Today, Explained - The FTX cryptocalypse

Episode Date: November 15, 2022

With the collapse of one of its largest exchanges, crypto’s having its very own Lehman Brothers moment. Semafor’s Liz Hoffman explains the repercussions for the real world. This episode was produced by Miles Bryan and Amanda Lewellyn, edited and fact-checked by Matt Collette, engineered by Paul Robert Mounsey, and hosted by Sean Rameswaram. Transcript at vox.com/todayexplained   Support Today, Explained by making a financial contribution to Vox! bit.ly/givepodcasts Learn more about your ad choices. Visit podcastchoices.com/adchoices

Maybe a year or two ago, your friend started buying crypto. Oh man, I just got 1 85th of a Bitcoin right now. And then you notice celebrities endorsing crypto. Fortune favors the brave. And then your dad was telling you he got a bunch of crypto. Hey. Hey, Harvey, what's a doge? And then you couldn't take it anymore.

And you were like, maybe I should get me some crypto. I don't think so. Well, if you didn't, a crypto exchange called FTX just gave you a reason to pat yourself on the back. New chaos in the world of cryptocurrency. FTX shocked investors by declaring bankruptcy this week. It spent millions making sure its name was seen and known. FTX now under federal investigation and its founder taking responsibility there was a run on the bank because its customers lost confidence in the entire system the cryptocalypse is coming on today explain

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years of age or older to wager. Ontario only. Please play responsibly. If you have any questions or concerns about your gambling or someone close to you, please contact Connex Ontario at 1-866-531-2600 to speak to an advisor free of charge. BetMGM operates pursuant to an operating agreement with iGaming Ontario. Perhaps you, like many of us at Today Explained, have been wondering, what the hell is going on with crypto all of a sudden? So first of all, there's like a succession level human drama here. I have you beat, you morons. One rival destroying another. You've got financial chaos. You've got exotic locales. This is going to be a movie and probably a good one.

Liz Hoffman has been following the story for a brand new news outfit called Semaphore. I think you don't need to either understand crypto or care about it to like understand and care about this story. There was a run on the bank. New chaos in the world of cryptocurrency. FTX shocked investors by declaring bankruptcy this week. It spent millions making sure its name was seen and known. Crypto pioneers for the last decade have been talking a big game about how they have created their own financial system. The one that you know that we all live in is rigged

and it's unfair and they are living outside of it and building a parallel one that will be the sort of financial utopia. They have not done that. The gravitational pull of the basic laws of finance continue to apply. And that's what brought FTX down last week. And a lot of people probably hear FTX and think WTF. What is FTX and why is it so important? FTX is or was a large cryptocurrency exchange, kind of like the New York Stock Exchange, but for tokens like Bitcoin and Ether and then all the like goofy ones you've heard about over the last year or two. You might be wondering why you've heard that name. and the answer is that they've splashed their name everywhere so they own the naming rights to the miami heat stadium huh it's the first time the

arena will have a different name in two decades ftx ftx you gotta remember that yes they took out super bowl ads including a delightful one that now seems pretty prescient with Larry David just like not buying the whole premise. Like I was saying, it's FTX. It's a safe and easy way to get into crypto. I don't think so. If you watch the World Series, they sponsored the umpires. The FTX logo was on the umpires uniform. So they have spread their money around in like huge advertising blitz, trying to sort of become the name brand of crypto.

We've known it as the FTX Arena for a little over a year, but that name will soon change again. Photos from overhead show crews already removing the giant FTX logo after the company abruptly announced it would be filing for Chapter 11 bankruptcy. And there's one dude behind FTX. Yeah, Sam Bankman-Fried.

My name is Sam and this is my story. Sam has crazy hair. Sam is vegan. Sam sleeps five hours a night. Sam lives in the Bahamas with 10 roommates, but Sam has $22 billion. Everyone in crypto land calls him SBF. And basically, like two years ago, no one had ever heard of this guy. And now he's fairly ubiquitous. I should say right up front, Sam Bankman Freed is an investor in Semaphore in my company. And Vox's Future Perfect received a grant from his foundation too? Yeah, he kind of came out of nowhere. He was at MIT.

He took over this sort of small brokerage firm a couple years ago and basically rebuilt it as a crypto platform. And by all accounts, like a pretty technically impressive one and certainly one that just got very big, very fast. Why create an exchange when there were already so many big global players out there? Yeah, I mean, the basic answer is that we didn't think any of them had nailed it. It made him, on paper, fabulously wealthy. FTX, in its last fundraising round, was valued at $32 billion. Even if you've never paid any attention to crypto, you've probably heard his name as a huge political donor to Democrats almost exclusively. You're on a list that includes George Soros, Ken Griffin, Richard Uline, Peter Thiel just below you.

