The collapse of the Sam Bankman-Fried empire is gigantic, sprawling and fast moving. While details are still coming out, it already ranks among the most prominent corporate disasters of all time and has left the entire crypto community reeling. To better understand the role that FTX played in the industry and how the exchange started to unravel, we speak with two guests on this episode. First, we have Evgeny Gaevoy, the founder and CEO of the crypto market-making firm Wintermute, to explain how he used the FTX platform and how he understood its relationship with SBF's trading firm, Alameda Research. Then we speak with independent researcher James Block, author of the Dirty Bubble Media newsletter, and one of the first observers to blow the whistle on the FTX disaster. This transcript has been lightly edited for clarity.
Points of interest in the pod:
On the FTX-Alameda relationship — (4:32)
What was it like being a crypto market maker over the past week? — 6:24
Throughput issues and FTX’s matching engine — 13:09
The role of collateral in DeFi — 18:00
What do crypto market makers do now? — 20:01
What to watch for crypto contagion — 21:27
What happens to institutional capital in crypto? — 25:16
The relationship between Celsius and FTX — 30:54
Was FTX/Alameda actually making money? — 34:09
Why FTX was bailing out crypto companies — 36:19
Is this about a ‘bad actor’ or about decentralized finance itself? — 41:28
The impact of the FTX failure — 46:05
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Tracy Alloway: (00:09)
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal: (00:14)
And I'm Joe Weisenthal. Now Tracy, obviously the big story, which we haven't talked about yet, is the collapse of the crypto exchange FTX and the broader empire, which was built by Sam Bankman-Fried, which includes his trading shop, Alameda Research.
Tracy: (00:28)
That's right. It has been really a stunning two weeks for the industry in part because Sam Bankman-Fried, or SBF, as he's frequently referred to, had become arguably the face of crypto. He was highly influential in DC. He was a donor to numerous non-profits and politicians, wildly rich. And of course we have interviewed him a number of times on this very podcast.
Joe: (00:54)
Right. So the last time we interviewed him, it had already become something of an infamous episode. We were joined by our colleague Matt Levine, and it was during that conversation that he described much of DeFi, or at least the concept of yield farming, in a matter that sounded a lot like a Ponzi scheme. And of course he didn't describe FTX or Alameda's own business as a Ponzi exactly. And we're still learning details about how it all collapsed. Nonetheless, in the wake of this implosion, I don't think there's any doubt that those comments were seen as just a massive red flag.
Tracy: (01:26)
Right. And as you mentioned, this is all moving very, very fast. It is a gigantic, really sprawling story that ranks up there with some of the biggest corporate disasters and potentially frauds of all time. And given its size and speed, it's a little tough to do a complete overview of the story. Right now there's already been a lot that's been written about it and reported on at multiple media outlets. So we're going to try to do things a little bit differently. We're going to try to break things up a bit.
First, today we are going to be speaking with a market participant who used FTX and was caught out in the scandal. And then we'll be speaking to a whistleblower who was among the first to sound the alarm about something actually being wrong at FTX and Alameda.
Joe: (02:14)
Right. And then we're going to be doing a follow up episode tomorrow with Matt Levine, where we'll try to understand more about what's happened and what is currently going on right now in the wake of the collapse. But for now, we want to start with the Evgeny Gaevoy. He is the founder and CEO of Wintermute, which is the largest crypto market making operation. It had been very active on FTX and he's going to help us understand a little bit more about FTX and Alameda's role in crypto market structure. So Evgeny, thank you so much for coming on the Odd Lots podcast. What don't you tell us, what do you do and what is Wintermute?
Evgeny Gaevoy: (02:48)
Yeah, hi. Thanks for having me. Yeah, I guess very quickly about Wintermute. We are one of the largest crypto market makers. We've been active since 2017 and I think at this stage basically, it’s the largest crypto native market maker after Alameda’s demise, it's an interesting way to grow the ranks, with all that's going on. But basically we, our businesses across centralized exchanges/decentralized exchanges have been active in DeFi since 2019 and of course OTC as well. So it's a lot of different diversified activities. We are trading billions dollars per day on all kinds of venues and in general very deeply intertwined with the crypto ecosystem.
Tracy: (03:29)
Can you explain that a little bit further? What does a market maker in crypto actually do and what is your business relationship with the various exchanges like FTX?
Evgeny: (03:40)
Yeah, on centralized exchanges it's fairly similar to how it works in traditional finance. We basically provide bids and offers algorithmically so that people get access to liquidity. When it comes to how we work with different exchanges, there are no formal contracts as such. It's basically us creating an account just like everyone else, institutional account, just like everyone else, and then effectively, yeah, send orders via APIs that exchanges provide.
Joe: (04:09)
So you mentioned that, you know, you've sort of grown in market share since the collapse of Alameda, which was a competitor. Can you talk about prior to the implosion of FTX and Alameda, which of course we'll discuss, what was your understanding and what was your view of the FTX Alameda relationship, I guess?
