After Sam Bankman-Fried’s Downfall, the Entire Crypto Fantasy Is Rapidly Unraveling
The next time a speculative bubble is massively inflating around a fancy new asset like cryptocurrency and financial carnival barkers are screaming it will change everything, remember Sam Bankman-Fried and how quickly all of his promises proved to be bullshit.
What a difference a year makes. This time last year, cryptocurrencies were all the rage. Everywhere you turned, celebrities were hawking them — from Kim Kardashian to Spike Lee to Matt Damon. NFTs, a crypto offshoot that assigns blockchain ownership certificates to digital assets, boomed to bizarre heights when cartoon apes sold for millions. And being a real estate agent for virtual land became an actual career. Meanwhile the oldest and most popular cryptocurrency, Bitcoin, crested on its ever-wild ride of price valuation, peaking at $64,000 last November.
Today, Bitcoin’s value is plummeting back to earth, currently at about $16,000, depending on the day (or hour). NFT trading has all but collapsed. And various celebrities are under investigation for promoting the now bankrupt FTX crypto exchange in a class action lawsuit. The last few months have witnessed a series of dramas in the crypto universe, bringing down major players — including Terra, a “stable coin”; Celsius, a crypto-lending firm; and Three Arrows Capital, a crypto hedge fund. Now FTX, previously the third-largest cryptocurrency exchange, has collapsed at a dizzying speed — and along with it the finances and reputation of crypto’s golden boy, Sam Bankman-Fried, aka SBF.
In a few short days in early November, FTX went from a $32 billion–valued company with investments from the likes of BlackRock and Sequoia to bankruptcy. And SBF has gone from hobnobbing with Bill Clinton and Gisele Bündchen to “a fallen wreckage,” in his own words.
On November 2, a report from CoinDesk found that FTX had used its own exchange-generated tokens (FTTs), a kind of internal currency printed by FTX itself to be used on its market, to inflate its balance sheet and that of its affiliated trading firm, Alameda Research. The revelations also pointed to the likely scenario that Bankman-Fried had used billions of dollars’ worth of FTX customer assets to fund Alameda’s financial bets through a “backdoor” accounting mechanism that funneled billions in FTX funds to Alameda without alerting auditors or triggering accounting red flags.
Four days after CoinDesk’s report, Changpeng Zhao, the CEO of Binance, the biggest crypto exchange (and itself under investigation by the US Justice Department for money laundering and sanctions violations) announced that he would sell his stock of FTT tokens. The crypto equivalent of a bank run ensued, with over $6 billion worth of funds withdrawn in seventy-two hours. Zhao then offered to buy FTX on November 8, but by the next day pulled out of the deal, tweeting: “Sad day. Tried, but” with a crying face emoji.
Sad day. Tried, but 😭
— CZ 🔶 Binance (@cz_binance) November 9, 2022
By November 11, FTX filed for bankruptcy, leaving behind an $8 billion hole in its customers’ accounts. To add to the drama, soon after bankruptcy, a hacker transferred hundreds of millions of dollars out of the company.
As part of bankruptcy proceedings, John Ray III was brought in as FTX’s new CEO. Ray is an insolvency lawyer whose claim to fame includes winding down Enron in 2001. He said in the bankruptcy filing: “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” Ray’s experience is certainly relevant, as FTX’s operations — fictional valuations and accounting manipulations were used to artificially pump up balance sheets — have clear parallels to Enron’s. By now the chaotic details of FTX’s “balance sheets” and its toxic corporate culture are on full display — described by media outlets as one part feudal court, one part gang of kids running wild in the Bahamas.
But you don’t have to have a long memory to remember the press, politicians, and celebrities fawning over SBF. Way back in… July, for instance, the Economist ran an article called, “Crypto’s last man standing,” and pondered, “Is Sam Bankman-Fried the John Pierpont Morgan of crypto?” The comparison to JP Morgan, they concluded, “is surprisingly instructive.” Others compared SBF to billionaire investor Warren Buffett, and as far back as two months ago praised FTX for emerging as an industry backstop during widespread fallout in the industry. SBF’s crypto empire was widely considered to be the most legit corner of crypto finance.
Thirty years old and charmingly or annoyingly disheveled, depending on your perspective, Sam Bankman-Fried was crypto’s wonder boy, a liberal darling, and incidentally the second-largest donor to the Democratic Party on top of being a major funder of the trendy philosophical fad “effective altruism.” This summer he was to be found at FTX’s conference in the Bahamas, sitting on a panel in his shorts and a T-shirt alongside Bill Clinton and Tony Blair. The impact of SBF’s cosmic failure goes beyond the shock it delivers to his erstwhile liberal fans and beyond the financial fallout it forces onto the broader crypto landscape. It gets to the credibility of the blockchain project itself.
