The collapse of FTX and Alameda is a staggering blow to an already wounded crypto industry. But how did it happen? How did two entities that were presumed to be highly lucrative lose all the money? On this episode of the podcast, we speak with Bloomberg Opinion columnist Matt Levine to get his take. The transcript has been lightly edited for clarity.
Key insights from the pod:
How FTX imploded — 1:53
The Alameda/FTX relationship — 2:47
The infamous “box” episode — 7:59
The FTX balance sheet — 14:06
Is this a failure of “crypto” — 17:12
FTX’s regulatory and legal jurisdictions — 25:01
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Joe Weisenthal: (00:10)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:16)
And I'm Tracy Alloway.
Joe: (00:17)
So Tracy, we're continuing to talk about the implosion of FTX and Alameda, the Sam Bankman-Fried Empire. Yesterday, we talked to two people who are involved in the story in different ways. One who is a market maker who had used and got caught out on the FTX site, another one who had attempted to blow the whistle. But of course, we're still just sort of like beginning to understand the story.
Tracy: (00:42)
A very fast moving story. But one of the things that people are talking about right now with the benefit of hindsight, of course, is the infamous Sam Bankman-Fried episode of Odd Lots. And in that episode we had him on with Bloomberg Opinion columnist Matt Levine. We were talking about how DeFi works, and of course he described it as this sort of magical money making box.
Joe: (01:07)
So in retrospect, and at the time of course, people were pretty shocked by those comments. But now everyone's going back and listening to that. And in retrospect it also helps explain perhaps certain aspects of the FTX balance sheet, particularly the tokens that it used to capitalize its balance sheet. Anyway, so we have to have Matt Levine back on. He's been writing a lot about this story. It's been a must read, his coverage, and of course he was there with us on that episode. So Matt Levine, thank you so much for joining us. Let me start kind of with a simple question, which is, what is your summary or how would you describe why FTX collapsed? What's the basic model of what happened here?
Matt Levine: (01:53)
So, it's a little bit unclear, but basically what seems to have happened is that FTX has an affiliated crypto hedge fund called Alameda. Alameda seems to have made some bad bets somehow or other. It ran into trouble. And to prop it up, at some point over the summer, probably, FTX started sending a lot of FTX customer money to Alameda, which Alameda then posted to its own lenders or otherwise lost. And then last week there were some doubts about FTX in the market, and customers started withdrawing their money from FTX and FTX realized it didn't have their money, and it went bankrupt about 20 minutes
Tracy: (02:38)
So prior to recent events, what was your impression of the relationship between FTX and Alameda?
Matt: (02:47)
I have to say, I didn't really have much of an impression one way or the other. Obviously, there were a lot of conspiracy theories about what FTX and Alameda were doing because they were run basically by the same group of people, the same people who kind of were all roommates in a big apartment in The Bahamas. They were founded by the same person. They were clearly connected and there were sort of these vague representations about them being separate. But like, you know, not a lot of necessarily enforceability to that.
So I didn't really know. I assumed that Alameda was a market maker on the FTX exchange and that, you know, it may or may not have had some benefits from being the affiliated market maker. When you hear people complaining about these things, you often think that the essential complaint is Alameda has some advantage in making markets on FTX. It makes too much money by trading against FTX customers because it knows something that everyone else on the exchange doesn't know. That's a story in standard equity market structure. And I don't find it that exciting. It might be true, but it's not that exciting like they like can see the order book a little bit faster than everyone else. That can be an advantage. But like those stories aren't that compelling, but it seems increasingly likely that that is not at all what was happening here because the basic problem here was very much not that Alameda was making too much money, Alameda was losing too much money. So the actual problematic relationship here is pretty much that Alameda lost a bunch of money and FTX just bashed over its customer money to Alameda.
There are other possible stories that are even worse, and I don't want to talk too much about them because they're all sort of speculative, but some speculations are basically that Alameda was more or less in the business of losing money on FTX. That rather than Alameda being too good at trading on FTX, Alameda was bad at trading on FTX. And so if you went to FTX as someone else, as a crypto hedge fund or even as a retail customer and you traded on FTX, you got really good prices because Alameda was making really bad prices because they were losing money on every trade.
