Reminiscences on my experiences with FTX. Could have escaped 100% but ...

Originally published on Feb 18, 2023

In an earlier post, I wrote about how I made a stable income on FTX before the whole fraud unravelled. It is easy to learn the wrong lessons in investing because an investor can make money despite being very wrong. Customers of FTX who escaped with some profits should not gloat about it. They were wrong and should count themselves as lucky. I was lucky. Regardless of whether the outcome was good or bad, this disaster calls for post-mortem reflections.

Right till the end, I never suspected Sam Bankman-Fried (SBF) to be a fraud even when the bank run was intense. I was duped. Thankfully, I assumed that crypto was unsafe and was constantly on alert to look out for warning signs.

I registered as an FTX customer in 2021. From the beginning, there were already signs that something was wrong. When I wired money to FTX Blockfolio last year, the recipient was "Alameda Research". Alameda was SBF's hedge fund. SBF was the biggest shareholder of both Alameda Research and FTX. At one time, Alameda was the biggest trader on FTX. This was a huge conflict of interest. Although Alameda was the main market maker in FTX, SBF had long insisted that the two businesses operated independently of one another. How can the two businesses be independent of each other when both can access the same bank account?

I chose to ignore this warning sign. As long as FTX does not go bankrupt, my delta-neutral positions at FTX will be safe. My main concern was counterparty risk. SBF doing shady stuff with Alameda does not affect my style of trading as long as FTX is financially sound and in no danger of collapsing. It was not unreasonable to expect some shady business in an unregulated industry, particularly one that deals with money. I was prepared to take this risk.

There was something about SBF that made me worried. He appeared on the cover of several prominent business news magazines. There have been past instances when appearing on the cover page marked the peak of a CEO's career. In some cases, the CEO turned out to be a fraud! Hello, Elizabeth Holmes and Sam Bankman-Fried.

I even warned SBF on Twitter about the cover page curse 3 months before the collapse out of concern for my money on FTX. He probably did not notice as I am a nobody.

https://twitter.com/ajs/status/1554101866581184512

I monitored FTX news on Twitter closely. If you want up-to-date news about crypto, Twitter is the place to go, not mainstream media. By the time news hits mainstream media, it is too late.

One fine day on Twitter, I came across this news article from Coindesk. It rang the loudest alarm bell about FTX. Alameda had a highly questionable, weak balance sheet. On the surface, the balance sheet looked fine with $8 billion in liabilities backed by $14.6 billion in assets. On closer look, much of its assets were FTT tokens and FTT are printed by FTX itself. $2.16b of the FTT was used as collateral and if the price of FTT crashes, Alameda will be liable for a big margin call. If Alameda falls, the contagion will spread immediately to FTX given their close links.

Now, I had a useful and easy reference point to monitor FTX counterparty risk. This critical reference point was the FTT price. If FTT starts to fall at a worrying pace, get the hell out of FTX. I relied on Luna and UST prices as warning signals to get the hell out of Anchor. Relying on market signals to get out of danger has saved me several times in the past and it did not fail me this time. This explains why my blog name is "Market Observer".

In hindsight, I should have withdrawn my funds from FTX when the negative news article from Coindesk was released but I did not. The lending rate of some coins in my crypto portfolio spiked up around that time. I remembered DOGE lending rate at FTX.US even shot up to 2000% during one particular hour near the end of October. The funding rate for perpetual futures also went positive. I was earning good interest from both lending spot tokens and shorting perps in my delta-neutral trades.

Before the FTX collapse, FTT had a relatively smaller price fall than other cryptocurrencies in the crypto bear market. The relative price strength of FTT gave me some confidence that Alameda was safe at the moment. I decided to wait for SBF's response to the damning Coindesk news article which was published on Wed, 2 Nov 2022. By Sunday, there was still no reaction from SBF. The part that made me most nervous was that the FTT price had started falling fast. Between Saturday afternoon (5 Nov 2022) and Sunday afternoon (6 Nov 2022 Singapore time), FTT fell more than 10%. This is a large amount compared to its normal volatility.

