[Feature] FTX and Alameda: The New Celsius?

Sam Bankman-Fried has dominated headlines for the past few hours – but not particularly for the best reasons. Once touted as an effective altruist, or a “Robin Hood”, Bankman-Fried planned to give away all of his wealth within his lifetime, and has supported causes for animal welfare and nuclear disarmament. Interestingly, lobbying has also formed a significant aspect of Bankman-Fried's portfolio. He is indeed a pioneer of crypto entrepreneurs dipping their feed in in U.S. politics on a significant level, and has raised eyebrows within the crypto community for lobbying and advocating for greater regulation of crypto activity – which includes the censorship of certain parties in blockchain protocols.

Despite Bankman-Fried's controversial climb to the top, it came to a surprise for many when FTX, Bankman-Fried's principal cryptocurrency exchange, suffered what financial institutions call a “run”, which saw a reported $US 1.4 billion being withdrawn within the span of a day. The news sent shockwaves throughout the industry, with Bitcoin and Ethereum tumbling 10% and 16% respectively on Tuesday.

Lily King, Chief Operating Officer of Cobo, Asia-Pacific's largest crypto custodian, shares with us that users should also be cognisant of the risks that come with participation in centralised exchanges:

"While centralized platforms provide an easy and friendly interface to their clients, these users give up full control of their funds to them. However, the risk of black box operation and single point of failure cannot be compensated by accessibility and convenience, which is a painful lesson that many have learned from the failure of some CeFis and CEXs. Not your keys, not your coins. On top of that, centralized platforms also takes away the freedom blockchain was invented to provide. This is the reason why we are working on MPC solutions, as well as assisting with risk management and compliance, to allow clients to have full control over their private keys."

While FTX’s downfall may serve as an unpleasant surprise for many to wake up to, a closer inspection of their tokenomics, as well as that of its sister market maker Alameda Research, reveals that the threads of devastation have already been unravelling for a while.

Financial details of Alameda Research, one of the largest crypto hedge funds in the market, were shared on November 2nd by Coindesk, which reported that the firm’s largest asset was found within its holdings of “FTX Token (FTT)”. This indicated that the hedge fund’s net equity was comprised solely of FTT, the token issued by Bankman-Fried's other company.

Annabelle Huang, the Managing Partner of Amber Group, tells us:

“FTX was unable to meet user deposits likely due to exposure to Alameda, who borrowed against their FTT holdings that is spirally down in value.”

According to the report by Coindesk, Alameda’s ownership of FTT tokens in June was valued at $US 5.8 billion, which amounted to a staggering 180% of the total circulating supply of FTT tokens. In fact, a brief search on Etherscan indicates that 92.37% of the total circulating supply of FTT is hold by a mere 10 addresses:

For many, this is a clear indication of what is called a “Flywheel Scheme” - the very same mechanism that was utilised by now-defunct Celsius Network.

The way a Flywheel Scheme operates is remarkably simple. First, a token is created (in this case FTT), and the majority of said tokens are maintained within the company’s balance sheet. Next, the token’s price is increased, or ‘pumped’, to its maximum achievable potential. This can take the form of cash injections, wash trading, or through market makers. Once the token prices have increased, it becomes natural for the company’s balance sheets to reflect astoundingly green figures, ensuring that marketing to investors becomes incredibly easy, from sales in company shares to purchases in equity. This could even look like the company being granted large loans from investors simply through token collateralisation. Of course, proceeds from these sales could then go back towards – and you guessed it – pumping the token price once again.

While this sounds like the perfect scheme to generate money from thin air, the Flywheel Scheme has proven to be an incredibly unsustainble form of financial engineering, as Celsius demonstrated earlier this year.

First, this scheme forces the company to constantly increase the price of the token, demanding more and more monetary injections. At the same time, increasing token prices serve as strong incentive structures for token holders to sell off the token to cash in, again forcing the company to not only own more tokens, but also to buy them at higher prices. Additionally, and most importantly, this leads to the critical scenario akin to that of Celsius – any value backed by these tokens is completely illiquid and merely generates wealth on paper. For instance, despite owning massive amounts of CEL, or the native token of Celsius, the company could not liquidate any of its holdings without reducing the token price to zero.

This then leads to three possible unfortunate outcomes: either the company runs out of inbound injections to sustain the FlyWheel Scheme; owns all of the existing tokens; or stops purchasing tokens altogether - which by default results in the FlyWheel Scheme collapsing in on itself. Either way, it becomes evident that the FlyWheel Scheme is beyond a doubt, an incredibly unsustainable financial strategy.

What this indicates is that Alameda will have an incredibly difficult time in liquidating a significant portion of FTT in order to repay its debts. There are only a handful of actual buyers of the tokens, with the largest buyer being FTX, Alameda’s sister company. In totality, the majority of the value that Alameda accrues to its FTT tokens is completely unrealisable, echoing once again the dreadful scenario faced by Celsius in its downfall.

If nothing else, this only serves as a reminder that even the largest of giants in the field may fall, especially if their financial strategies are in the wrong place.

This is an Op-ed article. The opinions expressed in this article are the author’s own. Readers should take the utmost precaution before making decisions in the crypto market. Coinlive is not responsible or liable for any content, accuracy or quality within the article or for any damage or loss to be caused by and in connection to it.