Good explainer on the FTX collapse

[Brendan Burgess]

Why Did FTX Collapse? Here’s What to Know. (Published 2022)

Things went downhill for FTX after Binance, the world’s largest cryptocurrency exchange, reversed on a deal to save the company.

www.nytimes.com

But it gives rise to a few questions.

So FTX was an exchange.
Does that mean that they were an agent.
So if I buy a Bitcoin and give them US$ someone else sells a Bitcoin and gets real US$.
Presumably FTX doesn't buy and sell Bitcoin on its own account?

FTX issued its own token FTT. But isn't that like printing money. They sell FTTs to buyers who give them real US$.

Or was that how it was supposed to work, but in reality, FTX was doing its own risky trading and put all their clients' funds at risk.

If I have BTC in my own wallet, then I still have them even if all the exchanges in the world collapse.
But if I kept them in an account at FTX, then I have probably lost all my money because I can't withdraw them.

Brendan

 

[Brendan Burgess]

What are the main exchanges?

The article said that Binance and FTX processed the majority of transactions. But what about Coinbase. I had assumed it was the biggest.

The 10 Top Cryptocurrency Exchanges, Ranked by Volume​

Top Centralized Exchanges​

The following are the top centralized cryptocurrency exchanges, according to traffic, liquidity, and trading volumes.

Cryptocurrency Exchanges

Cryptocurrency exchanges are platforms that facilitate the trading of cryptocurrencies for other assets, including digital and fiat

corporatefinanceinstitute.com

1. Binance
2. Coinbase Exchange
3. FTX
4. OKX
5. KuCoin
6. Gate.io
7. Huobi Global
8. Kraken
9. Binance US
10. Bitfinex
11. Crypto.com Exchange

 

[Brendan Burgess]

Which exchanges have collapsed?

Mt. Gox
FTX

 

[tecate]

Which exchanges have collapsed?

Mt. Gox
FTX

Mt.Gox collapsed in 2014 when the crypto ecosystem was incredibly small and it was one of the few venues where someone could trade.

FTX is done.

Crypto.com isn't looking too good - but I reckon we'll know the outcome within a matter of days.
Houbi and gate.io are also on the suspect list - but in saying that, it's opaque - and so, the advice is to self custody and not leave funds on any exchange.

FTX and SBF played an absolute blinder in presenting the exchange as being the most compliant in the business while for the duration, he was doing the opposite. He had most people fooled unfortunately, including the few institutions that were active in crypto as many of them used FTX.

Within the industry, the pressure is coming on for exchanges to provide proof of their reserves. That helps - although it's still only half of the picture. A couple of exchanges have had very big asset movements either side of the proof of reserves they've provided - so that's putting them in the spotlight (as it likely points to a contrived proof of reserve).

How to self-custody your bitcoin.

 

[tecate]

Why Did FTX Collapse? Here’s What to Know. (Published 2022)

Things went downhill for FTX after Binance, the world’s largest cryptocurrency exchange, reversed on a deal to save the company.

www.nytimes.com

But it gives rise to a few questions.

So FTX was an exchange.
Does that mean that they were an agent.
So if I buy a Bitcoin and give them US$ someone else sells a Bitcoin and gets real US$.
Presumably FTX doesn't buy and sell Bitcoin on its own account?

It's an exchange with a matching engine. They matched maker and taker trades.

Entangled alongside them was Alameda Research - a quant trading outfit. They shouldn't have anything to do with them - but the way SBF ran things, they very much did. It's widely suspected that they were trading against their own customers.

FTX issued its own token FTT. But isn't that like printing money. They sell FTTs to buyers who give them real US$.

Yes, they issued their own token. A dyed in the wool bitcoiner would in no way be onboard with that. I don't think that it's so bad if the token serves some form of utility. However, what it should never do is be issued by an entity and then used as collateral by that entity. That's what FTX/Alameda did.
Binance called them on it - and said that they would be selling off the token gradually. That was the spark that lit up the run.

Or was that how it was supposed to work, but in reality, FTX was doing its own risky trading and put all their clients' funds at risk.

Alameda got into trouble. SBF took billions of dollars of customer's deposits in FTX and lent them out to Alameda. They then tried to trade their way out and just made the whole thing 1000x worse. If he had accepted the loss re. Alameda, FTX would have stood as a perfectly fine and profitable business.

