FTX – The Post Mortem – Part 2: The “Liquidity Crisis”

In my previous article, I shared my thoughts and early experiences & concerns with the FTX cryptocurrency derivatives exchange. In this post I’m going to take a look at the collapse of Alameda & FTX, show some theories and give my thoughts.

TradingView Chart

The disaster started Monday night when FTX token (FTT) broke the $22 level which seemingly triggered a liquidity crunch at Alameda Research. In addition, people began to panic about potential insolvency and withdrew their money. $6B was pulled out before FTX ran out of money and halted withdrawals.

Let me state the obvious, cryptocurrency exchanges are not banks, they should not operate as fractional reserves. It would be reasonable for FTX to use a combination of hot & cold wallets to protect user funds, but that is just a matter of moving the funds. Clearly around Midnight PST Monday November the 7th, FTX was broke. The question is now, how did they get insolvent and how long have they been insolvent?

Before we get into various theories as to what lead to the fallout I think it’s worth reviewing an old story.

I started writing this last night (11/8/2022), today it’s become more clear that the Binance deal isn’t going to happen, FTX is even deeper in the hole than the initial $6B. The collapse in Solana leaves Alameda with essentially no liquid assets remaining.

The Mt. Gox Willy Fiasco

I believe I was the first person to compare Sam Bankman-Fried to Mark Karpeles, whether Sam is a sociopath or a cat trapped in a cage is a debate I wont get into. One of my early concerns with FTX was that if Alameda got into a mess, it’s likely user funds would be used to ‘make it all back’.

Linked: The Willy Report

The first Bitcoin exchange was a poorly run company called Mt Gox. It was named for Magic: The Gathering and was originally going to trade Magic The Gathering online cards. Jed McCaleb founded the exchange and sold it to Karpeles.

I’m not going to get into the early story of Gox here, as it’s not really relevant, but the Willy bot is interesting. Mark Karpeles swore in a court that the intention was to try and keep the company going. Likely Willy was being used to buy Bitcoin’s because Mt. Gox was completely out of BTC (and relatively ok on the fiat front).

Mt. Gox was using Willy to keep operations moving, until that was impossible. Bitcoin withdrawals were halted, and it was clear Mt Gox was going to file for bankruptcy, at that point Willy rushed into reverse gear needing fiat solvency (or to cover it’s tracks).

I imagine FTX was more optimistic, Alameda has historically had an extremely profitable quantitative trading operation, although poorly risk managed. There are two ways this could have started, option A: Alameda was always trading customer funds, either through a line of credit or direct access. Option B: Alameda was trading customer funds out of desperation (to try and make back lost capital).

The Hidden TOS Change

A rumor was posted on Twitter that FTX changed their TOS after Luna.

This makes the below Luna theory more likely, and that FTX has been insolvent since May 2022. It’s unclear what was actually changed, the new terms did come the day after Luna day, but that could have been coincident.


Luna / 3ac Bailout Theory

Twitter user @LucasNuzzi posted a thread detailing a theory of how Alameda Research may have blown up in Q2 2022, along with 3 Arrows Capital, maybe related to the Luna collapse. FTX made the decision to bail them out with money from FTX, which included customer deposits.

FTX also spent money on bailing out failing crypto lenders, probably because loans collateralized with FTT were essential to their survival. From the Alameda balance sheet leak, it’s clear that almost all of their operations were financed by cash borrowed against their FTT holdings. At this point they were technically insolvent, but could have survived as long as they didn’t have a bank run and FTT stayed up.

The systemic risk here is that those two conditions are inherently intertwined. The poster speculates that Binance knew of this risk and chose to crash the FTT market to blow them up, I’m less sure about the motive, but it was certainly the result. All of FTX’s tokens (FTT, SRM, RAY) are shockingly illiquid, you cannot easily sell six figures of these “billion dollar” scams.

I imagine Alameda and FTX owned almost all of the supply & used that to manipulate the price up, to then collateralize loans. They likely lost more money attempting to prop up the peg, and combined with a $6B bankrun, folded.

Unknown Insolvency / My 2021 Theory

In 2021 I wrote a now infamous and poorly worded tweet. “The company is not solvent and they don’t even know it” referring to FTX. What I was aiming to say is that due to the mess of their reporting (the PNL bug and all) I thought it was possible they would be unaware of whether everything checked out or not.

To this day the PNL bug has never been fixed, and certain dates historical PNLs still change. There are many potential reasons for this, some of which could be a very isolated issue and not related to actual balances or the core exchange systems. I’m less optimistic.

Ethics and Psychology: Hanlon's Razor

FTX is clearly a mess technically, it’s unclear whether actual front-running was going on, or if the platform was just running so poorly it seemed like it). The platform would frequently freeze and various pages have memory leaks, the balance curve chart would freeze and dip at times (that was fixed). The first iteration of this chart caused some sort of memory leak that crashed the entire exchange.

The balance curve chart. Both big dips were withdrawals.

Another concerning aspect was that FTX “tested in prod”. This could be beneficial, but also dangerous, when I called out some issues with the design of FTX’s options page, a few fixes were patched through almost immediately. A worse example, in April fools 2021, FTX decided to change the wallet page to display user balances in FTT.