Evgeny: (04:32)
Yeah, I mean the Alameda part was pretty shocking because basically pretty much everyone in the industry, including myself, assumes that Alameda has been running a pretty big and successful operation across centralized and decentralized exchanges. We, for example, we've seen them being very active Serum, the Solana native DEX. We suspected that they have a pretty decent market share on FTX itself, despite actually not being able to confirm it or deny it simply because, yeah, one of the great things that was about FTX is that they had a leaderboard for volumes and we were pretty public being there and saying that, yeah, Wintermute is whatever, number eight or number three or like whatever, depending on the month. But you would never see Alameda in there, which was kind of annoying. But yeah, we [kind of figured] that not everyone wants to show their presence as publicly as we did.
And now I'm thinking okay, probably their market share was either very big or maybe potentially very small, but more likely very big because like one of the main, because like I guess the main question is given the size of the hole that FTX faces and that they lent money to Alameda, somehow they managed to lose all those billions. And one of the ideas that's traveling around crypto Twitter is basically they were just very bad market maker, I guess, because they were kind of forced to provide liquidity in FTX and they basically lost a lot of money over the years supporting that liquidity.
Tracy: (06:03)
What was your experience of last week? When did you first think ‘uh oh, something is happening here? I saw you were quite early about pulling your money out of FTX US, but some of it is stuck in FTX, the international exchange. What exactly was your experience of the past 10 days or so?
Evgeny: (06:24)
Yeah, I guess when it all started with CZ’s tweets and when like the first withdrawals started in FTX, we basically withdrew roughly half of our capital simply because we basically, our initial assessment was the exchange was going to be fine, but it might be struggling with withdrawals for sometime. So it's just not smart to lock so much of our capital over there because like the way we operate, we have a number of exchanges that we consider to be safe and that's where, we basically have a pool of capital that we keep rebalancing across different exchanges and also decentralized exchanges, so, well, blockchains. And we have a number of exchanges which we consider safe and we basically park excess capital there every now and then because it's quite easy. And FTX was one of them, a great thing that was about FTX, another great things that was about FTX is that you could actually convert different stablecoins versus the other [exchanges]. It was a very neat exchange to park the cash on, but once we realized that it might be that they maybe close withdrawals for a bit, maybe they’ll just be super swamped with withdrawal requests. So yeah, it's just not great to have our capital on it. So we kind of stopped doing that and decreased it. But our initial assessment was, yeah, we want to keep some capital on because it's going to be great trading with all this volatility, which, turned out to be not very great.
Joe: (07:48)
I want to go back to something you said about maybe Alameda were just bad market makers or maybe they were bad market makers because they were the official or the unofficial in-house liquidity provider at FTX. I believe, and correct me if I'm wrong, I believe that prior to all of this, say like prior to this month or whatever, there was a perception that Alameda had an unfair advantage in its trading by dint of its relationship with FTX. In other words that it was very profitable but only because it had some sort of relationship with FTX. Did you have that perception beforehand? That it gave an advantage and now do you sort of view this other side that essentially the relationship actually made it harder for Alameda to make money?
Evgeny: (08:36)
I guess my perception was that Alameda was not really market making in FTX to make the liquidity bigger, simply because like there were enough market makers on FTX, it was probably second biggest exchange derivatives at some point. And honestly there was no need for somebody to, well, for some internal market making desk to provide this liquidity. So I was always thinking, okay, if they would be losing money on this, they would just pull off and let others do their job. Because yeah, there were very enough crypto market makers to fill in.
And so my assumption was basically the advantage they would be getting would be from basically realizing some synergies between like FTX listings, for example. I think it was especially apparent on Solana where Alameda/FTX would invest in the protocols and then the protocol would pretty much immediately get listed on FTX. And basically since Alameda would have, well, I think, basically better knowledge about like how all this stuff works, they would be just better positioned to make money out of it. And that, that to me sounded like a pretty good money-making machine and that that was one of the reasons I kind of expected them to print billions last year and maybe, I don't know, just losing some of the venture positions this year.
Tracy: (10:12)
So one of the criticisms that's come out about this whole thing, and my gosh there are a lot of things that you could say here, but one of them is that, ‘oh this is all about centralized finance because FTX was a centralized exchange. It wasn't actually decentralized like a lot of other ones, Uniswap being the primary example. What do you say to that criticism? Is that fair?
Evgeny: (10:38)
I think it's very fair and basically, I really disagree that this is a failure of crypto. If anything, it's a vindication of basically everything crypto is standing for, which is basically being completely decentralized, being completely transparent and basically yeah, people having access to their own assets, self custody and basically not relying on anything really. Because if you look at all the failures of this year, like even Terra, even though it was a decentralized protocol, the only reason Terra blew up to such a massive proportions was, well I think in my opinion at least, the main reason was that this crazy 20% yield was repackaged by centralized institutions in a very opaque way. It was repackaged to the retail. And so retail would, I don’t know, get 10% yield on the account. So centralized entities would get like 10% spread, and everyone was happy until basically everything blew up.
Then Three Arrows blows up, exactly the same thing. Like everyone lent to Three Arrows but nobody knew what the combined value of the loans was and then when they blew up, yeah, all the centralized lenders got hit simply because it was just centralized and transparent. And finally FTX -- exactly the same thing. They lent to Alameda, nobody knew about it because it was, yeah, it was not public, it was like somewhere on the internal ledger. Not even most of employees knew about it, I think. And again it blew up in a very centralized fashion. So to me, yeah, crypto kind of solves it and it's quite unfortunate there was a crypto exchange, but it's, to me it's an indication of all the crypto ideals.