Why did you decide it was politics and not something more charitable? I think that what it really goes down to is two things. And the first is that policy really matters, right? He was also the face of crypto in Washington, right? It was a fixture on Capitol Hill. And he just like seemed like the one who was going to take this from the goofy, outer, vaguely criminal fringes into the mainstream financial system. So I think like getting regulatory clarity is huge.

And I think it's good for everyone. I think it gives customer protection that we're missing right now, real federal oversight, protection against financial crimes, against systemic risk. So I think it's a win-win. He maybe has like a nemesis in this story? His nemesis in this story is this guy who goes by CZ, and he's the CEO of a rival crypto exchange called Binance. Huh. Zheng Pengzao has gone from flipping a burger in McDonald's to founding Binance,

now the world's largest cryptocurrency exchange. CZ had a different view than SBF, which is that crypto should really stand on its own. It shouldn't be integrated into the system. It should really replace it. In an industry where there's less regulation, it's actually more important for you to do the right thing. So sometimes regulation is very tricky

because there's 200 different countries, each one slightly different. But the right thing, people would apply the common sense, and it was quite easy to figure out. He was certainly not a public face, like much more the rebel. You know, Sam Bankman-Fried once had taunted him on Twitter saying, are you even allowed to be in Washington, D.C.? Which was a sort of a dig on his foreigner status. It's important to note, though, you know, their story started a couple of years ago when Binance invested in FTX. It was an early backer.

And by all accounts, Sam and CZ were fairly friendly. But FTX started to get very big and Binance started to see them as a competitor. They kind of became frenemies and then, frankly, towards the end, straight out enemies. And CZ is the reason that we are here. Okay, so tell me how this amicable relationship gets competitive. So FTX starts to get very, very big. And what looked like a fun investment by Binance and this sort of goofy little competitor that, you know, might be interesting one day, might be valuable one day, started to be really competitive. At some point a few years ago,

Sam Bankman-Fried said, you know what, I don't really want my biggest competitor to be really competitive. At some point a few years ago, Sam Bankman-Fried said, you know what, I don't really want my biggest competitor to be an investor in my company. And so he bought Binance out. Importantly, he did not buy them out with cash. He bought them out with tokens. So FTX launched this token. What is the FTT coin? FTT is the native token of the FTX launched this token. What is the FTT coin? FTT is the native token of the FTX exchange. Holders of FTT are entitled to cheaper trading costs and collateral for futures trading. It's funny money. It's money that you can use within the FTX universe and may have some value on its own. Bitcoin is also a token.

It's been around long enough that people see that it has some inherent value. You might remember Dogecoin just like went crazy last year for like utterly no reason. Binance ended up with like $2 billion of this token called FTT, the FTX token. And last Sunday, just a week ago, CZ tweeted that he was going to sell it. It was a little unclear. He seemed to be referring to an article that was published, you know, a week before by Coindesk, claimed they had some leaked financials from FTX's trading arm, this firm called Alameda Research, that suggested some weird ties between FTX and its trading arm, this firm called Alameda Research, that suggested some weird ties between FTX

and its trading arm. Effectively, if you read through the story, and they were careful, but the implication was that Sam Bankman-Fried was sort of propping up this failing hedge fund that he owned by stuffing it with these tokens that he had issued. Like, just like a real house of cards situation that appears to have made, you know, Binance pretty nervous. And so they said, we want out of this thing. And that is how every run on the bank starts. Don't look now, but there's something funny going on over there at the bank, George.

Which is that someone gets nervous and asks for their money back. And that's what happened here. I've never really seen one, but that's got all the earmarks of being a run. How does it play out? Well, the first thing that happens is that the price of that token collapses. You know, FTT was trading around $20, $25 a share. It just totally falls out of bed. And so then anyone else holding that token is like, oh, I don't want to own this either.

So they all try to sell. The first I heard of this story was on Tuesday morning. I started getting calls from people saying Sam Bankman Freed is out there looking for a billion dollars. He is calling rich people. He is calling investors. He needs money. And that is how you know people are desperate. That was really the start of the unwind here.

Does he get his billion dollars? No, no one will give him any money because financial investors are fairly savvy. And they looked at this and said, nope, like that is a hole and it is getting bigger. I'm not putting money into it. You know, by noon on Tuesday, I'd heard the hole was somewhere around five or six billion dollars. It looks now to be closer to $10 billion. I mean, just a ton of money that they were supposed to have that they don't. And so, you know, very quickly, Sam inked this sort of very hazy handshake deal to be sold to Binance, our tribal.

CZ, the CEO of Binance, tweeting that FTX, he says, this afternoon FTX asked for our help. There is a significant liquidity crunch. It was not a firm deal. And you could see it sort of in their tweets. Sam is saying, this is such a great outcome. You know, we're going to be united with this world-class firm.