If I have BTC in my own wallet, then I still have them even if all the exchanges in the world collapse.
But if I kept them in an account at FTX, then I have probably lost all my money because I can't withdraw them.

If you self custody your bitcoin, nobody has access to your coins except for you. Bitcoin purists feel vindicated by what's happened. They've been pointing to the other side of crypto as being a crapcoin casino for a number of years.

 

[Brendan Burgess]

tecate

Thanks for all that.

Binance called them on it - and said that they would be selling off the token gradually. That was the spark that lit up the run.

I didn't get that bit. Why did they not just sell the token and announce it afterwards?

Brendan

 

[tecate]

I didn't get that bit. Why did they not just sell the token and announce it afterwards?

While SBF/FTX managed to blindside people (SBF put out a tweet a few months back saying that people might be seeing a few wallet movements but that it was regular house keeping - we know now that it wasn't), onchain analytics is getting better and better. These are still public blockchains - and there are a number of professional analytics firms that concern themselves with blockchain analytics exclusively, being able to label particular wallets as belonging to various exchanges, etc. Binance is the worlds biggest exchange - and so they would have had quite a lump of FTT. Questions would have been incoming immediately I would imagine if they pulled the trigger and started to sell it. So I'd imagine Binance would want to get out ahead of that.

There's another aspect to this story. SBF/FTX was the second biggest contributor to the DEMs over the past 12-24 months. Alameda's CEO's Dad was Gary Gensler's (SEC chair) boss in his last gig at MIT. SBFs mother is best buddies with leading DEM Elizabeth Warren (who ironically is dead set against crypto). His dad (a law professor) endorsed a tax filing bill for Warren.

Both FTX and Binance had submitted proposals to take over Voyager (a publicly listed crypto lender that had gone to the wall earlier in the year). It's believed that SBF was bad mouthing Binance as being a non-compliant exchange under the control of the Chinese. SBF put out a tweet poking fun at the Binance founder suggesting he wouldn't be welcome in Washington DC. In tandem with all of that, SBF had basically written his own regulation - and on the basis of that pay for play - it was about to be put forward. It would have screwed purely decentralized exchanges and competitors and given him a monopoly.

That's the background. It's still unclear if this was just a pragmatic move by the Binance founder, a mixture of pragmatism with a touch of vendetta to it, or that he really knew that there was a major hole in their balance sheet. It's probably unlikely to be the latter. Although a competitor has been erased, none of this is useful for anyone in crypto (at least in the short term).

 

[Zenith63]

Which exchanges have collapsed?

Mt. Gox
FTX

I recently looked back through the exchanges I used. Mt. Gox disappeared in 2014, looks like people might get ~20% of their funds back next year. MintPal went in 2014 as well, funds stolen. Cryptsy went in 2016, funds gone. Coins-E also cut and ran in 2016.

Coinbase, Bittrex, Kraken and HitBTC were others I used who were kind enough not to steal or lose funds.

Leaving coins in an exchange for any period of time is crazy stuff, but the average person often doesn’t know better or their malware ridden PC may be little safer.

 

[jim]

If you self custody your bitcoin, nobody has access to your coins except for you

Why doesnt eveyone self custody? Why is non self custody even a thing?

SBF took billions of dollars of customer's deposits

Did customers really dwposit money with ftx? I thought it was an exchange where customers would have bought or sold crypto?

quant trading outfit

What does this mean?

They matched maker and taker trades

What does this mean?

 

[jim]

While SBF/FTX managed to blindside people (SBF put out a tweet a few months back saying that people might be seeing a few wallet movements but that it was regular house keeping - we know now that it wasn't), onchain analytics is getting better and better. These are still public blockchains - and there are a number of professional analytics firms that concern themselves with blockchain analytics exclusively, being able to label particular wallets as belonging to various exchanges, etc. Binance is the worlds biggest exchange - and so they would have had quite a lump of FTT. Questions would have been incoming immediately I would imagine if they pulled the trigger and started to sell it. So I'd imagine Binance would want to get out ahead of that.