Joe: (12:19)
So I want to go back to the experience of trading on FTX specifically. You mentioned that your perception prior to this was that FTX was a high-quality exchange, a safe place to park capital when it wasn't in a trade. What was good about FTX? It does seem to me, when I've talked to professional crypto traders, they liked this site and I think part of the reason maybe people are so blindsided by this collapse is the fact that by all accounts the FTX platform seemed to be a good one, that people really liked the experience that had a lot of uptime, people liked the way the liquidations worked on FTX. Can you talk about your experience just being a trader on it and in your view why FTX got the prominence that it did?
Evgeny: (13:09)
I think it's very much linked to SBF to be honest. Like, yes, sure it was a good platform to trade especially because they were, yeah, they were pretty quick about listing new assets. They were pretty quick about, well basically yes their perps [perpetual futures] were great and there were like a lot of different products there. One thing that wasn't great about FTX and everyone knows about it as well, is the throughput was pretty abysmal, like number of orders you can send per second. Like all those limits, they kept increasing them by, I don't know, sometimes they would come and say,’ oh great news, we increased it by 20%, but they needed like, I don't know, a 2000% increase. And one of the reasons I think, and yeah, I don't know, I have no idea, I haven't looked through the code base, but I guess one of the reasons for this was basically what Sam was promoting very much is that the matching engine was combined with their risk engine because you could use all those assets on margin as collateral to trade all those perpetual products.
Like every time you send an order and it gets matched, it would need to do both matching and the risk calculation, which I would imagine would slow it quite considerably. And I was always very curious how much you can leverage that. Like, how much you can expand that. Because honestly none of the centralized crypto exchanges are close to throughput to even like the worst, I don't know, European stock exchange for example. They're just all really, really bad, even Binance, and FTX was quite worse than Binance throughput-wise even though it was smaller volume wise.
So to me it was always a question like yeah, how is it going to grow? Like how is it going to continue making this throughput? Especially because, if it's just Bitcoin and Ethereum, that’s fine. But their idea was, I think, like expand into stocks, expand into commodities, expand in everything. Although I don't know, maybe it was all facade, but to me it was always a curious thing, like, yeah, your matching engine clearly needs an upgrade. Are you actually sure it it's physically possible to maintain this model?
Joe: (15:21)
So just to be clear, your perception was that there was this trade off that the throughput in terms of total volume at FTX was not, say, what you could get at Binance, but that was because it had this superior matching engine and ability to cross margin assets. Can you just explain what that means for the listener that the matching engine, the cross margining asset, and what is the advantage of that as a professional trader?
Evgeny: (15:49)
Yeah, so basically like if you go on Binance and trade Binance futures, you need to post BUSD, I think there's a cross margin with other stable coins as well now. But that's just one instrument. If you would trade on FTX, you could use your Bitcoin, you can use an etherum, you can use like dozens of other different tokens for which the price would be quite volatile, right? So let's say you have, I don't know, 1 million worth of Bitcoin and 1 million worth of dollars, you could use both of those positions as a margin to enter derivative contracts, which is very handy because you trade spot, you trade, I don’t know perpetuals, you can do it all in one account. And yeah, it's very convenient from the capital perspective.
Because you, for example, what if you only have Bitcoin, then just park a Bitcoin and still get margin on FTX, that's great, but it also means that their matching engine continuously had to keep in its mind what the price of Bitcoin is because maybe if Bitcoin falls you'll need to liquidate this guy, because the value of his positions, like his unrealized profit is low and so maybe we need to liquidate his Bitcoin and then yeah, initiate like the whole liquidation process. Which is basically way more complex than for Binance futures, which is just, yeah, we just take your perpetual exposure, it generates dollar P&L and you only have dollars in your account. So it's very easy.
Tracy: (17:16)
This actually leads into something I wanted to ask you, which is a sort of, I guess, fundamental criticism about DeFi, which is even if you're dealing with decentralized exchanges or you know, you hold your own keys or whatever because you don't actually know who you're lending to, DeFi often places a lot of emphasis on the underlying collateral, the quality of the collateral and the price of it. And so if it starts to go down, you do get these big margin calls because you don't really know who your counterparty is. That seems like a potential vulnerability for DeFi, particularly in an environment where we're seeing the collateral price, you know, be extremely volatile.
Evgeny: (18:00)
Well, I think that DeFi challenges potentially, they don't stem from the fact that you don't know who your counterpart is. They’re primarily stemming from two things. One is just the quality of collateral like you mentioned, and basically the fact that in extreme market moves, it might not be possible to liquidate it quick enough on DEXes. And that basically the quality of the collateral can drop so quickly that there will be no incentive for anyone to do liquidations. And that can create gaps and holes in protocol treasuries, for example, which happened after Luna with some protocols.
And the second issue is, it's also related to just potential manipulation vectors, and that that has to do with oracles because yeah, like what we, what we've seen with Mango markets a few weeks ago for example, was that yeah, if you manipulate the oracle price, you can potentially create sort of a run on the bank for those kinds of lending protocols as well.
Honestly, I think both of those issues are solvable. Basically most of the time issues with decentralized protocols were caused by yeah, just the quality of a collateral which works both on like a float level. So if it's just some altcoin which has a very low float, yeah, you just wouldn't be able to liquidate it fast enough. But also on the oracle level as well. Okay. If it's like a very small token and it's very easy to manipulate the price just like we saw as Mango.
