11th november 2022 / Anthony Cheung

FTX fiasco rocks the crypto market

In this episode, we attempt to unpack what exactly happened in the crypto market this week which was rocked by news about FTX and Binance, two of the world's largest crypto exchanges.

The move came as FTX CEO and founder Sam Bankman-Fried, who was hailed as something of a savior earlier this year, was subject to an investigation centering on the possibility that the firm used customers’ deposits to fund bets at Bankman-Fried’s hedge fund, Alameda Research.

What transpired was one of the fastest collapses of a company in recent history. So what went wrong? who's to blame? and what happens next? - we look to explain!

Other topics covered in this episode include, why the S&P 500 posted its biggest one-day rally since 2020 after the latest US CPI report, thoughts on Meta after Zuckerberg slashed 13% of the workforce and admitted he was wrong on strategy, and our initial take on the US mid-term elections.


This week we discussed the crypto market this week which was rocked by news about FTX and Binance, two of the world's largest crypto exchanges.
We also discussed why the S&P 500 posted its biggest one-day rally since 2020 after the latest US CPI report, thoughts on Meta after Zuckerberg slashed 13% of the workforce and admitted he was wrong on strategy, and our initial take on the US mid-term elections.

Here is how our conversation went -

Let’s kick off with what just happened. Looking at the charts everything has catapulted higher. I'm talking US. Stocks, US. T notes and gold. So if you're thinking about what's just happened there and you're thinking about correlations, the dollar is sharply lower. All of this has come after the back of US CPI which has just come out for the month of October and it came in at 7.7% year on year and in fact, that's the lowest year-on-year pace since January. It was below expectations. The core reading is also below expectations; 6.3% against 6.5.  Also compounding perhaps the knee-jerk intraday reaction was just last week and the markets reacted accordingly. And yet here we are like a week down the track. And the opposite data to probably where the market was leaning in its positioning has exacerbated some of the moves. Last I saw, the pricing on probability for the 14th of the deck next meeting is 80% for 50. And it was 50-50 between 50 and 75 basis points. 50 is the new call now as far as the markets are concerned after those figures. So what is your initial take on this?

It's a very good news inflation report, which has been a long time coming.  Well, it's early days obviously and this is data for just one month. But right now you could sit here and say maybe the peak of the inflation crisis is behind us. Maybe, we'll have to see. But there's a stronger case than we've had all year. But the inflation peak is behind us. And given that the whole year has been about inflation, it's dominated everything and it's controlled everything. It's controlled what central banks have been doing, it's controlled what governments have been doing, it's controlled, therefore, what markets have been doing. And so markets have generally been lower all year. So, yeah,  quite a significant moment in the story of 2022. 

Looking at the monthly movers on the breakdown. Food rose 0.6%, the smallest gain this year. Apparel fell 0.7%, the biggest decline since April. Household furnishings fell by 0.2%. The most since the beginning of 2021. Health insurance decreased a record 4% overall. Medical care services fell by 0.6%, most since 1971. Used cars decreased 2.4%, most since March, and airfares were down just over a percent as well. The one that did stick out is shelter costs, I actually increased 0.8% last month, the most since 1990. However, the acceleration was fueled by the biggest jump in costs of hotel stays in more than a year. Though private sector data points to a stabilization or even decline in rents in a range of cities across the country, there is a lag between real time changes and when those are reflected in this report.

I spoke about exactly that point when we had the inflation data a month ago. Pretty much the only thing that's driving inflation up is shelter costs and the problem with the way that's computed it's lagging. So it's taking the rental costs over the last twelve months. But there are way more current measures that are looking at new rental deals that are getting signed off right now and they are beginning to show signs of weakness. So the one big component of the inflation basket that's continued to drive things up is very lagging. And if you look at the near-term stuff, it's turned over. So that's why I'm saying I'm pretty confident that inflation has peaked and it's now going to start to decline. So yeah, markets are loving the US. Inflation report. 

So if the bottom is in and the Fed pivot is back on, what about what's happening in China right now? Could that disrupt this one-dimensional US focus where new COVID cases in Beijing jump to their highest level in more than five months.? The Chinese government have come out and is now being crystal. We're definitely not moving away from a zero-tolerance approach to the COVID lockdown.

