The fall of FTX

The latest drama over in Crypto is the collapse of the FTX exchange. This is an extremely large collapse and is a perfect example of a number of different topics.

The strategy adopted by many crypto ponzi schemes in 2021 "influencers" to promote the platform has been seen again with the promotions of FTX. There's a number of popular YouTube finance content creators who were on the payroll of FTX without stating that they were. These people were giving bad financial advice to their users because of these payments from FTX, always of course under the disclaimer that "this is not financial advice" after clearly telling their viewers to do certain financial things. Now that there's the potential of legal action due to these undisclosed dealings we are seeing some of these finance Youtube channels being deleted and other content hastily being removed. If this does turn into criminal proceedings in the future the hasty destruction of evidence will be an interest matter for discussion in the proceedings.

This practice highlights two themes I have mentioned in previous blog posts. Firstly this is a classic case of people giving bullshit financial advice due to a conflict of interest. Unfortunately such misaligned incentive structures are extremely common whenever there's enough money at stake.

The other is that its a good example of lies being spread via social media influencers, with explicit budgets for "influencers" being included in the budgets for finance companies. We saw this with the Shib coin where paying kickbacks to social media influencers to pump up that specific coin was part of the overall structure of the coin. In almost all of these cases the financial arrangements were not disclosed. This is the sort of thing you'd think would be illegal, but the regulators appear to be nowhere to be found on these things lately, more about that later.

Social media influencers

The amount of backtracking and deletion of posts since the collapse of FTX is an amazing sight to see. A lot of people were getting paid to promote FTX without disclosing their financial incentives and they are now in full panic mode since at the very least this is a massive hit to their reputations and at worst might be part of criminal investigations. In a world where accusations of shilling are somewhat common it's nice to see such a clear cut example of it backed by rock solid evidence. Some of these people might be liable for criminal charges, time will tell. In any case it's very clear that panic has well and truly set in with many of these influencers backpedaling in a hurry and/or deleting content where they were promoting FTX. Ironically for a financial influencer to be able to sell themselves out they benefit greatly by having a reputation of not selling out.

Unfortunately selling out ones subscriber base can be incredibly profitable and hence the temptation to do so continues to this day. I am surprised by some of the influencers who did this, Tom Nash selling out being a good example of someone who I wouldn't have expected to be involved in the FTX promotions.

There's many poor quality coins and tokens in crypto that have far more in common with ponzi schemes and scams than anything that is investable. Given the current hype it has become incredibly profitable for certain groups to employ shills in these schemes to generate initial interest to get money flowing in. This isn't a new strategy by any means, but what is new are the dynamics that social media introduce into this practice. Many of the influencers have been exposed via the same social media that they were using to get paid to influence. Given that there's no fundamental value backing a large number of these schemes it's imperative that money enters initially to make it look like there's investment interest and to do this there needs to be some catalyst. Getting people to vouch for these projects using their reputations is a good way to astroturf support for these sorts of scams. Even though greed rules the day in much of the crypto industry there's a level of natural skepticism that people have towards these products. Given the natural skepticism the value of having trusted people shill is much higher that it might be when compared to promoting other products.

Where this is a bit less common is to see a large crypto exchange engaging in so brazenly in this sort of behavior. Put simply the exchange has a lot to lose from doing this and creating their own token would appear to be a risky proposition that has more potential downside than upside. That is of course if you assume that the goal of the exchange is to actually be profitable, with FTX I'm now not convinced that this was the overall goal. After all the practice of rug-pulling is something that's fairly widespread in crypto these days.

FTX company structure

The operations of the FTX company are incredibly complicated with a vast web of shell companies in operation that are obscuring who owns what. This perhaps comes as no surprise since some highly shady things were happening behind the scenes are now surfacing. Also SBFs father Joseph Bankman is an expert in tax shelters. Interesting skills in the family for sure.

You'd think that this sort of company structure would be called into question for an exchange. But money from institutional investors flowed in anyway (if those investments immediately flowed out again in some form the whole thing would make a lot more sense).

The story of FTX can't really be told without also looking at Almeda. FTX sends Almeda money to buy FTT tokens, FTX does buybacks on those same tokens. This sort of circular dealing is the sort of thing that you'd imagine the SEC would step in and stamp out. But the SEC has been spectacularly impotent in this space.

None of this looks like it is above board and basically the drop in crypto prices has really exposed a lot of the bad operators. First we saw Luna/Terra implode and now this. When these ponzi tokens go bad they go really bad and fast. Exchanges offering tokens to raise money is one of those things that seems to introduce significant risks.

Given all this I'm sure there's people who'll call for regulations of crypto but really the bulk of the problems here aren't actually problems with crypto but are governance problems. Essentially the company took the funds of depositors and spent them on various things. Any corporation, including banks, could in practice do something illegal like this. Banks however could be bailed out more easily via various money printing means and depositors might be covered by some sort of deposit insurance so if it were to happen in that sector the impacts would likely be different.

For the longest time people have said if you don't hold the keys you don't own the coins and that remains just as true as ever. Much like the MtGox collapse in 2014 we see another stark reminder of the risks of storing crypto on exchanges.

Meme investment rounds

Another part of the FTX story that I find fascinating is just how many institutional investors put money into the company and who invested and the circumstances under which it all happened.

Apparently during zoom calls to raise money SBF was busy playing League of Legends. This is so absurd that my imagination is just not anywhere near good enough to come up with something like that.

The $420m round split between 69 investors (no joke) might have seemed funny at the time but I'm sure the people at those investment firms who are answering calls from angry clients have long since stopped laughing.

Sequoia capital for example has now marked its 210 million investment in that round down to zero.

I'd hate to be the unlucky person at the Ontario Teachers Pension fund answering calls about why they invested in this, the loss would be one thing but the nature of the round just makes it that much more embarrassing.

Contagion

The part I'll be keeping a close eye on is how the collapse of FTX will impact the broader markets.

An important aspect of the FTX collapse is just how many creditors there are and just how large the losses will be. This will no doubt have a huge impact on the entire crypto space. I'd expect this to put downwards pressure on things like the price of Bitcoin. I'd also expect that downward pressure on the crypto sector will expose other companies that have been very loose with their management of customer funds. There's also the question of collateral backing these companies, when times are good nobody asks questions even though they really should. When times are bad collateral issues can turn into liquidity or solvency issues.

The question many people will be asking is how much this impacts finance outside of crypto. For starters a lot of people have lost a lot of money, but what happens next remains to be seen...