Is FTX insolvent? Why is Binance selling FTT? – Deep Dive

• Binance CEO CZ announced the exchange is dumping their FTT holdings following revelations about the Alameda/FTX relationship
• Alameda’s $14.6 billion of assets are 40% FTT, FTX’s native token
• There is minimal information about how Alameda’s $8 billion of liabilities are denominated
• Bankman-Fried founded Alameda and FTX but has defended the conflict of interest
• Volume of FTT is low – the illiquidity would prevent Alameda selling their FTT
• Alameda has offered to buy CZ’s FTT at $22 per token, as concern mounts that selling pressure will tank market
• CZ says it will take months to sell
• My question is why is crypto going through this again?
• We live in a blockchain world, how difficult is it to put all this on a blockchain?

Not again.

With PTSD from the contagion of the summer still prominent for crypto investors, when seemingly half the industry went poof, it’s now feeling like déjà vu. And who to play the villain role this time round, but only FTX, the supposed white knight who had stepped in to save the day with last-minute bailout offers of companies Celsius and BlockFi.

What happened?

Back in the day – and in crypto terms, that means only a couple of years ago – Binance helped incubate FTX, who today present as their biggest competitor.

They exited the equity position last year, receiving $2.1 billion for their tidy investment. But this wasn’t paid in cash, instead they received the payment split between the stablecoin BUSD and, crucially, FTX’s native token,  FTT.

The trouble is centred on the payment taken in the FTT token. CZ, Binance’s CEO, announced on Twitter that “due to recent revelations that have come to light, we have decided to liquidate any remaining FTT on our books”.

He added that “we will try do so in a way that minimises market impact. Due to market conditions and limited liquidity, we expect this will take a few months to complete”.

As part of Binance’s exit from FTX equity last year, Binance received roughly $2.1 billion USD equivalent in cash (BUSD and FTT). Due to recent revelations that have came to light, we have decided to liquidate any remaining FTT on our books. 1/4

— CZ 🔶 Binance (@cz_binance) November 6, 2022

What are the revelations about FTX?

CZ’s announcement is in response to a CoinDesk story about trading firm Alameda Research’s balance sheet.

Alameda is (sort of) a sister company of FTX, although the details are a bit murkier. The hedge fund/trading firm was founded by Sam Bankman-Fried, the same Sam who heads up FTX, who has long faced questions about the conflict of interest between these two companies.

Exchanges live and die by their liquidity, and it is the hardest thing to achieve when launching a new exchange. Traders will follow liquidity, but when you start with zero liquidity, you don’t get traders. And by definition, liquidity only comes from traders. So, it’s sort of like a perverse chicken and egg problem.

Bankman-Fried solved this chicken-and-egg problem by funnelling a load of Alameda’s trades through FTX, hence bootstrapping up the liquidity. Soon, FTX was off to the races, its growth phenomenal (launched only three years ago, with Bankman-Fried catapulted into the billionaire club in his twenties).

The questions surrounding a conflict of interest centre around what information Alameda sees on the market that regular traders don’t. Bankman-Fried has pushed back on this, but the reality is that Alameda is one of the biggest liquidity providers on the exchange and actively trading against customers. Assuming it is all honest, the conflict of interest is still easy to see.

Alameda is a liquidity provider on FTX but their account is just like everyone else's. Alameda's incentive is just for FTX to do as well as possible; by far the dominant factor is helping to make the trading experience as good as possible.

— SBF (@SBF_FTX) July 31, 2019

But there are other tangled storylines between the two. While they “are two separate businesses”, CoinDesk reported that “the division breaks down in a key place: on Alameda’s balance sheet, according to a private financial document reviewed by CoinDesk”.

Alameda’s assets summed to $14.6 billion on June 30^th, of which $3.66 billion was “unlocked FTT” and $2.16 billion of “FTT collateral”. I charted the asset breakdown below, which includes a heavy dose of Solana, the cryptocurrency that Sam Bankman-Fried was an early investor in and remains a vocal supporter.

Obviously, that is a pretty concerning balance sheet of intensely correlated instruments. But it’s really the FTT token that stands out, occupying a staggering 40% (between locked and unlocked allocations). FTT is, after all, a token created by FTX.

How concerning is the FTX token?

It’s not just the incestuous ties between the company, nor the fact that FTX was printed out of thin air and is now occupying 40% of the balance sheet. Because there is a liquidity problem here, too.