But overall, the DeFi protocols over the last, I don't know, nine, 12 months worked perfectly well in terms of stress. Like you haven't seen any issues with Ava, you haven't seen any issues with Compound. They worked just like they intended to be, people were doing liquidations, it was all very much orderly. So I think from that perspective, I think it's, yeah, it's still pretty cool system to look at.
Joe: (19:48)
Are you going to change the way you think about counterparty risk and keeping money on exchanges, any exchanges, in the wake of this? How are you changing your business operations?
Evgeny: (20:01)
We're basically playing it very safe. So there are like a very small number of exchanges that we consider to be safe. And we have this drawing from a lot of like what we call Tier Three exchanges at the moment. And even some of the Tier Two exchanges, we basically, and I cannot really name names because we actually have a pretty good relationship with most of them, and like, if I say we withdrew from Exchange Y, it doesn't mean that we’re saying they're bankrupt, it just means that we are, we’re just waiting for our due diligence, we are waiting for them to provide financials, we're just waiting for them to kind of prove to us that they're fine. And so the idea for us is just to get this due diligence done and in a week or two we just resume trade in all the exchanges that remain. But yeah, my unfortunate understanding of the situation is there might be more exchanges failing, big and small. So yeah, it's just very good security practice to be very safe in this environment. I think for individual users I would generally advise to try self custody if you can, or withdraw to like very, very high-quality exchanges if you cannot.
Tracy: (21:06)
What exactly is the path for contagion here? Like FTX goes down, why should we worry about a Tier Three exchange? What's the knock-on effect?
Evgeny: (21:17)
The knock-on effect can be, I guess, like multiple vectors. First of all, some of those exchanges, like the way they operate with market makers, some of them provide letters of credit. So they basically can extend, well leverage effectively or just pure free capital, to market makers so that the market makers would have better incentive to provide markets. So if any of those Tier Three exchanges gave lots of credit to Alameda and Alameda lost money, they could be facing some losses.
The second way it can happen is basically a lot of exchanges will be keeping some of their capital on FTX and we've seen some exchanges coming forward, whether it can be for internal market making operations, so it can be simply because they just sometimes basically like broadcast liquidity on the exchange via FTX, as way, they could potentially keep tons of their money on FTX.
Joe: (22:13)
You know, one of the interesting things that makes crypto distinct from, say, TradFi or the stock market is you do have this separation of the broker and the market. And so if I log into a Schwab account to trade stocks, Schwab is the broker, but Schwab is not the stock market itself. It seems like that's different in crypto where it's like Binance or FTX, you have your account there, but it also is the market and that has the order book. Would it make sense to separate those?
Evgeny: (22:47)
Yeah, it's a very good question. I guess it depends, is the right answer. On the one hand, there are a few exchanges which I think it’s perfectly fine to do it basically. Let me give you this kind of framework. The main like, not necessarily cost, but like a huge amount of effort for centralized exchanges goes into KYC AML of their customers. So it's a pretty big, I'm pretty sure it's a big, big cost. It's a pretty big number of employees who are busy with this and that's honestly where the biggest regulatory attack vector comes from as well, because yeah, if you do not KYC properly, like if you KYC some North Korean people, I don't know, whatever, you can get in trouble. So that's a pretty big cost base effectively. If that part is taken away from exchanges, like whoever runs this needs to charge quite a bit for it because yeah, it's a pretty big cost to run.
And so you can argue that the centralized exchanges are offsetting this cost by charging trading fees from all those peoples at they KYC. Like if you completely separated, it would be interesting. I mean, it's kind of a different model again obviously because all those, I don’t know brokers effectively, would have to do KYC instead, but ultimately yes, they would need to figure out the way to, I don't know, either share revenue, so basically finding the different business model around it because currently all those costs are offset by training fees and whatever other auxiliary profits those exchanges generate.
Tracy: (24:20)
So we talked a little bit about how, you know, FTX was generally considered to be a good exchange from a technology perspective, some of the latency issues you described notwithstanding. But Sam Bankman-Fried overall was generally considered to be this titan of crypto and we can argue about whether or not that reputation was deserved given that he was running a centralized exchange versus a decentralized exchange, but this seems like a massive, massive deal for the industry as a whole. That this guy who was sort of held up as the face of it was essentially running some sort of fraud. What is the long-term impact of all of this on the crypto space? Does institutional capital just dry up at this point? How do you convince people to put money into a space that time and time again seems to either blow up or be the victim of hacks or fraud?
Evgeny: (25:16)
On the institutional side, I think it'll all come come down to yeah, just coming up with better ways to custody assets because yeah, one big issue, obviously, if you store your assets in FTX, you’re basically screwed, but I know that there are quite a few banks that are actively working on it, like traditional banks on the custody solutions. BNY came up with one like a month ago, something like that, right? I think that will be ultimately the path to institutional adoption because they will just need to replicate the same rails, effectively, to operate since the custody has been the major piece that has been missing and once it's done, like, SBF’s failure was not a failure of crypto, again, it was a failure of a centralized identity. So once you remove custody from it, okay, it shouldn't truly affect you that much.