And if you believe that, then you could tell a story that's like, well, ‘FTX became a very popular exchange and made a lot of money in trading fees because it offered this really good trading experience to customers by basically having its affiliated hedge fund lose money on every trade.’ And you know, that's a great story except that if the way that the affiliated hedge fund can afford to lose money on every trade is by taking the customers’ money, then it becomes a really bad story. It becomes effectively a Ponzi scheme. So I don't know that that's what happened. There was certainly some speculation about that. But in any case, the sort of standard story of like ‘Alameda has too many advantages and makes too much money by trading on FTX’ does not really seem to be true.
Joe: (05:32)
I want to just say, that point is really key because when I talked to sort of like professional crypto traders prior to all this, like back in the summer or earlier this year, they really liked FTX and they liked the liquidation engine, which I think we talked about on one of the episodes with you and SBF, was something they really liked. It seemed very professional, it worked really well for them. And so this idea that, and again, we don't really know for sure, that maybe some of this was only sustainable because of the loss making trading arm of the SBF Empire, again, we don't really know, but that would sort of explain many things at once.
Matt: (06:13)
Yeah. Like there's sort of two points there. One is the liquidation engine is one possible avenue that people have pointed to as a way that Alameda could be like losing money to provide a good customer experience on FTX and then through the backdoor of taking customer money. Like, you know, that being a bad story. But the other thing is that, you know, investors like FTX because it had good technology and it had like good products and it was, you know, there's a lot of like sort of finger pointing at venture capitalists and sort of everyone who dealt with FTX saying they were bamboozled by this, but there was something there. You know, like the exchange was good.
Now, part of why the exchange was good might have been sort of deeply problematic financial dealings, but part of it was like, you know, it was a good exchange. They built it well. Like, I often find myself in crypto thinking there was so much money to be made. Like why did you have to make money in bad ways when, like, you could have just taken fees and gotten super rich? So I think there's an element of that too.
Tracy: (07:10)
So maybe now is a good time to bring in the infamous box episode of Odd Lots where we had Sam Bankman-Fried plus Matt Levine on talking about the business. Matt asked Sam to describe yield farming to him and he famously described it as basically a magic box that you put money into and more money comes out.
And I think, you know, all of us were there when Sam said this, and we were all pretty shocked. We were shocked to hear someone describe DeFi basically as a Ponzi. But in retrospect, the really surprising thing about all of this was that it seems like Sam was basically describing what he ended up doing with two tokens, so FTT and Serum or SRM.
Matt: (07:59)
Yeah, I mean, in some ways it's not that shocking that the head of a centralized exchange would say a lot of stuff in DeFi is Ponzi schemes, right? Like in some ways he wasn't talking about crypto as a sort of broad concept. He was talking about a specific element of DeFi where, you know, in some loose sense DeFi is a competitor to centralized exchanges like FTX. And he might have incentive or you know, he might have reason to talk, to say bad things about them. So that's one thing. The one thing I did take away from that was just like a sort of general level of cynicism, but like I would've said something like agnosticism about crypto, right?
Like what he said was not that, you know, every cryptocurrency is this brilliant project that will change the world. What he said was like, look, you can abstract away from the claims that are made about these cryptocurrencies and just sort of talk about like their financial characteristics. And you know, at the time their financial characteristics were kind of that they went up. And so, you know, as the guy running an exchange who is making money from crypto volatility and from interest in crypto, you know, I interpreted that as sort of like this clear-eyed like, ‘I am making money because people keep putting their money into this asset class and I don't fully understand it, but I'm gonna keep making money for it.’ Which is like, when I put it that way, like a cynical view. But like, I also think that a lot of people in traditional finance are not, you know, necessarily vouching for the business model of every company whose stock they trade, right? It's just like, you know, you're a market structure guy, you don't worry too much about the underlying business. So I was shocked that he said it, because it was great tape. But I wasn't like, ‘oh my God, this guy is running a Ponzi scheme,’ right? I sort of was like, this is a market structure guy.
But yeah, as you said there, you know, FTX had its own token and the token is not entirely just a magic money box, right? I mean the token is sort of like shares of stock in FTX. It's not really, FTX is a company, it has shares of stocks that it raised money [with], but like the FTT token is kind of like a tokenized version of a bet on the future cash flows of FTX. And there's also another token called Serum, which is sort of a weirder case.
