Dear friends, customers, investors and team,
If you’ve been on Crypto Twitter lately or read any financial media, you’ve probably seen the FTX fiasco unfold right in front of you. The price of Bitcoin dropped to its two-year low of $15,660 and the total market capitalization of digital assets almost 1 trillion during the last couple of days. But what exactly happened over the last few days and why did it have such a huge impact on the crypto markets?
Recent events leading to the FTX collapse
Last Wednesday, CoinDesk published an article citing some balance sheet numbers of Almeda research, which is the investment and trading arm of FTX exchange. The article said they received it from a leaked “private document”.
According to this article, of the $15b presented on the balance sheet, only 130m were in fiat, the biggest part of the assets was in “unlocked” FTT with $3.6b in value and the third largest asset class was in “FTT collateral” around $2.2b. In short, the majority of the net equity of Almeda research was its own token.
The article started to ripple waves in crypto space as people start to worry about solvency of Alameda Research and FTX exchange.
The following Sunday, Binance CEO, Changpeng Zhao, who goes by CZ, announced in a tweet that Binance will liquidate all its FTT token holdings due to “recent revelations” hinting at the CoinDesk article about Alameda Research. Back then he held 23 million FTT tokens worth around $500 million. It is clearly quite a large position, as it makes up about 17% of the total circulating supply of FTT token.
Upon this announcement Almeda Research offers to buy FTX tokens at the fixed price of $22, in order not to impact market price. But this offer gets declined by CZ, saying that they will rather sell it on the open market.
This leads to traders starting to panic and rush to withdraw their assets from FTX. The fear and withdrawals spread like fire, joined by large stakeholders such as Nexo and other institutions. In total the withdrawals reached $5b on Sunday alone, according to FTX CEO.
On that same Monday, the CEO of FTX exchange Sam Bankman-Fried, who goes by abbreviation SBF tweeted:
“FTX is fine; just a competitor is trying to go after us with false rumours. We have 1 billion excess cash.”
This did not help much to limit the full bank run on FTX and people continue to ask for withdrawal.
One day later, on Tuesday, Sam came out with announcement that FTX made a strategic agreement with Binance. At the same time Binance’s CZ retweets saying:
“FTX asked for help due to liquidity crunch, so we signed non-binding LOI (letter of intent) to acquire FTX.”
Everyone watching this event develop live on Twitter is shocked. Did Binance just crush FTX? How could such a player as FTX so mismanage their balance sheet. How could a liquidity crunch of such size happen so fast? We were all watching this storm unravel in shock.
The surprise was even greater, as during this year FTX became a lender for the last resort, bailing out other crypto companies which went bankrupt impacted by Terra LUNA collapse. The algorithmic stable coin reached $41 billion market cap at its peak in April 2022. As it exploded many hedge funds, lenders and even some exchanges who held LUNA were wracked and had to seek bankruptcy protection or shut down. FTX, acting through Alameda Research, appeared as a white knight buying up the largest failed players such as Celsius, Voyager Digital and BlockFi. The reason for these purchases was partially that FTX was deeply involved with these players on the lending side and their full collapse would harm FTX even more. So they took them over. But this did not de-risk the whole structure. The black hole torn by Terra had to be closed somehow. To finance it, Alameda Research put their own token, FTT on the asset side, using it as collateral. In addition FTX obviously was using customer funds to cover the shortfall. The exchange is said to transfer to Alameda Research around $4b. around $4b.
On Wednesday, the next part of FTX drama happened: Binance announced that they withdraw from the FTX acquisition agreement due to the size of the shortfall on the deposit side, which they discovered after about a day of due diligence.
Currently FTX is trying to find $9.4b in rescue funds, while their HQ regulator in Bahamas freezed their assets.
The two richest men in crypto – the background story
Now let’s step back from the stormy events of the last days and look at what happened during the last years. If you were watching this space, you probably already had an impression that the big fight is coming.
The story began in 2017 when Changpeng Zhao, CZ for short, launched Binance. Binance quickly grew, listing an impressive number of new coins, with initially rather light AML compliance. Within two years Binance became one of the largest exchanges in the world.
At this time, in 2019, Sam Bankman-Fried entered the space launching FTX. Coming from Wall Street with a successful track record as a trader, he managed to raise significant funds from top notch investors including BlackRock, Sequoia Capital and SoftBank. CZ was also one of initial investors in the FTX exchange. They even had a plan to work together. FTX said they will be building institutional service offering for Binance. Love and peace were on faces and in handshakes.
Yet the love did not last long. Fast forward two years and FTX started to grow into a Binance competitor. But more importantly, SBF started to do regulatory lobbying work in Washington, parts of which were pointed against Binance. Sam knew that to win the race he would have to leverage his home turf, US market and the US regulation. For this he needed to gain the support of politicians. So, he positions himself as pro-regulation, even going as far as to suggest that DeFi needs to be regulated. Nobody liked this in crypto space and many people turned their back on him. But he was quite successful in Washington and even became one of the biggest donors to Biden’s campaign recently.
On the funding side FTX was the biggest success we have seen in crypto before. Sam managed to raise $1.8b in investment in 7 rounds, latest at a valuation of $32b.
But last year Binance’s CZ decided to divest his $900m stake in FTX. Sam bought it back from him, paid mostly in fiat/stablecoins and a smaller part in FTX tokens, amounting to 23 million tokens, those tokens which CZ said he is selling last Sunday.
What went wrong with FTX
Being in the crypto investment space for almost ten years now, I hardly remember distress of such magnitude. This situation reminds me of the fall of Mt. Gox back in 2014. Doubtless many investors have lost and will lose significant amounts and the overall implications for our industry will be quite pronounced. The regulators will step in and toughen the regulatory requirements. Fundamentally this is a good thing, but the devil is always in the details and we still need to see how this will play out.