Because yeah, if you stored your money not on FTX, but with custodian for example, or just store it yourself, it should be fine. I think like if you're talking about more longer-term impact of this, I think, yeah, it's safe to assume there will be a pretty big regulatory response because regulators should have a field day around this. I kind of hope that yeah, there, there would be, like at least some of the fault will be recognized like on the SEC side given just how close those guys were, how this looks like.
But overall, yeah, I think there are laws that we will see implemented on the US side of things and maybe globally as well, [they] won't be as favorable as they would have been like a few months ago. For me, the events of the past week kind of proved that we need to go back to those ideas of decentralization, of basically existing in the trustless world, when it comes to individual users. And I think, that to me is just something that kind of like rebooted the whole thing for me. Like rebooted my whole approach to crypto, rebooted my faith in crypto as something that can replace the future financial system as well. I actually believe it even more than before after this somehow.
Joe: (27:20)
Evgeny, thank you so much for coming on Odd Lots.
Evgeny: (27:23)
Yeah, thank you for having me.
Joe: (27:25)
That was if Evgeny Gaevoy of Wintermute, talking to us about how he had seen FTX his business.
Tracy: (27:31)
Next up we'll be speaking to James Block. You might know him better from his Twitter handle @MikeBurgersburg. He also writes about crypto and fraud at the Dirty Bubble Media substack. So we will be talking to him about what he saw at FTX that raised some initial red flags.
So we are back and we are about to speak with James Block. He was one of the initial researchers who sounded the alarm on FTX and Alameda and set some of these events in motion. So James, thanks so much for coming on Odd Lots!
James: (28:20)
Hey, it's great to be here.
Tracy: (28:21)
James, tell us who you are because it seems like you are basically, a doctor by day and crypto researcher by night. Is that accurate?
James: (28:32)
Something like that, yeah. I'm trained as a physician-scientist, kind of got interested in this space, if you want to call it that, about a year ago. Just kind of always had a fascination with financial crimes and kind of the oddities of how financial markets work. So crypto seemed like a really interesting place to kind of dive in and learn some stuff.
Joe: (28:51)
What first got you interested in FTX specifically?
James: (28:55)
So before I was writing about FTX, I was really looking into the Celsius network scandal, which I had been writing about extensively prior to their collapse. And it turns out that there were extensive ties between Celsius network and FTX, both financial and other. So that's kind of how I kind of got into it, looking at it from that perspective. And then I was able to find out some information about their actual financial condition and then that's when I wrote an article about Alameda's financial situation that had some impact on how the events turned out.
Tracy: (29:26)
So one of the things that we hear about crypto quite a lot is that, you know, it's very transparent. You can trace wallet addresses, you can sort of follow the money and figure out what's going on, and yet we seem to have repetitive frauds in the space. What's your sense of that part of crypto? When you're looking at crypto, trying to expose potential frauds, is it easier than with traditional finance?
James: (29:54)
I definitely think that it is easier in some respects. I mean, a lot of the information is public and easily legible if you understand how to read the data, which isn't, honestly it’s not that complicated. The part of it that people forget about is that the vast majority of the economic activity happening in this space doesn't happen on the blockchain. It happens in centralized exchanges and other platforms that don't use the blockchain for any of the transactions they perform. So for example, FTX is an exchange. You would deposit your crypto there and then it just sits there. Theoretically it should sit in their wallet and then all of the trading actually happens on an off-chain, like centralized platform. And then eventually, let's say you want to take your crypto back out, then it goes back onto the blockchain and moves back to your wallet. But there's never, the trading that happens, any of the market activity that happens that's totally opaque.
Joe: (30:42)
So why don't we start with the details. You mentioned that you saw there were more links between FTX, you believed, and Celsius, than perhaps people appreciated. What did you first see there?
James: (30:54)
Yeah, so for people who aren't familiar, Celsius was a lending platform. Basically what it allowed you to do was either deposit crypto and earn yield on it, kind of like a savings account, or you could borrow against your crypto, you could borrow dollars against say Bitcoin. And then what Celsius would do is rehypothecate those assets into various supposed yield-earning strategies. And it turned out that what they were doing wasn't actually profitable and they collapsed. And there's a lot of allegations about kind of what was going on in that company that are still being kind of figured out. But what I noticed among other things was that in June they froze withdrawals, so all their customers could no longer withdraw their funds. And then there was a month period of time between June and July where the company was engaging in a significant number of transactions on the blockchain.
And then on July 13th they filed for bankruptcy. And what I found was that they had sent hundreds of millions of dollars worth of assets from their wallets to the FTX exchange. And then in return it seemed like they had received about a billion dollars in USDC from that exchange and used it to pay off various debts. According to the bankruptcy filing, Celsius owed FTX about $108 million. And apparently that loan was also discharged in that time period. So my concern was that there were some very questionable transfers happening that were within the 90-day period prior to filing for bankruptcy, that seemed to me to be preferential transfers, although, you know, I'll let the lawyers figure that one out. And additionally just the opaqueness of what they were doing with those funds. So I started looking into that. And then there's a number of other connections too. I mean, Celsius, one of their main shareholders was the Tether stablecoin company, and that was also very closely tied to FTX and Alameda Research. So there are multiple ties between these companies that go back number of years.
Tracy: (32:36)
It seems like there were a few months between Celsius experiencing problems and all the FTX issues sort of coming home to roost. Why do you think it took a while?