Obviously, we'll have to monitor it. In China, April was the last significant lockdown period. Shanghai is a big hub for shipping, so a lot of the exports come out of China. It's definitely a risk. But right now the positive force from the idea that inflation has peaked is a larger positive force than the negative risks of what might happen in China regarding restriction of movement and lockdowns. That's the feeling right now. Obviously, that could change where you might have to wait a few weeks, but it could be that China locked down more aggressively. Who knows? It could be that the inflation report that we get for November, which will be in the middle of December, maybe shows inflation going back up. And all of what I've said is entirely incorrect. But right now, that's the feeling.

Moving on to Bitcoin, it has got slammed in the last 48 hours. One of the latest major headlines that have captured attention is that Binance has abandoned a deal to rescue FTX citing concerns about its business practices and investigations by US Financial regulators. Bitcoin was trading up $22. Now it dropped to nearly 150. So perhaps you could explain a little bit about what's going on. Why has there been a shake-up in the crypto space? It's not just bitcoin. Everything moves significantly.

It's quite a big and complex story; So FTX is a crypto exchange. It's another episode in the crypto journey. Looking back over the years, it's definitely another massive episode that undermines the whole house. That's why crypto, absolutely across the piece, collapsed sharply yesterday. I'm talking about Bitcoin and all of the others. So this is off the back of FTX, basically imploding, being one of the biggest crypto exchanges in the world, founded by Sam Bankman-Fried, or SBS as they call him.

So here is the story; So last Wednesday CoinDesk published an article and it had information about Almeda. Sam Bankman-Fried, not only is he the founder of FTX, but Almeda is a  hedge fund. So CoinDesk did an article and they said the crypto hedge fund and market maker basically had 14.6 billion assets on its balance sheet, but 5.8 billion of that was made up of a crypto token called FTT. Now, FTT is the in-house currency for trading on FTX, the exchange. So Sam Bankman Fried owns both; He owns the exchange, and he owns the hedge fund. His hedge fund in terms of capital on its balance sheet, 40% of it is FTT tokens. Well, what's that worth? Because whilst it was printing and marked to market at $5.8 billion, it turns out that maybe it's not worth that and actually it's a phenomenally illiquid asset. So basically, customers who use FTT, y use it as a medium of trade. They get discounts on exchange fees and other goodies for using it. And so basically, using FTT encourages trading. And obviously, the more trading, the more fees are generated by the exchange and so on.

But essentially, in the real world, what are these tokens? It's like the best analogy the Ft came up with is like they're carnival tickets. When you go to the carnival and instead of paying pound coins to get on a ride, you hand over £10 and you get a load of tickets and then you go into the carnival and to get onto a ride, it's a certain number of tickets. It's the same thing with these tokens and this exchange, if you want to trade on the exchange, you've got to trade in the medium of FTT tokens, and you got to buy these tokens before you're allowed into the exchange,  The only difference being that the FTT token value, so your carnival ticket, is at a fixed value, you've paid ten quid for ten tickets. They were £1 each.

But then the value of those tokens is not fixed. It can fluctuate, it's a tradable asset and it can go up and down. Now, the problem here was that Almeda, the hedge fund, held so many FTT tokens on its balance sheet.

There are basically three problems with that. First of all, hedge fund solvency should not depend on essentially a carnival ticket because it's not a tier-one asset. It's incredibly illiquid. And what's the value of it anyway? And so for a huge portion of its balance sheet to be made up of this, which is not sustainable,  And also, secondly, the FTT token derives its value from trade on an exchange that's owned by the same person who owns the hedge fund. So it's incredibly incestuous and dodgy and this is why all of this is being questioned by the regulators now.

So this is one of the biggest crypto exchanges on the planet. This guy, Sam Bankman Fried is known as this amazing guy, apparently,  who's done amazing things, and yet there's just schoolboy dodginess going on in the background. How is it that this isn't known about before now? People were making so much money so quickly. 2021 was the bubble, and in a bubble, everyone's making a fortune by piling cash in and making fortunes thinking “Do I want to do any due diligence on what it is I'm getting myself into? Well, no, I haven't got time, because if I wait to do my due diligence, well, I'm going to miss the gravy train and I won't make the fortune that everyone else is making”. That's the bubble mindset and when it all bursts, this is where it all comes out in the wash.