The collapse of FTX was due to mistakes in these three areas:
- Transparency and contagion risks need to be taken very seriously. Events such as the Terra LUNA collapse, the algorithmic stablecoin experiment, were so big that they pulled a string of large businesses into bankruptcy such as Celsius, Voyager, BlockFi and more. FTX acquired all of these businesses and kept accumulating shortfall.
- The native token of any company or project should never be used as collateral. The prices of such assets are normally too volatile to serve as solid collateral. In most cases such assets should be activated on the balance sheet with a maximum value of $1. The investment arm of FTX, Alameda Research put on balance sheet theirs native tokens at the value of over $3b.
- Customer funds should never be used to finance investments or operations. It is not just a bad practice, it is fraud. Banking practice and supervision evolved over hundreds of years to prevent events like this. According to Reuters, FTX transferred at least $4 billion to Alameda, including some customer deposits, to prop up the trading firm after a series of losses.
The problem today is that there are too many unregulated exchanges, or exchanges operating from certain islands or countries with light or no regulation. More than that, even here in Europe we still have no unified regulation and requirements. For example, Smart Valor AG is authorized to act as Financial Intermediary based on its membership in VQF, financial services standards association, which is a self-regulatory organization supervised by FINMA, the Swiss financial supervision authority. On the exchange side we are registered with FMA, financial supervision authority of Liechtenstein, a neighbouring country of Switzerland. Here we were the first exchange to open its doors back in 2019 and one of the first to achieve registration as custodian and exchange under the Blockchain Act Law (TVTG), which is seen by many as one of the most comprehensive regulatory frameworks for crypto today in Europe.
One of the requirements of such registration and AML supervision is that customer assets are held in segregated (separate) accounts and never used for operational or any other purposes. This requirement was always absolutely sacred and self-evident to us. But the regulation and requirements are not the same in all European countries and what is a must-do for us, might not be the same in some other jurisdictions for companies operating there.
How SMART VALOR is different
Missing comprehensive regulation is a big problem. We saw this problem ever since the inception of our company in 2017. On the other side we saw growing demand from the side of traditional finance players to engage with legitimate crypto players. So, we took the long road of receiving all necessary registrations and authorisation as an exchange, custodian and asset manager, which enabled us to operate from such trusted jurisdictions as Switzerland and Liechtenstein. These jurisdictions impose on industry players one of the strictest AML requirements in the world. Even though we got this Herculean job done, we felt we can do more.
Going public – our path to maximum transparency
We found the way to deliver the extra mile to build the trust in applying for listing on the most prestigious and world largest technology stock exchange, Nasdaq. We knew the requirements are very high. We knew it would be very difficult. The list of requirements is long and work connected to being compliant with these requirements is a Herculean mission, which includes among others:
- Providing transparency publishing quarterly financial statements and quarterly reports;
- Publishing audited annual financial statements done through independent external auditors;
- Being subject to market abuse regulation, which in stock markets evolved over a hundred years and became very strict and explicit;
- Being subject to disclosure/publication requirements whenever something important happens in the company which could have a material influence on the market price;
- Having to implement an independent board and high standards of corporate governance.
Clearly, to comply with all of the Nasdaq requirements about transparency, disclosures and good governance is tough even for large companies. For a young crypto company, it is a big endeavour. Yet we decided to go this way. So last year, to receive approval from Nasdaq for listing, we went through in-depth legal, business and regulatory due diligence. We worked on this mission for almost one year and have shown that we comply with regulatory requirements, have sufficiently stable finances, have good corporate governance and no legal disputes. As a result, in December 2021 we received Nasdaq approval to list on the European branch of Nasdaq: Nasdaq First North in Sweden. It was a big victory for us.
Today as the FTX storm burns the sea in crypto markets, we feel confident that we can weather such a situation. Because safe and stable was in our DNA from day one. This is visible not only in our product offering, but also our compliance with regulation, choice of jurisdiction, handling of customer assets and accounting practices. Our ten points of soundness include:
- We hold our customers assets on segregated/separate accounts and have never used them for any type of operational activity or investments.
- We never used our native token as collateral for any investment or operational activity, activating them on balance sheet with total value equal to 1 CHF.
- On the side of our own financial reserves, we never held any FTT tokens and have no direct or indirect exposure either to FTX exchange nor to Alameda Research.
- On the exchange side, we have no integration with FTX exchange and never held any funds there; we also never listed FTT token on our exchange.
- We never offered any yield farming products, nor margin trading, nor lending products and never used any type of leverage.
- We went through multiple AML audits during the last four years and proved to regulators that we operate according to regulatory requirements.
- We have no debt or loans owed to external parties.
- We are headquartered in Switzerland and Germany and are registered for service offering in Switzerland authorized to act as Financial Intermediary and in Liechtenstein authorized by FMA.
- We were the first and the only Swiss digital asset exchange to be listed on Nasdaq First North, complying with strict rules and regulations.
- As a public company we provide audited annual financial statements and quarterly reports accessible to the public via our Investor Relations page.
With this, I hope we can give our customers and investors a bit of peace of mind and reassurance during these difficult times. Please remember that, while events like the FTX collapse cast a shadow on the whole industry for the time being, it is also clear that by far, not all players are gambling with customers’ money and leverage inappropriate collateral.
There are many legitimate companies out there. Just as we do, they deliver the hard work of providing the transparency and complying with all regulatory requirements day after day. Jointly, we do all of this to earn the trust of our customers, to prove to them and the world that crypto companies can be trusted. On days like this it feels like all the hard work we are putting in building trust is the most important mission and an achievement that should not be taken for granted.
Olga Feldmeier, Co-founder & Board chair of SMART VALOR