Collapse of FTX’s Ponzi scheme heralds end of the crypto bubble
The collapse of crypto exchange FTX and its founder Sam Bankman-Fried is a seminal moment for crypto. Many have called it crypto’s Lehman Brothers, while former US treasury secretary Larry Summers recently compared it to Enron.
Whatever it resembles, it is an extraordinary tale. FTX itself was, until recently, valued at $32-billion. Initial estimates are that the outstanding liabilities of FTX are between $10-billion and $50-billion. The infamous Bankman-Fried, more commonly known as SBF, was personally valued at $16-billion. He is now worth $0.
As for what happened, it is easy to get bogged down in the thick weeds of the cryptoverse. Suffice it to say that the world constructed by SBF was nothing more than a Ponzi scheme – labyrinthine structures owing vast sums to each other in a dense and incestuous spider’s web.
The fact that one of the ways SBF did this was by using the FTT token, which functioned much like a fair- ground coupon for FTX, made everything exponentially worse. Though you can use coupons in exchange for rides and snacks at the fair, you cannot use them as collateral for loans or exchange them for money.
As with all Ponzi schemes, the longevity of the whole thing depended on one critical factor: attracting unsuspecting individuals to give you their cash. As is always the case, when that stops the whole thing collapses.
To prolong the charade, two factors were critical. First, as with Bernie Madoff and Steinhoff, credibility was the most essential commodity for FTX so that punters would trust it with their hard-earned savings (or just the cash sent to them in stimulus cheques by Donald Trump and Joe Biden).
SBF knew this, which is why he marketed himself as the most trustworthy person in the shadowy world of crypto. The investor list of FTX read like a who’s who of the US financial establishment – BlackRock, Sequoia Capital and a raft of government pension funds. SBF made extensive political donations and promoted the philosophy of effective altruism, which rationalises wealth accumulation as a moral good. He met Goldman
Sachs CEO David Solomon in March, appeared on stage at an FTX event this year next to Bill Clinton and Tony Blair, and counted Katy Perry, Gisele Bündchen and Tom Brady as friends. FTX was the first crypto firm to pay for the naming rights of a stadium – $16-million to the Miami Heat basketball team.
In hindsight, he made such an effort to appear respectable because there was nothing respectable about anything he was doing.
Second, the reality is that the scheme was only possible in the pandemic era of free money and ultra-low interest rates. As soon as rates started to rise, sending the value of his crypto collateral crashing, the game was up. The Federal Reserve and other central banks effectively kept FTX flush with liquidity. Now, with the tide moving out, it is clear that SBF had been swimming naked.
Beyond a lot of people losing unimaginable amounts of money, it is too early to tell what the implications will be. It calls into question the credibility of crypto itself. If you cannot trust one of the most important protagonists of the entire cryptoverse, then who can you trust?
Worryingly for those outside crypto, the links between SBF and traditional finance are profound. His business empire included up to $54-billion of illiquid investments such as in Elon Musk’s SpaceX. These will have to be fire-sold, putting even more pressure on already stressed valuations.
It remains to be seen if all this will cause a Lehman-style credit crunch. Let us hope not. Either way, this is the end of the road for crypto in its current state. Either it evolves and becomes more regulated and transparent, possibly subsumed by traditional finance, or it will simply cease to exist.
As with Dutch tulips, the South Sea Company and dotcom mania, a chapter on crypto will be added to the history of financial bubbles. One can only hope that such is the scale of this implosion that it will be some time before the next.