Serum is like this decentralized finance, like a decentralized exchange protocol on the Solana blockchain that, you know, is not exactly owned by FTX, but is kind of started by FTX and Alameda and like clearly has ties to them. And it's sort of like, I would interpret it as kind of like FTX has bet on, like if everyone really wants decentralized exchanges then they won't want to trade on FTX, but like Serum will be sort of like the FTX of decentralized exchanges. And fine, he started these companies or whatever, you know, these entities and issued these tokens because like, you know, you do that in crypto. But it turns out that when he was sort of shopping for a rescuer last week, he was circulating this balance sheet and it basically showed that like, to exaggerate slightly, basically everything at FTX, all they had was like these tokens.
So he started these companies, FTX and Serum are like, you know, trading entities, exchanges, they issued these tokens, Serum and FTT and like that's fine, that's sort of part of the crypto business. But then it turned out this balance sheet that circulated last week when SBF was shopping for rescue financing for FTX, like most of their assets or like a lot of their assets, certainly more than their net equity, were in these tokens and at like really implausible valuations. Basically they would issue like a little bit of these tokens, they trade a little bit in the market. It's unclear if anyone other than Alameda was actually trading them, but they had a market price. And then you take that tiny bit, you know, there's like a hundred million circulating and you multiply that by the, you know, millions more tokens they held in reserve and you say, ‘oh, we've got like $2 billion of Serum token.’ It's very hard to imagine anyone putting a $2 billion valuation on all those tokens. And so in some sense, like what happened at FTX was kind of what he described to us on that Odd Lots where he got a lot of money against the box and what was in the box was these tokens that turned out to be worthless. And now the money is gone.
Joe: (12:35)
There's a lot of people in crypto who talk about changing the world and you sort of have the Bitcoin view of the world about, you know, monetary disorder and the Fed. I don't know how to articulate Vitalik’s philosophy, but it’s like crypto itself can sort of reorganize society in a positive way. And my interpretation of the box comment was kind of like yours that he saw basically crypto as a way to make money. And of course SBF has his own vision or had his own vision of how to change the world through the Effective Altruism philosophy. But that basically, my read at the time was he more or less cynically saw a huge opportunity to make money from all of these de facto Ponzis, to filter money through his own causes.
Now on the tokens, Serum and FTT, here's something that I'm like a little confused about. And you’ve written about this a lot. So okay there they were holding these tokens of their own creation on their books at these multi-billion dollar evaluations, which they almost certainly couldn't get in the market. Who was that for? Because they're not a public company, so it wasn't like they needed to show these to investors per se. What do you think the purpose of these inflated marks on a private balance sheet was? Was it self deception about the strength of their balance sheet? Was it about the auditor? What purpose did this serve?
Matt: (14:06)
Yeah, it's a good question. I don't know the answer. I mean I think part of the answer is like the place where we immediately see this is this Excel sort of rough balance sheet that they circulated to rescue financers, right? So that's the audience that we know of, right? Where they were like, we need rescue financing, we actually have positive net equity, so if you rescue us, you know you'll do well. And you know, if you look at the totals on the balance sheet, it's like, yeah, there's more assets than liabilities and then you like look at the actual entries and you're like, these are all just these weird tokens that you could never monetize. So the immediate audience is like, the people who might provide bailout financing were the audience for like these inflated numbers.
But you know, that doesn't really answer your question because like, you know, they created these tokens before last week, you know, and like presumably they were thinking before this like, ‘oh, you know, we have billions and billions of dollars worth of these tokens.’ So I do think that’s part of the answer, and I don't know here, I'm really speculating, but part of the answer seems to be that the FTT token, which is really the thing that brought this down, right? Like what triggered a crisis of confidence in FTX was basically Coindesk publishing a story about how much FTT tokens Alameda had and then CZ at Binance tweeting, you know, we're gonna dump our FTT token and that kind of collapsed everything. So like the FTT token was doing some work and I think the basic work that it was doing was that presumably Alameda was using it as collateral for loans.