And CZ is like, oh, no, no, no, no. Like this deal is extremely like subject to, no, no, no, no. This deal is extremely subject to us getting in there and looking at stuff and really trying to walk it back. And once they did get in there and start looking at FTX's books, they bailed immediately by Wednesday. Binance have any sense of this when he knew that by dumping this token, he would raise a lot of doubts about FTX's solvency and could potentially buy his rival on the cheap. I don't actually buy that theory because this is incredibly bad for the entire industry. And CZ is smart enough to have seen where this was going to end. You know, there is a reason that airlines don't compete on safety.

They compete on a lot of things, but they don't compete on safety. And that is because if a Delta plane crashes, that's not a good day for United Airlines. People don't fly United because they think they're less likely to crash. They stop flying. And so I do not buy the theory that this was all orchestrated by CZ to take down a rival, but there are plenty of people on the internet who do. It sounds like a very tumultuous, if not like the worst week for crypto ever. Where does it end? So, I mean, it hasn't ended yet.

So Binance pulls out of the deal on Wednesday. On Thursday, Sam Bankman-Fried goes on Twitter and has this long thread, the gist of which he starts by saying, I f***ed up. And then has like a lot of sort of financial tap dancing about, we thought we had this much money and it turns out we didn't. But never gives like a plausible explanation for where it went. He's tweeting through it, right? Like his world is utterly collapsing around him and he's tweeting through it. FTX has filed for bankruptcy in federal court, and that will be a pretty traditional process of figuring out where the money went

and how much is left and who it's owed to. I should say Sam Bankman-Fried has not been indicted. He has not filed for bankruptcy. I would imagine that one or both of those things is probably going to eventually happen. None of that has happened yet. More with Liz Hoffman in just a minute on Today Explained. Support for Today Explained comes from Aura. Thank you. directly from your phone to the frame. When you give an AuraFrame as a gift, you can personalize it, you can preload it with a thoughtful message, maybe your favorite photos.

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And to top it all off, quick and secure withdrawals. Get more everything with FanDuel Sportsbook and Casino. Gambling problem? Call 1-866-531-2600. Visit connectsontario.ca. Today Explained, Sean Ramos from back with Liz Hoffman from Semaphore. Liz, I think a lot of people out in the world who aren't investing in crypto feel like it's all smoke and mirrors and far too wild of a West. And this story sort of confirms it. But you're telling us that these are like the two biggest players in crypto.

How is this all so fake? It is like a tale as old as finance. This is exactly what happened with Lehman Brothers in 2000. Strip out the wallets and the tokens and the weird crypto jargon. This is exactly what happened with Lehman Brothers. When Lehman Brothers collapsed, 26,000 employees lost their jobs

and millions of investors lost all or almost all of their money, triggering a chain reaction that produced the worst financial crisis and economic downturn in 70 years. It's exactly what happened with Washington Mutual. WAMU didn't just make loans that were likely to fail, creating hardship for borrowers and risk for the bank.

It also built a conveyor belt that fed those toxic loans and mortgages into the financial system like a polluter dumping poison into a river. It's exactly what happened in 1929, which is that people got out over their skis. There was a loss of confidence in the system, and it was a run on the bank. You know, no financial institution has their customers' money in a lockbox. That's not how it works. They lend it out. They invest in things. But there's all these rules that try to keep them on the rails. They're supposed to have a certain amount, like, on hand that if you showed up at the bank tomorrow and said, I'd like my deposits back, they would give it to you. If they couldn't, that would spark a

massive panic. And that's basically what happened here. It's a little less clear where the money went and if there's underlying criminality. But the way that this unraveled is just very basic financial stuff, which is why the story is interesting to me, because again, crypto bros claim to be like living outside of the system. Like you're a bunch of schmucks. You're being lied to and used by the man. And we are creating this brand new financial system from the ground up that will be egalitarian and utopian and it'll be great. I think the most beautiful thing about it is there's no one person setting the direction. And there's no one person on the other side that can stop it.

But, like, there is no escape velocity. Gravity still applies. And they got taken down by a very basic problem, which is that they ran out of money. I want to be careful here because no one has been accused of a crime. But the reporting that's emerged is that they just took their customers' money and put it in their own pocket. It's a little more complicated than that, but that they lost money speculating on crypto. And rather than just own up to it and eat the loss, they said, well, we have all of this customer money over here in the exchange. All of these people bought tokens from us and it's just sitting there. What if we took it, solved our trading loss, but we're making so much money that we'll be able to

pay them back and no one will ever notice? And that is the moment that this started to unravel because you think you can stay on this treadmill and it works as long as everything is going up and everyone is making money. No cracks start to emerge. No one like pokes too closely at it. But CZ, when he went to sell this, that was the crack. And that took out the entire house of cards. And you're comparing this to Lehman Brothers and Washington Mutual, which is to say the Great Recession. Who gets screwed here and how screwed do they get? There's two buckets of people who get screwed, and they both get screwed pretty badly. I mean,

