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What the FTX is going on?

Let me bring you up to speed if you missed the news. There is a Pompeii-grade meltdown happening in the cryptocurrency world.

FTX is/was a cryptocurrency exchange. In the past two weeks, it went from industry darling to catching a falling knife. Here’s a summary:

While there had been signs of trouble in the past, things really kicked off earlier this month when the world’s largest crypto exchange and FTX competitor, Binance, entered into an agreement to purchase FTX.

Shortly after due diligence started, Binance pulled out of the deal, indicating that FTX’s financials were so bad the company couldn’t be saved.

A run on the bank began as spooked users — FTX had over a million — started pulling their funds. FTT, FTX’s token, lost nearly all of its value.

The folks over at FTX also controlled a related quant trading firm called Alameda Research, which was heavily invested in FTT. Customer funds were loaned to Alameda (which was against FTX’s terms of service) to fund risky bets.

FTT and other tokens are not securities. They are currencies. There is no true-valued underlying asset, making it different from purchasing a share in a company. However, company-issued tokens like FTT often behave like stocks. When FTX was doing well, FTT went up. When FTX was not doing so well, FTT went down.

Back to Alameda, here’s where the real trouble lies. In exchange for the billions in loans, FTX, in part, accepted a significant amount of FTT as collateral from Alameda. Meaning the value of the collateral for the loan was dependent on the performance of the company giving the loan.

This would lock FTX and Alameda into a death spiral if FTT ever saw any significant decline in value. When Binance pulled out of the deal, that significant drop in value happened.

Poof.

On November 11, the Bahamas-based exchange declared bankruptcy and is said to be under investigation by (at least) the DOJ, the SEC, and agencies in the Bahamas.

To help understand the scale of this implosion, consider FTX co-founder Samuel Bankman-Fried (a.k.a. SBF). He saw his net worth plunge from its peak of around $26 billion to $0.

Last week, Sequoia Capital told its limited partners that it had completely written off its $214 million investment in FTX.

Why does this matter? One of the most shocking things about FTX’s fall from grace is the speed at which everything happened.

Queue the compliance officer.

Perhaps the single biggest complaint against compliance officers is that they slow things down. In FTX’s case, maybe a speed bump for them, and their investors, would have paid off. 

Or maybe not. 

FTX appointed a chief compliance officer in May 2022. According to research on LinkedIn, at least five individuals are in relatively senior compliance roles at FTX or affiliates. 

Sophisticated investors like Sequoia Capital also have high-ranking, talented compliance folks. 

Was this a perfectly executed Machiavellian power play by Binance to take out a chief rival? Was it greed or delusional thinking at FTX? Perhaps it’s a straightforward case of fraud? 

It seems strange that all of the compliance and due diligence functions from both FTX and investors over the years didn’t uncover what took Binance only a couple of days to allegedly find.

I have no idea what went haywire with FTX. It’ll likely take years to untangle, if it is even possible to know the whole story.

But in the meantime, maybe it’s worth contemplating the value of compliance officers getting in the way a little more, and complain about them slowing things down a little less. 

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