like it at first. It just looked like Saiss had caused a panic. And that panic had created more panic and it had created a run on FTX that they couldn't keep up with. A few days later, there are rumours and stories starting to emerge about maybe some problems with Alameda Research, which was the Sam Bankman-Fried hedge fund that he used to, I guess not paper over, but Mike Hull. There are some allegations and some stories starting to come out, but the story coming from the official line at this point is if there wasn't a panic, everything would have been fine. 

Audio Clip: [00:06:53] Finance walking away. Hey, there. Yeah, that's right. Wall Street Journal reported that Binance is walking away officially from that deal. 

Sascha: [00:07:00] But that official line is being challenged by Binance, who said that they'd done their due diligence on FTX and found there was evidence of mishandling of customer funds and alleged U.S. agency investigations. And they said, quote, Beyond our control or ability to help, end quote. Pretty strong words. So what next? What happens to users' money or crypto that was held by FTX? 

Alec: [00:07:26] Now it's important that we pause here and make a distinction. There are lots of companies under FTX, but for us, the company that takes money and customers from the United States continues to operate as usual. Okay, we're talking about FTX International here. That's the exchange that's at risk for simplicity from here on in. Whenever we say FTX's, we mean FTX's international. But if you're listening in the US, it's a little bit of a different situation for you. Okay. Sam Bankman-Fried told investors that FTX needs 4 billion USD to remain solvent and is facing a shortfall of about 8 billion USD. That's $8 billion of customers' money that they may not be able to return. Wow. Now FTX's claim that they have the assets to return the money to users, but it will just take time to turn those assets into cash and then return it to users. So it's not that they don't have the money, it's just that they don't have it right now. Yeah, but on the other hand, if folks do not have the money, if they don't have the assets to return the money to customers, because remember, a lot of the assets we're talking about here are cryptocurrencies or stakes in cryptocurrency businesses, both of which seem to be losing a lot of value. This week, FTX may be forced to file for bankruptcy, and if that happens, then FTX customers become unsecured creditors. We likely see lawsuits dragging on for years, and based on history, customers might get 10 to 30% of their money back. 

Sascha: [00:08:56] Wow. 

Alec: [00:08:57] Sam Bankman-Fried today tweeted an apology and said he would repay users of FTX. But I guess at this stage how that happens remains a little bit unclear. We did say, Sam, back on Friday, net wealth was $26 billion. So you might be wondering, why can't he just make up the shortfall with his money? But according to Bloomberg, Sam Bankman-Fried is now worth less than $1 billion. He saw his net worth dropped 94% in one day, which is the biggest one day fall on record.

Sascha: [00:09:28] And the impact of this FTX's collapse goes far beyond FTX's users. And Sam Bankman-Fried We've seen Bitcoin fall 25% in the last five days and Etherium for 33% in that same time period. And now, of course, there's talk of contagion. So let's take a break and then I want to discuss the broader implications. 

Audio Clip: [00:09:54] We just got 22 tweets from FTX's founder, Sam Bankman-Fried, apologising for the chaos that's happening in the crypto industry right now. Just to bring you up to speed if you don't already know. FTX was pursued in a deal by Binance's Binance stepped away from that deal, citing some of their own due diligence. 

Sascha: [00:10:12] Welcome back to The Dive. Today, Alec and I are unpicking the collapse of the world's second largest crypto exchange. But the implications of this crash, Alec, go far beyond FTX ss users. What else have we seen happening? 

Alec: [00:10:29] So you mentioned before we went to break that Bitcoin fell 25% and Etherium fell 33%. Well, what we've actually seen in the last sort of 12 hours is Bitcoin and Ethereum both jumped up double digits because of a better than expected US inflation report. But before that, we'd seen almost a third of value wiped off both of these two blue chip crypto currencies. It still sounds strange to talk about blue chip cryptocurrencies. 

Sascha: [00:10:56] Yeah, I know it sounds like an oxymoron, doesn't it? 

Alec: [00:10:58] Yeah. But the reason these two blue chip cryptocurrencies were down is because people were concerned about the whole crypto ecosystem. And in particular, they were worried that if other companies had lent money to San Bankman-Fried two companies, FTX, which we've spoken about and is a second company, a hedge fund, Alameda Research, there was a chance that those lenders may not get their money back and then those lenders would have a hold to fill that they may not be able to fill and then they might go bankrupt as well. 

Sascha: [00:11:29] And this is when you're talking about the contagion or this domino effect that can take place. 

Alec: [00:11:34] Exactly. If we think about it from a really simple example, if I borrow money from the bank and then I lend that money to you and you don't pay me back because. 

Sascha: [00:11:43] A likely story, Alec. A likely story. 

Alec: [00:11:45] If you go bankrupt and can't pay me back, then I might struggle to pay the bank back and I might go bankrupt as well. And then if I go bankrupt and then I can't pay the bank back, and then the bank goes bankrupt, then we have a financial crisis. So think about that little chain. But on a global scale, with billions of dollars worth of cryptocurrency, that's the contagion effect. 

