Headline: What is going on with FTX?

Date: 11/13/2022

Body:  Wow!!  It seems only yesterday I was watching the World Series!  Each official was in uniform, and prominent on each was a patch that read, “FTX.”   I don’t know what it cost the exchange, but it couldn’t have been cheap!  Now, days later, I read that they are in some serious danger of not being a going concern?   How does this compute?

In a nutshell…

FTX, an exchange owned by billionaire Sam Bankman-Fried was hemorrhaging money and oozing red ink.  Just one day after Binance announced that there was a deal to buy FTX (details not available) the CEO of Binance announced that they would not be following through with the non-binding deal for the $32 Billion company.  The reversal is apparently due to reports of mishandled customer funds and U.S. government investigations.  They are facing an $8 Billion shortfall.  Bankruptcy is not out of the question.  (Mind you, this is a very fluid situation and by the time you read this, things might have changed.)  One particularly bad sign was that the exchange began to sell off its own holdings in FTT, the currency native to FTX.  Also bad is that the CEO warned people of earnings that could drop nearly 60% from the year before.  Sequoia Capital, a major backer suggested publicly that their $213 million investment was considered to be worthless.   Add all of this to $6 Billion of customers demanding withdrawals, and things look quite bleak indeed.  They are not the only ones, as both Bitcoin and Ethereum have declined significantly in concert with FTT.

So, what did Binance say, in particular?

This is unusual, but I will append the entire published announcement, as it is pretty interesting.

“As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged US agency investigations, we have decided that we will not pursue the potential acquisition of FTX.com.

In the beginning, our hope was to be able to support FTX’s customers to provide liquidity, but the issues are beyond our control or ability to help.

Every time a major player in an industry fails, retail consumers will suffer. We have seen over the last several years that the crypto ecosystem is becoming more resilient and we believe in time that outliers that misuse user funds will be weeded out by the free market.

As regulatory frameworks are developed and as the industry continues to evolve toward greater decentralization, the ecosystem will grow stronger.”

This sounds to me like Binance is suggesting that in the future, the information they have to deal with will allow them the ability to not be fooled in the first place.

What is the history of FTX?

Mr. Bankman-Fried’s rise began in 2017 when he founded Alameda Research, a crypto trading firm that made a fortune exploiting arbitrage opportunities in the Bitcoin market. He parlayed that success into the creation of FTX, which was based in Hong Kong before relocating to the Bahamas last year.  Until quite recently, Mr. Bankman-Fried could be seen striding around the Capitol building, creating friends among the leadership, and he personally made a $5 Million contribution to the Biden election campaign.  CZ, for his part, used to be an investor himself, but was effectively bought out by Mr. Bankman-Fried.   Along the way, the CEO of FTX made a very public joke, and CZ was the subject of it.  Though no official reaction was noted, there was certainly some bad blood engendered. Not long ago, CZ announced on Twitter that Binance would sell its holdings of FTT. He insisted that he was not engaging in a “move against a competitor.” But he later compared the FTT token to Luna, a cryptocurrency that crashed in May, setting off a broader crisis.“We won’t support people who lobby against other industry players behind their backs,” he added on Twitter.  Given this history, it would seem that these 2 billionaires were some type of frenemies. 

What are the Pros v. Cons of FTX?

Margin and futures trading is supported.  Some sophisticated investors would like to place bets on the future markets for cryptocurrency, and FTX allowed them to make these bets.U.S. residents are excluded from this exchange.  Residents in the US can use a subsidiary, but the offerings are limited compared to FTX based in Hong Kong.
Access  to even more exotic bets on cryptocurrency.   Some of these  investors might wish to place a bet on volatility or other attribute, and FTX allows them to place these bets too.There is no live chat support for the exchange.  This is standard on most exchanges, but on this one, finding information in the resources that are available can be very time-consuming.

FTX was pretty clear on what could prompt margin calls, but this policy appears to be important to the pros and cons.  A margin call requires the investor to provide enough capital to substantiate a portion of their entire bet in cryptocurrency.  Let’s assume that the “maintenance margin factor” is 5%,  When the leverage nears 20, the peoson could be challenged to offer collateral.

FTX and Binance appear to be puppies from the same kennel?

Yes, they are very similar, but there are a few key differences in how they function.   Chiefly, Binance has begun to offer an online chat feature, and Binance has slightly higher fees than FTX.

Could this”conflict” all be part of a strategic hit by competitors?

This may be true, but it seems unlikely. 

However, there are some experts who do give us a bit of context, which might be helpful.   The CEO of Binance is often referred to as “CZ.”   There is a cryptocurrency expert who works at Duke University at their Law School, Lee Reiners.   Per Professor Reiners, “CZ executed a pincer movement.  He surprised all of us.”  The CEO of FTX suggested that the concerns FTX floated publicly were never expressed to him before.

So, how does FTX compare to Coinbase?

 Ok, first thing to understand is that Coinbase is a centralized exchange, and FTX is organized as a decentralized exchange.  So, by their very organization, they are different.  Both offer custodial and non-custodial wallets for your cryptocurrency  and NFTs.  But, Coinbase makes the custody feature, a feature, as your cryptocurrency becomes a lot more useful since you can negotiate it  at will.  The downside of this custodial  approach is that Coinbase will also have to have your private key.   This always makes for a risk, when you give anybody your private key.  That said, Coinbase does have some excellent security (98% of cryptocurrency stored with them is in cold storage) and they do not believe in using leverage.

The Verdict

“This episode highlights the vulnerability of the entire crypto edifice,” said Eswar Prasad, a Cornell University economics professor. “Even large and apparently financially solid institutions turn out to have fragile and shaky foundations that crumble at the least hint of trouble.”  While Economics is widely known as the dismal science, perhaps we should take a look at what’s happening here.  Remember Prodigy Internet?  They also tried to offer a service that was notable because of its refusal to edit the comments its users made.  Perhaps that is akin to what is happening to FTX.    They are doing something new, and getting financially punished for it, but soon, there will likely be hundreds doing the same thing.   Then, it will be heralded as a model for decentralized exchanges.   Only time will tell.






Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.


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