James: (32:48)
Well, I don't think that Celsius was necessarily material to the collapse of Alameda and FTX. They were doing business together and FTX actually got their money back. So for them it probably worked out pretty well. I think Alameda was a party to the bankruptcy, was owed something like $10 or $11 million from Celsius, but relative to the amount of money that they apparently got paid back, it's not very significant.
What appears [to have happened] with Alameda, and we don't actually know, I mean, honestly, I don’t even want to speculate at this point, I still can't imagine how they managed to lose the amount of money that they're saying that they lost. I mean, $8 to $10 billion is a lot of money. Celsius by comparison is maybe $3 billion to $4 billion in the hole. So it's a massive loss, and nobody, I don't think, knows entirely yet where the money went in terms of FDX.
Tracy: (33:33)
Right. So just on this note, I mean this was one of the things that I think was surprising for a lot of people, which is, you know, we all listen to Sam Bankman-Fried when he was on this podcast, describe yield farming as this sort of magical money box. But he was describing the business of crypto, and we sort of thought, well, you know, he's operating an exchange where people are trading these things and that's how he's making his money, and that must be incredibly profitable. And it turns out it wasn't. Where do we actually think the money went?
James: (34:09)
Well, I mean, we know for a fact at this point, we know that a large portion of user assets ended up going to Sam Bankman-Fried’s trading firm, which was Alameda Research. Where it goes from there is the $8 to $10 billion question, I guess they were doing a number of different things with the funds. We know that they were investing in a lot of different venture opportunities. You can call them various crypto projects that never seemed to work out. I think $500 million went to some AI research non-profit, you know, obviously they were in spending a lot of money on advertising and on political contributions. So I mean, I don't think anyone's come close to accounting for the amount of money that's apparently missing here, but we know at least where some of it went. The question is, yeah, I mean, so were they profitable?
I mean, you can look at Coinbase's earnings, and just as a disclosure, I am short Coinbase, so my opinions about that company are colored by that position. But I mean, Coinbase has been losing a substantial amount of money in the last year. Were they actually profitable is a very good question. And you know, the thing to remember too is that FTX always billed themselves as sort of the exchange for institutional traders. Like there was retail involved, but a lot of the volume was supposedly these institutional people who were playing on there. And so their actual revenue from that would've been much lower than what somebody with primarily a retail customer base would make. So it's actually very questionable if they were ever really making money or not.
Joe: (35:30)
That's a really interesting observation and it just, you know, it's something that's come up with Coinbase specifically. Obviously as, you know if you're short it, this idea that institutional clients are way less profitable than retail clients. It's something that Jim Chanos has talked a lot about. So the fact that FTX was so institutionally focused would be a suggestion that you know, it's margins even in the best case scenario, were pretty slim. But let's go back to just Alameda for a second. I think the perception was that, you know, it was a profitable market-making firm and that maybe it had some leg up by dint of its relationship with FTX. What is it that first caught your attention and got you thinking that maybe it wasn't all sound with Alameda specifically?
James: (36:19)
I'm a very skeptical person when it comes to crypto. I view most of these things as very, very, very questionable operations. That many of them, most of them, are probably losing money and engaging in things that aren't very savory. But of all the people, I actually did think that maybe if anybody was making money, it was Alameda because everybody always said they were the smartest guys in the room to make a reference my favorite documentary of all time.
When I really started thinking there was something wrong was when all of these firms started failing, like BlockFi, and Voyager and FTX was suddenly stepping in and Alameda was stepping in and bailing these companies out. And I knew enough about how these firms operated and how big the holes were to just think there was no reason for them to do that, that would make any sense.
I mean, these companies, like the names of these companies are worthless now because they've shown that they did a very poor job of handling people's money. It's not like somebody's going to want to invest again in BlockFi once they find out that they went insolvent, because they were lending to what was allegedly a Ponzi scam, the Three Arrows Capital. So it wasn't like he was getting any kind of advantage by doing that. And so my question was, was he just trying to get ahold of the user assets or was he trying to cover up debt that Alameda had to those platforms?
And it seems like it's the latter case, that both of those platforms held large amounts of these illiquid tokens that Alameda owned and that FTX had issued and that basically they were trying to protect themselves from getting liquidated on all of that. So basically it was him protecting himself. And that's what kind of initially made me think there's something wrong here. I didn't know how bad it was until I saw their balance sheet though.
Joe: (37:47)
Sorry, just to be clear on that last point, because I think that's really key, this idea that some of these other firms held on their books assets that Alameda didn't want liquidated, was that public?
James: (37:59)
Yes, that's public. That's in the Voyager, I can't remember what docket number, but it is in the Voyager bankruptcy filings. There was an agreement for FTX, or Alameda to receive their collateral back and pay back the loans that they had taken out. And it was all FTT and Serumtokens, which are the tokens that I and CoinDesk showed were kind of the albatrosses around their neck on their balance sheet.
Tracy: (38:24)
So the CoinDesk report sort of kicked all of this into high gear and there was, you know, speculation and research before then, including some of the work that you did. But when that came out, I mean, things happened very, very quickly after that. What's been your just personal experience of the past 10 days or so?