The problem is making such a low level change to the exchange for a prank is not a reasonable thing to safety wise. FTX ran a small team and clearly wasn’t super focused on code quality / safety. The other possibility given that very few employees knew what was going on is that these ‘bugs’ were somehow used to masquerade the problem. FTX passed a solvency audit, and had to appear solvent on it’s internal dashboards.

Since writing this segment: @AutismCapital on twitter has reported that it was rumored multiple employees including Caroline knew of insolvency since Summer 2021. Unclear what might have caused that, but the PNL bug I mentioned may have been designed to cover up internal checks.

My Best Guess (Continued from above)

After the recent WSJ reporting that Alameda had borrowed US$10B from FTX customer funds, which was more than half (16B total, 6B withdrawn by users, 10B lost to Alameda) of total assets under management. I imagine this wasn’t a one day thing, it probably started slowly.

Reuters reported overnight that in Q2 2022, Alameda suffered significant losses which were bailed out by FTX, but it’s probable that the scheme has been around longer, possibly dating back to the 2021 date above. It probably started to support Alameda’s market making on FTX, and at some point Alameda started taking heavy losses.

It’s possible as the market changed, Alameda lost their edge and seemingly changed focusing from a primarily market delta neutral strategy to one of speculation. All the way back in 2020, Alameda was using FTT collateral to short YFI, which upset the community & the defi lender they used promptly blocked FTT collateral. Alameda had then been going to centralized lenders to borrow coins & cash through this scheme.

There’s also the question of the massive Solana rally, was market manipulation a role in that? If so, running Solana up to $300 would be very expensive, perhaps they weren’t expecting an imminent bear market and hoped to distribute more at higher prices before the collapse. Alameda executives were explicitly publicly bullish on crypto near the first top.

FTX’s serum ecosystem was vaporware, the runups of SRM and RAY were clearly the work of manipulation. It was throughout the entire period impossible to buy or sell more than 5 figures without moving the price heavily (I crashed SRM from $5 to 4 when I exited my 100,000 srm position, a friend experienced 50% slippage on a $1m position). Given SRM was posted as collateral for some Alameda positions, it’s dramatic fall from grace may have done damage to their solvency.

Below I’ve laid out a few alternative theories for what may have happened. I don’t think these are correct (or at least the prime reason for insolvency), but they are worth sharing.

The November 2021 Wick


An alternative theory is that FTX blew up during this November 2021 wick. Sticking with our view on their competence, Alameda had a software bug that lead to extreme fluctuations on the books, meaning they potentially sold a significant amount of Bitcoin’s for $6k. This is similar to the disaster that lead to the market manipulation allegations back on Binance Futures.

The Infinite Money Glitch

This is an emerging story, I have contacted the poster for more information. If this is true, it’s possible that a bug allowed an attacker to dupe money & break the platform. It’s also possible this bug occurred later, or as a result of the process.

The most concerning possibility is that a bug was actually a ‘cheat code’ left in to allow a way for FTX to print money with plausible deniability. The user also posted a very negative USD balance.

screencap for posterity.

The Catalyst

While we don’t know which if any of the above scenarios are correct, we do know how the story ended. Monday November 7th, Binance announced intent to sell $500M worth of FTT, and after seemingly refusing SBF’s offer, they did so via a TWAP. It’s unclear how much was sold, but in CZ’s words “they still have a bag”.

One of Alameda’s tricks was to use their illiquid coins which primarily trade on their own exchange to borrow against. No sane lender would accept the majority of an illiquid coin’s supply issued by the recipient but here we are. It’s similar to those “I became a trillionaire” posts involving illiquid ERC-20’s. Given Alameda’s reliance on the accessibility of loans against their massive FTT holdings, Alameda likely used most of their remaining liquid assets to hold the line.

FTX prior to the bankrun had $6B in assets, $10B loaned to Alameda and assumed that without any panic, they could hold. I’m not clear whether the balance sheet rumors and FTT crash lead to the bankrun, or if the FTT crash had more of a material impact on the insolvency. It would have never been possible for Alameda to sell that FTT, so it’s unlikely even if the crash had been avoided they would have lasted.

The Current Situation

Based on the results of Binance’s due dilligence, and later reports, it seems unlikely FTX is going to be acquired. It also seems extremely unlikely much in the way of liquid assets will be recovered.

SBF’s recent thread claims that FTX is technically solvent but not liquid. I’m not sure whether he’s counting the Alameda loan directly, or the fact that Alameda has illiquid holdings that may technically exceed their liabilities. It’s also been reported Alameda is seeking to fire sell their coins 70% below market, I doubt this ‘solvency’ extends to a 70% discount.

Alameda also has massive liabilities to other firms, law enforcement is also getting involved. Tether has frozen FTX’s assets, management are likely going to jail soon. I would be surprised if we see 10c on the dollar when it’s all said and done, maybe Justin Sun will save Tron holders.

One of the most tragic things is almost every employee didn’t know. People were moving there lives to the Bahamas to join Sam, many had millions on FTX, most of their net worth in FTT. The same goes for many of the influencers who were friendly with Sam, Alex Wice lost his entire net worth, nobody was warned in advance, I’d like to ask that all of you show respect to former FTX promoters.






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