like an analogy that might be helpful here is, I'm like a child of the 80s and 90s, like Chuck E. Cheese. And you would give them money. You would buy tokens when you walked in the door. And then you would use tokens for all kinds of fun stuff at Chuck E. Cheese. And when you left, if you had tokens left, you could give them back and they would give you some money back. Right now, when mom buys 40 game tokens at Chuck E. Cheese's, we'll give you 40 more for free. It's double token time. Double the games, double the fun. Right? If you had a bunch of tokens, you were like a superpower user of Chuck E. Cheese,

you've kept a bunch of your net worth in Chuck E. Cheese tokens because you go there all the time. If Chuck E. Cheese went bankrupt, you would lose a lot of money because you're holding all of these tokens that you had sort of intended to use in the system or to exchange for cash, and they're worthless. That is the people who bought FTX tokens, so crypto bros, right? Largely outside the U.S., I should say. The other group are the people who own Chuck E. Cheese, right? These are FTX's investors, and they had raised money from like a who's who of Silicon Valley. These big venture capital firms, one of whom, you know, Sequoia last week had invested in this at a valuation of $32 billion, wrote down the stake to zero.

So they will lose money. Their investors are pension funds and university endowments. So there is some knock-on effect here. I don't want to belittle the losses that real investors are going to take. That said, I don't think this is like a contagion. I don't think this spills over into the broader economy. And in part because like,

by design, crypto was not plugged into the economy. The crypto entrepreneurs were so disdainful of the traditional economy and the traditional financial system, that they largely live outside of it. The thing about Lehman and AIG and those firms in 2008 is that they were incredibly plugged into the regular financial system in ways that people didn't appreciate. It was like, oh, AIG is just like an investment bank. They're doing their Wall Street-y stuff. But no, it turns out they had depositors and, depositors and customers like all over the financial system. Everything was massively intertwined. There was a ton of debt.

And so when the thread got pulled, the entire sweater unraveled. This is the largest bankruptcy in the world. What were the effects? The effects were the financial disaster that we are living our way through right now. And who got hurt? Everybody got hurt. The entire economy has suffered from the fall of Lehman Brothers. So the whole world?

Yes, the whole world. I don't see that happening here. I do think, you know, we're talking a lot about crypto winter. I think this is probably a crypto ice age that's coming. And people will lose money and the entire industry. To the extent you think it has some long-term value, I'm like still sort of agnostic about that. I don't know. This is a very bad day for that. Do we think the government's paying attention to this? Is there a chance that crypto becomes more regulated as a result of this massive fallout? Yes. And I think the government really wishes they had paid more attention a year

ago. This was a little bit of a jump ball in Washington, D.C. It was a little unclear, like, who was supposed to be looking at it because, you know, there's one school of thought which is like, no, this is just like a stock or a bond by another name. It should be regulated like any security that you would buy or sell. The other one is like, ah, it's like more like gold or like cattle. Like, it's a little more of a commodity. No one could really figure out what it was. And so the upshot is that it just wasn't very heavily regulated. If I buy Bitcoin, am I buying a share of stock? Or am I buying a pork belly?

Or am I buying euros? Or are you buying air? Oh, wow. Okay, you're going in. I'm going in. Yeah, what is it? There were certain things you couldn't do. You couldn't market tokens to U.S. Okay, you're going in. What is it? I'm going in. Yeah, what is it? There were certain things you couldn't do. You couldn't market tokens to U.S. investors, which is why most of FTX's clients were abroad.

But I think there's a very good argument for me that regulators were asleep at the switch, very slow to act. I think that will change very quickly. How do you think crypto recovers from this moment where, I don't know, it kind of felt like it was confirmed that the emperor indeed didn't have any clothes? Emperor extremely naked. There's a chance that it doesn't. Oh. There is an argument to be made that there is fundamentally value in the technology. That the financial system, that it is just incredibly inefficient and that it's just like dumb and relies on a lot of paper and a lot of trust. And that you could build a more efficient kind of trustless system where the code did the jobs that, you know, hundreds of thousands of people in the financial system do. I think there's some value in that and I think that the underlying technology will probably continue to exist and evolve here. I'm not sure that there is any need for, like, these goofy tokens.

Free tokens won't last forever. So remember, Chuck E. Cheese, please. So there are some, like, good pieces of the technology, and I think those will be fine. You know, go back to 2001. Like, a lot of the dumb dumb.com companies got washed out but like it laid the foundations of fiber optic cables and broadband and e-commerce and you know amazon was the winner there but eventually someone will come in and look at the wreckage and say you know what these are the good pieces i'm willing to put some real institutional grown-up money behind it.

And they'll start to rebuild. today explained.