James: (38:46)
So CoinDesk wrote their article, I believe on the second [of November]. I had my own information that suggested basically the same thing they had said, and I had a little bit more information about exactly how much of the other holdings they had, which was interesting to find out. And so on the fourth I published my article, which basically just showed, took the CoinDesk article a step further and said, instead of just saying they have this much of these tokens, my question was, how much are these tokens actually worth? And it's pretty easy to show that they were, in all practical senses, worthless because nobody else owned them except Alameda. And the market was entirely controlled by this company and they were basically faking an entire market. So that came out on the fourth, it kind of went viral, which was kind of cool.
And then a couple days after that was when the head of Binance announced that he was going to liquidate all of their assets and this FTT token, which was some $550 million or more worth of it. And that's the point when it really kicked off the bank run on FTX. And the thing was that they were fighting a battle on two fronts, right? They had to simultaneously pay people back their money and then they also had to keep the price of this token up because they had levered themselves on this totally illiquid asset. So they couldn't win that. Here's the thing, like I said, I'm a very suspicious person by nature. When I saw their balance sheet, I knew, and based on the information I had, I knew that they were in very serious trouble.
Joe: (40:00)
Sorry, when you say they, just to be clear, do you mean Alameda specifically?
James: (40:03)
Alameda and FTX. And the thing to remember for people listening is that for years, Sam Bankman-Fried and others have always alleged or stated that Alameda and FTX were totally separate entities, despite the fact that they were owned by the same person. The argument was that their leadership is different. They don't share information, they don't share assets, they are separate companies. And clearly that was not the case because they actually filed for bankruptcy together a couple days ago. So they were one and the same, but yeah, so they were fighting a battle on two fronts. And I mean, like I was saying before, I knew that they were in trouble based on looking at their financials, but I didn't realize the extent to which they had lost customer assets. The hole that they were in, I didn't think they would go down as quickly as they did for sure. But very shortly after that they were insolvent and froze withdrawals, and from there on we kind of know what happened. And I guess we're going to find out who else has a lot of exposure to this thing.
Tracy: (40:56)
Just on that note, you kind of touched on this already, but one of the big talking points now is that, well, this isn't a failure of crypto, this is a failure of a centralized exchange and you know, real crypto is decentralized and you should own your own keys and run your own node and, you know, only trade through Uniswap or whatever. Is that a valid argument to make here? Is the problem the centralized entities who act badly or is the problem something fundamental about crypto and its tech?
James: (41:28)
So here's my answer to that question, and I've had to answer that question a few times in the last week. My opinion about crypto is I'm fairly negative, I'm fairly skeptical, but I think arguments about whether or not the blockchain technology or Bitcoin has any intrinsic value can be set to one side. Because the fact is that regardless of whether or not it's crypto's fault or centralized exchanges’ fault, the fact of the matter is most of the people involved in this ecosystem at this point are transacting through centralized exchanges. All of the prices are determined by centralized exchanges. Centralized exchanges hold most of the assets and are controlling the entire market. So regardless of whatever is good or bad about the crypto, in its essence, there's a very, very, very, very big problem here that defines the industry, in my opinion.
I don't think there's, you know, how many people, the number of people who own crypto on these exchanges and don't even know how to pull the assets off into their own wallet is unbelievable. It's unbelievable. So to say it's a specific problem, it's, ‘Oh, it's only Sam. It's only this one exchange. It's only this one lending platform.’ I think we're going to find out that it is an industry-wide problem, because ultimately none of these things produce anything of value. All they do is they trade money in a circle and that money has to leave the system eventually. And what we're going to find out is that there is much less money in the system now than there was when it started. And a lot of people are not going to be able to exit the system without losing a lot of their money.
Joe: (42:54)
I'm so glad you said that because I keep hear seeing these discussions on Twitter and elsewhere, it's like, oh, the solution is decentralized exchanges or just holding your own keys etc.
Tracy: (43:00)
On-chain auditing is the new one.
Joe: (43:05)
And maybe there's some truth to that, but I'm also surprised how rarely I hear what you said. It’s like, why don't you make a product with a point, and you would not have these same problems if there were sort of like coins and platforms that solved real problems, that had revenue that wasn't tied to speculation, that had real businesses. And so, to my mind, it almost doesn't matter. Centralized, decentralized if there is no naturally pulled-in revenue. I want to ask another question though, which is why couldn't, in your view, FTX have just let Alameda go? Okay, it was blowing up, its balance sheet was wrecked. Could FTX have just said, ‘you know what, our trading arm blew up, but we still have an exchange?’
James: (43:49)No, because they were trading with their customers’ money. They took their customers’ assets. You could literally watch as they were paying out withdrawals, you could watch the funds returning through Alameda Research addresses. This is confirmed by multiple individuals. They had taken the funds. I mean they've essentially admitted to that at this point. That's why there's a hole there. I mean, because you have to remember, part of the reason that crypto is what it is, is that people are so against the traditional banking system and fractional banking and all that stuff, and these exchanges are supposed to operate as fully capitalized. They're not supposed to be playing around with their customers’ assets. And that's exactly what they were doing. And you know, I mean, FTX was offering yield on their customers assets as well, which is, I mean, obviously a red flag that they're doing something more than just holding onto the assets and keeping them there for safe keeping.
Joe: (44:35)Just to be clear, your perception or your view is that the transference of customer assets to Alameda was going on for a very long time.