Sascha: [00:12:06] And this leads us to the ultimate irony at the heart of cryptocurrency. We've seen brokers and hedge funds blow up before, but they are in a centralised finance system. So central banks step in to ensure that there's no contagion or to stem the bleeding. In 1998, long term capital management blew themselves up and the U.S. Federal Reserve stepped in. In 2008, the American banks blew themselves up in the global financial crisis, and the U.S. Federal Reserve stepped in. But the world of crypto doesn't believe in central banks, which means when highly leveraged firms blow themselves up, their lenders are in trouble as well.

Alec: [00:12:44] Yeah. So as we mentioned earlier, FTX have said that they need about 8 billion USD to remain solvent or to return all that money to their customers. And a recent leak out of Sam Bankman-Fried hedge fund Alameda Research allegedly showed that of its $14.6 billion in assets, 5.8 billion of that is or is tied to FTT tokens for his own digital assets. The one that sees they tweeted he was dumping right back at the start of this thing and they're collapsing in value. One year ago, FTT was trading at $59. Today it's about $3. So it's down 95% in a year. And as FTT becomes worth less, it becomes harder for Alameda to pay off the $8 billion in debt that they have, which means that the companies that lent Alameda billions of dollars could be in trouble as well. I guess, again, to really simplify this, let's say we own a house, we go to a bank and remortgage it, and we basically borrow money and use the house as collateral. If things go wrong, the bank takes the house. So there isn't really a massive risk for the bank. That's essentially what Alameda Research did with FTT tokens. The problem is these tokens are now almost worthless. Hmm.

Sascha: [00:14:05] So it's like we bought $1,000,000 house, and then something's happened during that year, and now the house has been revalued for less than 50 grand, and it's like, Oh, hang on, what are we going to do with this asset now?

Alec: [00:14:17] Exactly. 

Sascha: [00:14:18] Yeah. Okay, let's bring this back to how it affects us as individuals. So I don't own any FTT, just some bitcoin and aether is my crypto safe. 

Alec: [00:14:29] So there's two parts to this answer. The first part is, is it secure on a platform like FTX or Binance or anything like that? And unfortunately, what the collapse has shown us is that no exchange is really safe in crypto. There's not enough regulation. And so these black swan events, they never really seen that far away. So there's a saying in cryptocurrency, not your keys, not your coins. And the only way to really keep your cryptocurrency safe once you've bought it is to transfer it to a cold storage wallet. You take it off Binance or FTX or whatever exchange reported on, and you move it to what is essentially a USB stick. Then if an exchange like FedEx goes bankrupt, your cryptocurrency isn't sitting on their exchange. The second part of the question really is about the price of these crypto assets, and they're up overnight, but they've been falling all week. FTT is down 95%. You just have to be very aware when you're investing in the world of crypto that it's very high risk and it's very volatile from a price perspective. And then I guess also what this story has shown us from a security perspective as well. 

Sascha: [00:15:40] All right. So final question. What does this collapse mean for the future of crypto?

Alec: [00:15:47] Well, Sascha, if there's one thing I can guarantee you right now, there is more regulation coming for the world of crypto. We can't see the collapses we've seen this year without the government's feeling the need to step in. We saw lunar collapse, Terra USD collapse, three arrows, capital Celsius. And now after an element of research and unfortunately billions of dollars of wealth of everyday people has been erased. 

Sascha: [00:16:10] Just open up your Twitter and see the crypto conversations going on. And it's pretty real. 

Alec: [00:16:15] Yes. So regulation, it's going to come what form it takes. I guess it remains to be seen. But I want to leave you with this sentence from a news report. I feel like it really sums up where we are in 2020. To quote the CEOs of Coinbase, Ripple and Circle called for a clearer policy framework in a tweet thread started by Senator Elizabeth Warren. I want to say senators and say who's lobbying is now out in the open on Twitter. 

Sascha: [00:16:44] Yeah, look, I wouldn't have had that on my bingo card for 2022, but here we go. If you've enjoyed this episode, please tell a friend about it. It really is the best way for our podcast to grow. If you're interested in cryptocurrency, then go check out our sister podcast. Crypto Curious. They are also unpacking this story this week, so make sure you go and subscribe to them. If you've just joined us for the first time. Welcome. Go check out our back catalogue. We talk about everything, not just cryptocurrency. And remember, you can follow us on Instagram. We've got a new handle at the dive business news. No Dot. You can contact us by email thedive@equitymates.com and you can subscribe wherever you're listening right now so you never miss an episode. Alec, thank you so much for joining me today and helping me unpack what's going on in this wild world of crypto. 

Alec: [00:17:32] Thanks, Sascha. Good to be back. Yeah. 

Sascha: [00:17:34] Until next time.