And I think it's a reasonable guess to say that it was using it as collateral for loans from FTX, you know, possibly of FTX customer money and that the, you know, use of this inflated amount of FTT as collateral was designed to sort of like make everyone feel a little bit better about it, right? Like you can sort tell your auditors we got fair value back in collateral, but you can, like, you can tell your junior employees that, you can tell yourself that. You can sort of like point to that. I'm not really sure that's what’s going on, but clearly like somebody is posting FTT as collateral for something and having an inflated market value of FTT made that possible. The Serum stuff, it's less clear to me that how that was done, what purpose that served. And it might be just, you know, we shopped that Serum around as we're looking for bailout financing.
Tracy: (16:28)
So Matt, one of the things that you hear from crypto proponents even now is this idea that, well, the FTX saga, it doesn't show that there's necessarily a problem with crypto. It shows that there's a problem with bad actors in the crypto space. And FTX wasn't a truly decentralized exchange, it was a centralized one. And not only that, but it was performing all these different market functions all wrapped up in one entity. So, you know, brokerage, custodian, all of that. Is that like a valid excuse at this point? Is the problem here a market structure one or is the problem something fundamental to the crypto business?
Matt: (17:12)
Well, I don't know that you can completely separate those things insofar as like, I think it's true that like Bitcoin as like a concept is not really affected by this, right? But I also think that like crypto is, you know, sort of refers to a broad ecosystem and it's just clearly the case that big centralized exchanges are a big part of crypto, right? And certainly there are people who do not use centralized exchanges and who sort of self custody their coins and use decentralized finance and are very bullish on decentralized finance and think everyone who uses FTX or Coinbase or Binance or any other centralized exchange is not sort of true to the true meaning of crypto and like that's fine. But like, it is hard to imagine a world where crypto is really big and really mainstream and really, you know, big institutional investors are putting money into crypto and there are no centralized exchanges and everything occurs on the blockchain.
I just think like that is a world where you can do some stuff like that, right? And where people are building stuff on that, but it's not the world of sort of like mass mainstream adoption. The world of mainstream adoption is like, there's a company with a website and, you know, you have a password and you can trade on a centralized platform that is fast and not around on the blockchain and you have like a legible entity that a BlackRock can custody its coins with and all these things. And so like when one of the biggest and most respected and most sort of like compliant-seeming of the big offshore crypto exchanges, I'll talk about that, but like when FTX was like sort of viewed as a good actor turns out to be very much not a good actor, like I think it is fair to say like, you know, the crypto system broadly needs to do some introspection about that.
And I think that some of that is like you have these giant levered financial institutions that don't have public balance sheets and don't really have a regulator, right? Or like sort of have a regulator, but they have a million different entities and no one knows which one runs the exchange. And the regulator is like, you know, The Bahamas and like they're like one of the bigger contributors, you know, there's a lot of what you don't have is like an ecosystem where the biggest players are headquartered in like, you know, the US and Europe and have like a regulator who has, you know, 50 examiners in their offices every day looking over their books and who have capital regulation and stress tests and public balance sheets and all these things.
And I mean, I know Joe, you are skeptical about the future for crypto regulation and I am too, because I think like the path of crypto is that these big firms have sort of grown up in a sort of jurisdictional limbo where they all live offshore and are sort of, you know, get to choose their own regulation a little bit. There's an advantage to a bank of being an American bank, right? And the advantage is like the Fed, but also like the sort of market confidence that comes of like you're an American bank, you're listed on the New York Stock Exchange, like your balance sheets are audited by American auditors.
The US regulatory apparatus is helpful for banks that want to raise money and trade. And in crypto, like that doesn't really exist. Like it exists a little bit, right? There are some crypto entities that make the choice of we're going to be in the US, we're going to try to be regulated by the US, we're going to try to be US public companies because that is going to be really onerous and annoying. And I think they all find that, because US crypto regulation is tough, but also it's going to in the long run lead to more confidence because we are going to be more trustworthy than people who form their exchanges offshore and don't publish their balance sheets.
Joe: (21:23)
You know in finance you can implode for benign reasons. You make bets, you thought they were gonna go one way, they go the other way. You have to close up shop and then there's fraud. It is weird when it's an exchange because we don't think of exchanges as making bets and typically, you know, they say we’re holding your money and they don't take positions, etc.