At this point, I decided to get the hell out of FTX on Sunday afternoon.

One alarming aspect of Alameda's balance sheet was that the sheer amount of FTT held on Alameda's books itself exceeded the total market capitalization of FTT in public circulation. Alameda and FTX had an interest in supporting FTT price. They certainly were not selling FTT. I believe most retail investors' FTT holdings were staked at FTX to enjoy lower commissions and other platform benefits like mine. So, they cannot be the ones selling. I wonder who was selling down FTT that weekend to cause the rapid price fall. Whoever it was, it was probably a big whale. The answer was out by Sunday night.

https://twitter.com/cz_binance/status/1589283421704290306?

 With a small public circulation and a large whale who wants to sell out everything, FTT was toast.

When CZ's tweet triggered a bank run on FTX, I was not out yet. It took me several hours to unwind my delta-neutral positions on FTX. I had to unwind bit by bit to get a good exit price and each time, I had to wait for the right trading set-up to exit. I slept only 2 hours that night.

I was only able to withdraw a fraction of my funds from FTX to my DBS bank account. Most of the money was still stuck in the withdrawal process as reflected on FTX webpage after 12 hours. By this time, there was an intense bank run going on. My body was shaking.

My engineering training instilled in me the good habit of building redundancy into a system to ensure reliability. Always have backup systems ready. Thus, I had other crypto exchange accounts as a ready backup for fund deposit in case I want to withdraw funds from FTX urgently one day. I turned to withdraw the funds to my backup crypto exchange accounts instead of the DBS account. Again, the withdrawal was always stuck in progress on the FTX webpage. My heart rate shot up.

I took a few deep breaths. I remembered when I was self-learning how to write smart contracts, I could view coin withdrawal status on the blockchain. When I looked at the transaction status, it said something like "Error. Insufficient funds." Hmm ... maybe the amount I tried to withdraw was too large. So, I cancelled the withdrawal ticket on FTX and initiated another withdrawal with a much smaller amount. This time, the withdrawal went through after waiting for about 15 minutes. I still remembered this was on Monday night (7 Nov 2022 SG time). By withdrawing bit by bit each time, I managed to withdraw most of my funds by the next morning (8 Nov 2022 SG time).

I could have withdrawn everything but I did not. Why didn't I?

Just 1 week before the FTX collapse, FTX made an announcement that caused me to believe they were not scammers running a Ponzi scheme.

 

https://twitter.com/FTX_Official/status/1587249585885679616

Prior to this announcement, customers were earning a 5% yield on the first USD10m worth of cryptocurrencies in the FTX Earn programme. With this announcement, the 5% yield is limited to only the first 100k. Big whale customers who had millions in their FTX account to enjoy the 5% yield would be withdrawing down to $100k since the yield has dropped to zero beyond $100k. I thought if FTX were running a Ponzi scheme, they would not have made this policy change as it would cause a mini bank-run among their whale customers. Ponzi scammers will be hatching plans to attract more funds instead. Hence, I deliberately left some funds on FTX even though I could have withdrawn everything during the bank run that caused their collapse. My funds are now stuck and I have written them off to zero.

Many people thought CZ's tweet was the trigger that caused FTX's collapse. Sometimes, I wonder if the tweet announcement on the FTX Earn 100k limit was the one. FTX will be vulnerable to a bank run after this announcement because the whales will be withdrawing. If an enemy is waiting for an opportunity to strike, this will be it. The very next day on 2 Nov 2022, Alameda's weak balance sheet was leaked in a news article, highlighting how vulnerable they were on FTT token price. 4 days later, a major competitor struck at the heart of FTX's weakness by announcing they are selling down their FTT holdings. 5 days later, FTX declared bankruptcy.

I am not implying that this enemy caused FTX to go bankrupt. CZ was the trigger, not the cause. The root cause was SBF himself.

I am still puzzled today why FTX made this policy change to limit the 5% yield to the first $100k. Hopefully, someone can explain this mystery to me one day.