As I write this, the market cap of FTT token is $3 billion (according to CoinMarketCap)  and the fully diluted market cap is $7.9 billion. And now you see the problem – Alameda holds $3.7 billion of that market cap, alongside another $2.2 billion in “FTT collateral” – for which your theory is as good as mine because I haven’t a clue what that means.

Other assets mentioned in the CoinDesk report don’t quell the concern either. SRM is one, which is the native token of the Serum decentralised exchange founded by, you guessed it, Sam Bankman-Fried.

There are three other tokens mentioned – MAPS, OXY and FIDA. I won’t pretend I know much about those, but that in itself sums up the problem. Again, these are highly illiquid – a lot more so than FTT.

And so, the big question points towards liabilities. FTX have liabilities on their balance sheet totalling $8 billion, of which $7.4 billion are loans.  I couldn’t track down any more information on them, but there is no doubt that this figure presents as worrying when compared to the illiquid asset side analysed above.

It should be mentioned that FTT is mentioned among the liabilities. This would soften the fear considerably, as the same issue of “phantom” assets could then apply to the liabilities side.

But we have no idea what the bulk of the liabilities is denominated in. While I don’t think for one moment that Alameda could be insolvent, the doomsday scenario is a liability side full of fiat, as the asset side simply cannot be liquidated en masse to meet liabilities. Arguably, it is erroneously overstated given the ties to FTX  and the fact that FTT can be printed out of thin air and has such low liquidity.

That chart says it all. Daily volume over the last 6 months averages $25 million, before the ramp-up this week as this story has begun to get airtime. There is quite simply no way that Alameda can liquidate a meaningful chunk of its FTT holdings without tanking the market price. Therefore, its assets on paper vastly overegg what they are worth in real life.

So what happens when Binance sell?

So, CZ is spooked by the revelations around the FTT token. A perceived lack of underlying value is one thing, but creating it out of thin air and using it to prop up balance sheets is another. So in comes the sell order.

Interestingly, CZ gave the cryptic tweet that “we won’t support people who lobby against other industry players behind their backs”, suggesting there is more to it than concerns about the Alameda /FTX relationship.

Liquidating our FTT is just post-exit risk management, learning from LUNA. We gave support before, but we won't pretend to make love after divorce. We are not against anyone. But we won't support people who lobby against other industry players behind their backs. Onwards.

— CZ 🔶 Binance (@cz_binance) November 6, 2022

And while we don’t know what amount of Binance’s $2.1 billion equity payout from FTX is denominated in BUSD and FTT, there is no doubt it is substantial compared to the liquidity trading on the market – with $500 million the rumoured total.

This is why Alameda CEO Caroline Ellison waded in with an offer to buy CZ’s total bag of FTT at a price of $22 per token. At time of writing, the market price is $22.20. CZ had acknowledged the liquidity situation by stating it would take a number of months to complete the sell order.

@cz_binance if you're looking to minimize the market impact on your FTT sales, Alameda will happily buy it all from you today at $22!

— Caroline (@carolinecapital) November 6, 2022

She also had earlier moved to clarify that the balance sheet referenced in the CoinDesk report was incomplete, although this did not dissuade CZ from selling.

My thoughts

As is commonplace here, there is a frustrating lack of clarity here.

Ellison’s comments that the balance sheet is incomplete show this. But let me ask this – in an industry built on the blockchain, why is there so often a problem with transparency? Why can’t we have these big players present their holdings and balance sheets on-chain for all to see?

We saw the same during the Terra fiasco, with nobody certain of what capital the Luna Foundation Guard held, who were deploying Bitcoin desperately to defend the collapsing peg.

And again – also déjà vu here – the whole thing is more incestuous than a Lannister family gathering. Alameda holding FTT tokens, launched by FTX, which was invested in by Binance, who got paid out in FTT. From the outside looking in, this is madness.

It was the same with Three Arrows Capital holding Luna. And BlockFi had exposure, too. And then Celsius and Voyager Digital. And the list goes on. They all had exposure to each other, Terra and a tanking Bitcoin – a nasty downward spiral that fell like a house of cards.  

I don’t think this is the case here. FTX seem OK and I believe Alameda do have their ducks in a row. But the information above is concerning, and it’s ridiculous that I even have to speculate on this in the first place. Not to mention the tangled link between the two is unhealthy for all involved.

This is just a guess. Of course, we have no information on the liability side of Alameda’s balance sheet. If it is $8 billion of fiat, then there could be a problem. But again, we don’t know.

This is crypto, so why can’t we just stick it on the blockchain and stop having to opine about it on the Internet? We have seen this movie too many times and it’s getting tiring.