Matt: (21:51)
Yeah, I do want to push back on that a little bit just because, like a crypto exchange is a broker dealer.
Joe: (21:57)
Well, so this is basically the question I was going to ask, which is like, is there a version of this story that I don't know, not benign per se because people are destroyed and they may have a million people who have lost money and there's been massive damage, but is there a better version of the mainstream narrative that we perhaps aren't thinking about?
Matt: (22:27)
It's tough. You know, as I was saying, like crypto exchanges are not just exchanges, like people use the word ‘exchange’ and so they think of like this neutral thing that doesn't like that just matches buys themselves, right? I mean, crypto exchanges are broker dealers. They hold their customers money for them, they provide leverage to their customers. And so if you're a futures exchange, like you're sort of taking risk, right? You're taking market risk. And so there are versions of the story where you get sort of mismatched on that risk and then you implode and it's a series of understandable but bad market judgements. I think that the reporting about this has been pretty bad. I'm sorry, I don't mean the reporting has been bad. I mean like the sort of facts that have come up seem pretty bad for FTX, right?
I mean I think that, you know, FTX’s terms of service says ‘we can't use your crypto deposits for our own purposes.’ And SBF tweeted that ‘we don't invest customer deposits even in Treasuries.’ And then it turns out, as far as I can tell, in fact, customer deposits are being sent over to Alameda to make some sort of bets that lost money, right? So that's bad.
You could tell a version of the story that's not so bad, right? Where it's like Alameda is a customer on the exchange. We made a reasoned, possibly biased, possbly unfortunate decision to extend credit to Alameda as part of our function as a crypto exchange and like, you know, the crypto exchange, that exchange that extends leverage to customers. Alameda was a customer, extended leverage to that customer, and it blew up and took all of the exchange’s capital with it. And the exchange’s capital was in some ways synonymous with the other customer deposits. Like, I don't know, in the abstract you can tell a story like that, but it's not the most likely explanation at this point.
Tracy: (24:16)
So I have one more question and it's kind of a process question, but with your former lawyer's hat on, the complicated structure of the FTX empire, and I think there was a sort of a diagram floating around recently that showed something like 130 corporate entities and I think in the diagram they mixed up some non-FTX entities with actual FTX entities, but that just shows how confusing it all is. The fact that there's FTX US and FTX International and, you know, one of them is based in The Bahamas and Alameda itself is based in Hong Kong, how much does that complicate, I guess, the resolution and potential prosecution of what we've been talking about?
Matt: (25:01)
It's a mess in terms of, and particularly like the thing that I'm like really in the dark about is FTX US, which is like the US entity, which exists because US crypto regulation is really tough. And so you can't do like a lot of the products that are the bread and butter of FTX, you can't trade in the US because of some, you know, interaction with either securities law or like futures law. And so FTX US offers sort of a subset of FTX products and is, you know, possibly more regulated and possibly safer.
And for a while the storyline was that FTX.com was bust and bankrupt, but that FTX US was you know, walled off from that and now there's, you know, there seems to be some trouble at FTX US too, and it's just unclear like how intertwined these things are financially, but like, you know, regulatorily, they were different.
In terms of like prosecution and in terms of like, broadly speaking, likeFTX.com is in The Bahamas because it offers products that would've required like regulatory, like let's say, registration in the US, like products that probably would be securities in the US and would have to get securities registration and like require FTX to register as a stock exchange or products that would be like regulated futures where FTX would have to register as a futures exchange.
There would be, and you know, US regulation is tough enough that it might be hard to actually do those things. And so FTX didn't trade those products in the US, and FTX.com is not I think technically open to US persons, but if the question is can the US attorney's office for the Southern District of New York go after FTX.com for wire fraud? Which is like kind of the question here. Like the answer is yeah, of course, easy.
I don't know the exact mechanism, but basically like, you know, at some point someone's moving dollars from a bank into FTX.com and probably a lot of the people whose money got lost at FTX.com are not like, you know, US retail investors, but are Cayman Islands crypto hedge funds that are run by New Yorkers or whatever, right?