Is crypto on its way out? It’s too soon to tell. But whether the industry manages to limp along until the next speculative bubble reinjects life into it, or whether it crawls back into the fringes of finance, remember this moment when crypto’s absurd claims about revolutionizing finance and the world were exposed as little more than a scam.
The Day the Crypto Music Died
Cryptocurrencies have rightly earned a reputation as tools for criminal activity, scams, and hacks. The earliest days of Bitcoin were defined by ventures such as the Silk Road, a market for illicit goods using bitcoins. Silk Road was shut down by the FBI, and over a billion dollars’ worth of bitcoin was eventually seized. Its founder, Ross Ulbricht, using the pseudonym “Dread Pirate Roberts,” was arrested for, among other things, contracting the murders of six people he believed stole his bitcoins or had otherwise crossed him.
But for over a decade since, the history of Bitcoin and other cryptocurrencies has been littered with other such schemes large and small. The rise and fall of SBF and his crypto empire are so consequential because he was widely perceived to be the guy who would help crypto go mainstream. This is not only because of his liberal, “effective altruism” credentials, but because he was a proponent of some regulation of the industry. Bankman-Fried’s argument for a “light touch” regulatory framework made him unpopular among crypto’s more hardcore libertarians. But for mainstream investors to go all in on crypto, the Wild West on the blockchain would have to be at least somewhat tamed and safeguarded.
Whatever the antiestablishment pretenses of many of crypto’s proponents, at the end of the day, the viability of cryptocurrencies depends on large-scale investment and mainstream adoption. For Bitcoin and other digital coins to rise in value — let alone for them to ever be used as actual currency — the states and the financial institutions so derided by crypto’s hardcore proponents have to get in on the action. It’s why crypto enthusiasts enthusiastically celebrated El Salvador’s adoption of cryptocurrency. It’s why bitcoin “whales,” the largest investors in the currency, are treated with such reverence.
What did SBF have in mind by a “light touch”? As others have pointed out, he wanted to get ahead of more aggressive regulatory measures from the Securities and Exchange Commission by positioning the smaller Commodities Futures Trading Commission (CFTC) as crypto’s regulator. FTX was itself registered and licensed by the CFTC and had hired many former CFTC officials, according to Better Markets’ president Dennis Kelleher. The cozy relationship between FTX and the commission helped FTX use former CFTC officials’ “knowledge, influence, and access at the agency and in Washington to move FTX’s agenda.” It also led the commission to act, in Kelleher’s words, as “a cheerleader for crypto.”
In his more honest (or desperate) moments, SBF admitted that calling for more regulation was little more than a PR stunt. More stunningly, he all but admitted that crypto was largely a Ponzi. On Bloomberg’s Odd Lots podcast in April, he explained how crypto yield farming works, in a “toy model” version:
You start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that’s gonna replace all the big banks in thirty-eight days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It’s just a box.
From there, the people that put money into the box are promised an X token. And “in the world that we’re in,” he continued, “if you do this, everyone’s gonna be like, ‘Ooh, box token.’ Maybe it’s cool. If you buy in… that’s gonna appear on Twitter and it’ll have a $20 million market cap.” People start making money off of their X tokens’ rising value, and eventually sophisticated firms tune in, adding more money into the box.
So you’ve got this box and it’s kind of dumb, but like, what’s the end game, right? This box is worth zero, obviously. And like that, you know, you can’t like keep this smart cap or something. But on the other hand, if everyone kind of now thinks that this box token is worth about a billion-dollar market cap, that’s what people are pricing it at. […] Everyone’s gonna mark to market.
During the podcast, Bloomberg columnist Matt Levine was taken aback by the cynicism of SBF’s description. Yet the conversation went along with everyone agreeing that this kind of scenario does indeed play out in practice. Throughout the podcast, and for months following, Bloomberg and other media outlets continued to defer to SBF as some kind of nerdy genius. Meanwhile he and FTX staff saw themselves, in the words of one longtime employee, as “the good guys.”
Now the tone of the conversation has shifted, hard. SBF is getting a drubbing from all quarters. And mainstream financial commentators are referring to crypto as just “funny money in the ether with speculation.” And it’s unlikely that FTX’s rival exchanges are in much better or more legitimate financial standing.
FTX’s meltdown has sent shockwaves through the crypto industry, with the price of Bitcoin and other coins falling fast. But more than that, it has delivered the final nail in the coffin of an idea: that crypto is the money of the future. If the most “legit” corner of crypto is also a Ponzi, what’s left to fall back on?