“Only when the tide goes out do you discover who’s been swimming naked.” — Warren Buffett
The comedy classic A Shot in the Dark aired in 1964. It stars Peter Sellers as Inspector Jacques Clouseau, an idiotic French policeman. Clouseau visits a nudist colony as part of a murder investigation in one scene.
The scene was shot 58 years ago but it could be a precursor for crypto exchanges. Investors have been found with their pants down.
A crypto exchange is a platform where you can buy and sell cryptocurrency. It is like the stock exchange, except that it does not have a physical location. The crypto exchange is supposed to have strong security features and liquidity.
On Tuesday, the crypto world was shaken by the collapse of one of the world’s largest exchanges. FTX was once valued at US$32 billion ($44.77 billion) at the start of the year. It announced that it had entered into an agreement to sell out to Binance, its largest competitor.
FTX has been unable to meet its obligations in the last few days. It faced US$6 billion of withdrawals in the last 72 hours. This is at least 600 times the average withdrawal on a typical day.
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FTX’s founder is 30-year-old Sam Bankman-Fried. SBF, as he is popularly known, has been the symbol of the industry. He has appeared in conferences outshining Bill Clinton and Tony Blair. SBF sports shorts in these events while others wore suits.
The exposure of his knees could be a metaphor for FTX’s naked risk. The unravelling has been swift and sudden. It escalated once rumours surfaced about Alameda Research. Alamada Research is a sister company of FTX. It was a hedge fund that was founded by SBF before he started FTX. FTX and Alameda are tightly knit.
A leaked financial statement showed that Alameda Research was tottering. It appeared that the core of Alameda’s assets was a cryptocurrency known as FTT. FTT was concocted by SBF as a token to be used on its platform. The players of the board game Monopoly may recognise this currency. Monopoly money is legal tender only for others who play the game. You would be hard-pressed to buy beer with FTT.
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It suggested that FTX was yet another cryptocurrency with feet of clay. A fall in FTT prices could wipe out FTX.
The Binance founder, Changpeng Zhao (who prefers to be known as “CZ”) acted promptly. He sold his FTT positions. The price of FTT fell 63%. Bitcoin and Ethereum dived too. Investors rushed to liquidate their positions in FTX. The run on FTX left it with no option but to try sell to Binance.
The unravelling is ironic. FTX has been viewed as the most efficient of the crypto exchanges. It operated from its headquarters in Bahamas, where its employees were lavished with massages.
SBF, the son of Stanford law professors, has been a passionate advocate for crypto regulation. He has spent US$30 million funding Democratic candidates.
The latest reversal comes on the heels of a devastating year for cryptocurrencies. Bitcoin is down 65% YTD. FTX has itself been bailing out others in the industry.
The collapse questions the very foundation of crypto exchanges. It appears that the exchanges are trading other people’s tokens. There is little substance in the tokens when sentiment collapses.
Binance, the big daddy of crypto exchange, is itself vulnerable. CZ has vowed not to repeat FTX’s fallacies. For instance, the crypto assets would be backed by liquid assets.
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The Securities and Exchange Commission (SEC) has probed Binance. It operates a skeleton operation in the US. Most of its operations are lightly regulated.
It trades US$76 billion in crypto, which is a third of the market. The Binance bailout has fallen through. FTX is looking for alternatives. The fear is that the bailer could be the last man standing. Who would bail out the bailer?
Matt Milsom of Qantex Capital Markets is a crypto trader in Singapore. He urges investors to go long on Coinbase Global, which is a crypto exchange operating in and listed in the US. It could benefit from FTX customers moving over. Companies with crypto assets on their balance sheets could be on thin ice. MicroStrategy is a tech company with a Bitcoin portfolio of US$2.5 billion. The bitcoin holding is larger than its market capitalization of just under US$2 billion.
In the film, Inspector Clouseau avoids looking at others in the nudist colony. He discovers a naked corpse in the bushes. There may be more dead bodies in the crypto world.
Nirgunan Tiruchelvam is head of consumer and internet at Aletheia Capital and author of Investing in the Covid Era. He does not hold any position in the stocks mentioned in this column