The second reason- So $2.2 billion worth of Almeda’s FTT tokens were pledged as collateral against 

loans. So not only is it on their balance sheet, incredibly illiquid, hard to value anyway, it's incestuous with his exchange. The's then used these tokens as collateral against loans and some of these loans are to bail out other exchanges that are in trouble.

Thirdly, the market value of FTT tokens that are actually used for trading is 3 billion roughly. So Almeda's holdings were much bigger than the entire traded market. So basically it's all a bit of a Ponzi scheme, in short. And this Coin Desk issued this report. After the report, we now bring in Binance Changpeng Zhao tweeted over the weekend that “due to recent revelations, we have decided to liquidate any remaining FTT on our books” He said that they would try and do it in a way that would minimize market impact. But basically, when you got one of the biggest holders of FTT going amount and it's incredibly illiquid anyway and then you've got an illiquid market, which just means there aren't many buyers or sellers at any moment in time, and suddenly you have a massive player that comes in with a single direction trade, as in a seller in this case, and there just aren't many buyers, well, then the market's price collapses. Then panic ensues. So when it's collapsing and unravelling, everyone else who has got deposits in this exchange, they want out - If you smell smoke, you’re out. And so this is what's happened.

And all of a sudden, the FTX exchange has been left now with an $8 billion hole in terms of cash they owe to their customers versus cash they've got available. They are 8 billion short. Now, Binance was going to rescue the deal here and ride to the rescue and buy out FTX, which would have made the biggest exchange on the planet. But Changpeng Zhao basically has pulled out, saying “after 48 hours of due diligence we've concluded the scale of the financial problems and the potential wrongdoing at FTX make the deal impossible”.

There's a great, great marketing opportunity for finance. Like the way, he's played that, he's like, “yeah, I'll come in, I'll rescue it. Well no actually I’m going to dump it.  I'm going to consume all power in the marketplace.”

So it's one way to get rid of your rivals, because not only is he not bailing them out, you could argue he forced the run on them anyway forcing the collapse!

Part of me thinks, well, this is a good thing, not for Sam, but this is a good thing because it's like another lesson learned, another thing comes to the forefront to adapt and change and try and work out the process better. The other part of me thinks then that Changpeng Zhao is now a single dominant player in the market and then he's just dominating that space, making every decision, and the barrier now to the market gets even harder.

But doesn't that counteract the whole point of crypto in the first place, where it's decentralized?

See when I say people didn't do their due diligence, I'm not talking about just retail traders who perhaps don't have access to the information to do proper due diligence or aren't educated or skilled enough to be able to do it or whatever; I'm not just talking about people like that. And of course, there are many of those but the FTX is backed by some of the biggest institutions in the world, such as BlackRock, SoftBank, and Sequoia - these are some of the most sophisticated investors on the planet, and yet they've been hoodwinked. Sequoia Capital is one of the biggest venture capital firms in the world today and they've just marked down their investment to a big fat zero today. 

Such as life right? That  We are still wooed by a good-looking opportunity. It is the cost of doing business, I guess?

Yeah, even this year they were raising money. In January they raised 32 billion!

As you said, he did put out a good piece around himself, right? So that's part of the attraction for any startup right? It’s got to have a good frontman. He had pedigree, didn't he? He is just 30 years old. He'll be back, I have no doubt, in some shape or form.

So tell me about Bitcoin. I put a poll out asking if Bitcoin has already bottomed?  The least popular choice was that we've already bottomed. The next popular choice was 15,000. At 14% of the choices from the community, then 32% for twelve and a half thousand, but almost 50%., So by far, the largest choice was that 10k  was the call.

Can I go contrary?  The bottom is in There are two reasons.

The first one; I was monitoring some of the order flow, and I saw a big clip come in and I thought, that is the crypto whales currently Hoovering up 15 800 last night. The hysteria around FTX is very raw, it's super current. But look, just step back out of this super current situation and what's been going on with crypto in 2022? Well, it's been trending lower all year. And the reasons are the macro reasons about inflation.