James: (44:45)
That is what everything points to. I think there's been a fair amount of reporting at that point that, I mean I saw it myself, but yeah, there's been a lot of other reporting as well that shows that the money came back through their wallets and if you look at where the money went, it went to their wallets. What they did with it after that, nobody's figured out yet. That's a very massive problem to figure out probably far beyond my abilities. But yeah, I mean they, they absolutely were. There's no excuse, again, there's no excuse. If you look at FTX's user agreements, they weren't supposed to be doing that with the customer's assets. They were supposed to hold onto the assets and keep them safe and if the customers wanted to leave, and that's the thing now is there's a lot of other exchanges facing very big withdrawal pressure. The fact is all of them should be able to give back all of the money and be fine. They shouldn't have any problem with that. And if they do have a problem with that, that means they were doing something with the money that they weren't supposed to be doing.
Tracy: (45:35)
Right. So it is true, if you look at the FTX user agreement, it says specifically, we will not lend out the cryptocurrency that we custody. So, Okay, two quick questions. One, overall, how damaging is this for crypto, given that, you know, part of crypto's raison d’etre, I guess was to reform the financial system in a way that would avoid a lot of these problems. And then secondly, what are you watching out for in terms of contagion?
James: (46:05)
So I'm going to disagree with you a little bit. I think the narrative for crypto is that it's there to change the financial system and offer an individually responsible alternative to the central banking world and, you know, inflation-free alternative that's like gold or something. In practical terms, most of the people that have gotten involved in crypto in the last year and a half or so, are not people who care about that narrative. They're people who just want to get rich. It's just like any other gambling that's going on in the stock market. It's the same thing. Most of the people don't really care about that narrative. The number of people in this space that actually care about that narrative is relatively small.
I think that this is going to have a tremendous impact and we're just starting to see that because of a couple reasons, number one, FTX because of Sam's spending on advertising, is one of the most recognizable firms in the entire, I hate calling it industry because it's not productive, but I'll call it an industry.
He had his name on the, I mean, I swear I can't get over it. He had the name of FTX on the umpire uniforms for Major League Baseball. I mean, he literally had his name on the regulators. You know, he had his name on one of the most famous stadiums in the country. He had one of the most popular athletes in the world advertising for him and apparently invested in him. So yeah, everybody knows who FTX is, which is why obviously the story is getting as much press as it is. So them failing, number one, is going to have a massive psychological impact both on the people who already own crypto, who are realizing now that maybe they can't trust any of these exchanges. It's also going to have a massive effect on anyone who hasn't invested yet. Because ultimately this space depends entirely on new money coming in in order to drive prices up.
So that alone is going to have a massive impact. And then secondly, Sam was very close to regulators. He was very close to a lot of politicians. He donated, I think he was the second largest donor to the Democratic party this year, this election cycle. There's going to be a lot of politicians who are going to have to explain why did I take money from somebody who may have been running something that was, um, you know, very, very, very questionable. Let's just put it that way. I think that there's going to be a lot more impetus for the regulators and for lawmakers to act on what's happening in crypto. And I don't think they're going to act in a way that the industry is going to enjoy very much.
Tracy: (48:15)
And then in terms of contagion?
James: (48:18)
Oh yeah, everybody. There is no, but I mean realistically, I mean, number one, this system, again, like we talked about a little bit earlier, this is not a productive system. Ultimately this is a destructive system. There is no money created by what they're doing. There is no value created by what they're doing. So it's a closed system that only gets new money from people who believe in crypto and want to invest more. So once that’s cut off, everybody has to fight over whatever liquidity is left. And if it turns out other exchanges were playing the same games as Sam was, which it appears that at least some of them were playing the same games and moving money around in ways that they shouldn't have been doing and people start withdrawing, it's game over. Anybody who lent money to Alameda is in trouble. All of the VC firms that invested in Alameda and in FTX just got burned to the tune of billions of dollars. So are they going to be investing any more in crypto firms that don't generate income and need constant infusions of capital in order to stay afloat? I don't think so. I mean, if any exchange going down could have had like a systemic effect on crypto, FTX is probably one of the biggest candidates for that. So it's going to be interesting to see what happens the next couple weeks.
Tracy: (49:25)
Yeah, for sure. And it does seem problematic, when your use case is basically predicated on speculation, if you don't get inflows anymore. James, thank you so much for joining us. Really appreciate it.
James: (49:37)
Hey, no problem. It was fun talking to you.
Joe: (49:52)
Tracy. I found that conversation to be helpful, both in terms of understanding how FTX had been perceived prior to the collapse, the relationship between FTX Alameda, and of course what those early signs were in terms of collapse. And it really did materialize it lightning speed once fears of its insolvency started to percolate up, right?
Tracy: (50:11)
And I do think it's worth noting that within the industry there is still this furious discussion about whether the fault was crypto itself or whether it was more traditional TradFi structures that actually imploded. But on some level the debate seems really philosophical and one that we will probably be talking about for a long time.
Joe: (50:34)
Right. So in the meantime, tomorrow we're going to be going over some of these topics further. Zooming out a bit with our past guest, Matt Levine.
Tracy: (50:41)
Shall we leave it there?
Joe: (50:42)
Let's leave it there.
You can follow James Block on Twitter at @MikeBurgersburg and Evgeny Gaevoy at @EvgenyGaevoy.