Like there's enough connection to New York that I don't think, you know, I think in general like the federal prosecutors are aggressive and creative about finding US jurisdiction for foreign companies doing things to foreigners abroad when they want to. And I don't think this is one of their harder challenges. Like, I think there's going to be enough kind of US stuff here that if that like US prosecutors are going to feel very comfortable looking into it. Which is not to say that I'm, you know, I don't wanna prejudge whether they'll find any crimes, but like, I think that they'll find jurisdiction.
Joe: (27:46)
In other words, the problem won't be, ‘Oh, they committed these crimes but they're in The Bahamas, we can't do anything,’ if they conclude there are crimes, they'll find a way.
Matt: (27:55)
Yeah. Being in The Bahamas is a way to avoid securities registration requirements. It's not a way to avoid US criminal fraud law.
Joe: (28:03)
Matt Levine, thank you so much for your perspective. Great to have you back and uh, this was a very helpful conversation.
Tracy: (28:12)
Thanks Matt.
Joe: (28:30)
Obviously Tracy, talking to Matt is always helpful and I want to start with actually just that last point. We don't know as of recording this right now on November 16th, whether there are going to be criminal charges ultimately brought in the FTX case, but it is sort of useful to know that simply by virtue of technically being domiciled FTX, or I guess not technically because that's where they were based, in The Bahamas, that that is not some sort of like escape card, so to speak.
Tracy: (28:57)
Yeah, absolutely. Certainly seems like it isn't. The other thing that's standing out to me is, I think back to all of this, is I think the FTX/Alameda relationship, I think there was always a perception in the industry that there was something there. That there was some sort of, you know, beneficial relationship as Matt described it, maybe they were getting like early info on tokens that were about to list on FTX and then flipping them and things like that. But in retrospect, it seems like what they were doing was pretty simple and just going massively long various coins. Like, there wasn't really a secret sauce. There wasn't necessarily like some amazing liquidation engine. It seems like they were just taking outsized bets on digital tokens.
Joe: (29:47)
Yeah. You know, that’s the thing, I think it's the Jane Street pedigree, right? It's not just Sam, but others who he worked with who had gone through the sort of like famous quant trading shop, Jane Street, which we talked about with Sam the first time. And so you sort of get the impression like, okay, Alameda is going to recreate Jane Street in some way, but for crypto.
But I mean, maybe not. And this idea, you know, I think everyone, right, as Matt was saying, and you know, one way or another it seems like Alameda lost a ton of money. So either they were trying to do something sophisticated and they couldn't do it, or maybe they were taking bad directional bets or they were spending badly, or it was sort of like this loss leader to make the FTX platform more attractive to institutional investors. But whatever it is, it does not seem to have been that sort of like super brilliant quant shop that you would sort of expect from like Jane Street alum.
Tracy: (30:43)
No, and the other thing that stands out to me, and this has been a recurring theme on the podcast recently, but this idea of truly decentralized crypto versus centralized players and exchanges. And I've said this before on Twitter, but I very much agree with Matt, this idea that like everyone is going to be running their own node and storing their keys in cold storage and no one's ever going to need to interact with a centralized player, I think is unrealistic because A) not only not only is a lot of crypto stuff still very difficult for people to figure out and do on their own, but B) people wanna do stuff with their money, right? You wanna get additional credit for it, you wanna trade it, you don't wanna necessarily just keep it on a wallet and never actually use it. And that's what a lot of the centralized entities and exchanges actually did.
Joe: (31:37)
Yeah. I mean look, you can trade and speculate on a DeFi exchange, but I think Matt is right and it's definitely true that in the last few years there is no way crypto would've gotten as big had it not been for numerous websites where you log in and you have a password and you move your money onto a website like, which is like the idiom of normal finance, right?
And so maybe there is like an alternate scenario in which everyone in crypto like really adhered to like these sort of like DeFi principles and maybe that would've been better and maybe that would've been more, you know, I don't know, something. But I don't think there's any way in that world it would've gotten nearly as big or like attracted this sort of like money risk-seeking behavior in such volume that it
Tracy: (32:22)
Yeah, I agree. All right. Shall we leave it there for now?
Joe: (32:32)
Let’s leave it there.
You can follow Matt Levine on Twitter at @matt_levine.