There's another aspect to this story. SBF/FTX was the second biggest contributor to the DEMs over the past 12-24 months. Alameda's CEO's Dad was Gary Gensler's (SEC chair) boss in his last gig at MIT. SBFs mother is best buddies with leading DEM Elizabeth Warren (who ironically is dead set against crypto).

Both FTX and Binance had submitted proposals to take over Voyager (a publicly listed crypto lender that had gone to the wall earlier in the year). It's believed that SBF was bad mouthing Binance as being a non-compliant exchange under the control of the Chinese. SBF put out a tweet poking fun at the Binance founder suggesting he wouldn't be welcome in Washington DC. In tandem with all of that, SBF had basically written his own regulation - and on the basis of that pay for play - it was about to be put forward. It would have screwed purely decentralized exchanges and competitors and given him a monopoly.

That's the background. It's still unclear if this was just a pragmatic move by the Binance founder, a mixture of pragmatism with a touch of vendetta to it, or that he really knew that there was a major hole in their balance sheet. It's probably unlikely to be the latter. Although a competitor has been erased, none of this is useful for anyone in crypto (at least in the short term).

It just all reads to me like a bunch of US rich kids acting the ejit, playing monopoly, tweeting and fooling and defrauding the masses.

 

[NoRegretsCoyote]

If he had accepted the loss re. Alameda, FTX would have stood as a perfectly fine and profitable business.

If my mother had wheels she'd be a bicycle, etc.

If you self custody your bitcoin, nobody has access to your coins except for you.

I'm pretty security conscious but down the years I've forgotten passwords and had many devices fail on me. For all sorts of things I rely on providers (bank, Google, even AAM) to be able to verify my identity via other methods. It's utterly unrealistic to imagine that any system can be sustained on the basis of no one ever forgetting a password.

 

[Brendan Burgess]

Alameda got into trouble. SBF took billions of dollars of customer's deposits in FTX and lent them out to Alameda. They then tried to trade their way out and just made the whole thing 1000x worse. If he had accepted the loss re. Alameda, FTX would have stood as a perfectly fine and profitable business.

If my mother had wheels she'd be a bicycle, etc.

Hi Coyote

Not sure the comparison is fair.

If I were trading or holding crypto I would assume that an exchange was doing what it is supposed to do. I would not expect them to be trading on their own account.

But I think that this all comes from the "decentralisation" and "anti-regulation" culture. A bank would never get away with that type of misbehaviour... oh, on second thoughts...

Brendan

 

[NoRegretsCoyote]

If I were trading or holding crypto I would assume that an exchange was doing what it is supposed to do. I would not expect them to be trading on their own account.

Absolutely!

@tecate has implied that self custody is the only solution to this which I think is absurd. Consumers will always need protection. I wouldn't hold crypto for many reasons but even if I wanted to I wouldn't as the exchanges and custodians can't be trusted.

 

[tecate]

Why doesnt eveyone self custody? Why is non self custody even a thing?

Coyote has covered this in his post. Self custody has its own difficulties. It's not intuitive because we've become used to centralised systems where its always possible to reset passwords, etc. There are people that are comfortable with self custody and those that aren't. It's something that I think will be made easier as this progresses through the use of multi-sig (where you could use a centralised entity to store your crypto and have the ability to reset access if you lost it - but at the same time they wouldn't be able to move or take ownership of those funds.

Did customers really dwposit money with ftx? I thought it was an exchange where customers would have bought or sold crypto?

There were various products offered beyond trading. Tokenised stocks is one example. And if you're wondering why anyone would bother, bear in mind that all this while the conventional banking system isn't necessarily playing nice with funds that originate in crypto. Accounts are closed down all the time simply because a customer has transferred funds from a crypto exchange into their bank account. That's very much part of the problem here.

What does this mean?

What does this mean?

A matching engine pairs up bids and offers. Quantitative trading I know little about but you can find an explanation of it here.

If my mother had wheels she'd be a bicycle, etc.

What Brendan said. That's the Madoff component you're misunderstanding. Someone could operate an exchange and be incompetent - that's one thing. In this case, he took customer funds and used them to patch up what should be a completely unrelated business.

I'm pretty security conscious but down the years I've forgotten passwords and had many devices fail on me. For all sorts of things I rely on providers (bank, Google, even AAM) to be able to verify my identity via other methods. It's utterly unrealistic to imagine that any system can be sustained on the basis of no one ever forgetting a password.

I agree that it presents its own difficulties. I know because I've had to think long and hard about what you've set out there. It will have to be improved upon for ordinary people for sure.

If I were trading or holding crypto I would assume that an exchange was doing what it is supposed to do. I would not expect them to be trading on their own account.

And that's trading on the account of a completely separate business - having illegally taken customer funds from business A (FTX) and bunged them into business B (Alameda) ....and other movements to other entities.

But I think that this all comes from the "decentralisation" and "anti-regulation" culture. A bank would never get away with that type of misbehaviour... oh, on second thoughts...

This is being misunderstood. When it comes to centralised entities like exchanges, everyone involved has been trying to get regulation in place. There's any amount of evidence to prove that. The very same with a Bitcoin ETF. The distinction here is that nobody wanted heavy handed regulation that would suppress digital assets.

 

[Brendan Burgess]

Your overall point that there is no way to safely hold crypto is valid.

There have been many cases of people who self-custodied and lost.
There have been many cases of people who lost through exchanges.

But is it a bit like cash?
I can keep it under the bed if I don't trust the banks, but I could lose it.
Or, I can leave it in a bank and the bank can go bust.

But the banks are regulated so are less likely to go bust. Or if they do, they are more likely to be bailed out.

Brendan

 

[tecate]

@tecate has implied that self custody is the only solution to this which I think is absurd. Consumers will always need protection. I wouldn't hold crypto for many reasons but even if I wanted to I wouldn't as the exchanges and custodians can't be trusted.

I'm not sure how I've implied that - because that is not my belief at all. It's widely understood that not everyone is going to be comfortable with self custody. Those that can should and there should be more movement towards decentralized exchanges and moves to make such systems intuitive. The same with early internet systems, developers don't make stuff that's intuitive to ordinary people - at least in the first iteration.

Maybe the misunderstanding is that I've suggested anyone holding funds on an exchange today should self custody. That's the best option right now in the absence of FDIC insurance and proper control of centralised exchanges - regardless of whether people are comfortable with self custody or not.

 

[tecate]

But is it a bit like cash?
I can keep it under the bed if I don't trust the banks, but I could lose it.

Yes, it's very much like cash. You could keep cash under the bed, house goes on fire - no more cash. Someone breaks into the house and steals cash. Flipping to digital asset self custody, if you either lose your private key or its compromised by someone - that's it - your funds are gone.

I referred to multi-sig products. These guys are taking that approach. This is what will happen in the future and this is the way I believe that TradFi banks will end up offering crypto in the future. With this approach, if you lose your key or your key gets compromised, then you can still recover through the service provider. The service provider has a key - but that's not enough for them to run off with the funds either.

 

[Horatio]

Leaving coins in an exchange for any period of time is crazy stuff, but the average person often doesn’t know better or their malware ridden PC may be little safer.

Yes absoutely, same goes for leaving cash on an exchange. Any person that is even somewhat savvy know & observes this golden rule.
Make your trades & take your assets off line immediately.

Kraken does seem to have very good security protocols & store the on exchange assets offline in cold wallets such that if they are attacked or somehow compromised there is only a fraction of assets that can be taken - think Bank teller & remote Bank vault model. Of course anyone could reasonably counter that paper never refused ink or that such protocols don't necessarily protect against bad actors from within.

 

[Horatio]

It just all reads to me like a bunch of US rich kids acting the ejit, playing monopoly, tweeting and fooling and defrauding the masses.

There is certainly an element of that particularly with the FTX case - he is well connected politically & only a Gasson to be fair.

There is an element of pretenders & fraudsters being washed out at the expense of their clients. I predict this will normalise over the coming years & the steady state protocols with good governance & best models will prevail to become mainstream - it is literally like the wild west right now with everyone throwing their hat into the ring to get while the getting is good.

 

[Horatio]

But I think that this all comes from the "decentralisation" and "anti-regulation" culture. A bank would never get away with that type of misbehaviour... oh, on second thoughts...

There is a cohort within the Crypto space that are lobbying / advocating for regulation because they recognize the damage that the wild west completely free market approach is having on the legitimate crypto actors.
Charles Hoskinson (Cardano - ADA) is one such advocate & he regularly speaks on the need for thoughtful proactive regulation.