So back to my earlier point, if inflation has peaked, if the Fed's peak the hawkishness is behind us, then that's a very powerful force to say all assets have bottomed, including crypto.  Now I know, unfortunately for the crypto community, this FTX thing has coincided with this inflation report. Now we get over or the markets tend to get over these things relatively quickly. So the bigger force on Bitcoin is the inflation story, not the FTX storm that's currently raging. So it's for that reason that  15 was the low.

Also, I do feel like the crypto market has been desensitized because of the Terra Luna situation. If that hadn't happened, this would have been a bigger event.

Moving on to what is happening at Meta, Mark Zuckerberg has fired 11,000 employees from Facebook. To give some context, that's about 13% of their workforce. However, I've got a friend at Salesforce. She called me earlier today and was a little bit nervous on the phone because the salesforce's job cuts are far bigger. So these big tech companies, are brutal right now. I'd say job cuts in the range of 10 to 25% of companies that employ tens of thousands of people. This is pretty large, but not a surprise. Facebook shares are down 70+ %. This is necessary.

With Meta, why didn’t they do it 6 months ago?! Their costs are out of control and their revenue model is heavily reliant on advertising and is still under threat because of the macro forces. It's under threat because of Apple's change in its security settings. They're a bit of a dinosaur with that old advertising revenue format. So yeah, why wait until now to do it is the bigger question for meta!

For others, like Salesforce, this is the recession starting. If you've now got hundreds of thousands of people being laid off, this is demand destruction engineered by the Fed that is now going to see inflation drop. So again, this is a lead indicator because people get made redundant, but they'll get a redundancy payout. So they still got some money and that's not going to last for long. So now since they've lost their job, they're obviously going to be super prudent on how they spend that. But this is a lead indicator towards future demand and therefore a lead indicator towards what might happen with inflation. But with these big giant companies like Salesforce, when you're running a business and you've got to tighten the belt, then it's often these SAS products. So it's your advertising budget and it's your SAS products that you're starting to go, “well, hang on a minute, I've been taking on all these SAS products without really thinking about it because they sound cool and they make my business operate more efficiently” But all of a sudden before you know it, your monthly SAS spend is like actually something quite significant. So when the downturns come in and you want to tighten your belt, finally you get out the list of the SAS subscriptions and you realize you’re paying that much so you start trimming them off. So these SaaS businesses are going to start to lose customers and therefore they're going to need to tighten their belts on their side. So job losses are coming.

Secondly, those tech businesses that aren't yet profitable, then they've got a massive problem. So if they're reliant on your series A funding series B, series C, series D, series E… series Z, this is funding your way to profitability at some point in the distant future, but in the near term like 2020 and 2021 they have been like “ I don't care how long that future is until we make any money; Let's pump this thing with cash because it's growing so fast” Interest rates were zero. Cash was free. Now it's all changed. Interest rates are really high. Cash is really expensive. We've got a recession. Investors are having to write down the valuations of these holdings. Companies raising money in 2022 are having to raise money at valuations less than half of the valuations they're getting last year. And all of a sudden, the story shifted and investors are now saying, “I'm not going to give you money unless you reduce your cash burn. Forget about growth, no matter what, at all costs. Let's just tighten our belts. Let's just review what we're spending here. Let's just get that cash burned down, let's tighten up. Let's run a tight ship, let's not die in this recession. Let's see if we can get through it and raise money when the macro climate shifts.”

But if companies don't reduce their cash burn, they're going to get killed in this recession. So it's now about survival rather than growth. And so job losses are coming. You could argue that Elon at Twitter, what he's just done, could be the playbook that others use where he's just gone “You know what? I'm here. I'm a new guy. I'm looking at this business from an entirely new perspective. We don't need half of the people who work here.” That's how you cut costs. I know that's super brutal, but he's not going to be the last person to cut his workforce in half in the tech industry in the coming months.

Do you think it's time for Zuckerberg to go? I read a piece it was talking about a parallel universe, and it had, like, some suggested points about what if. Mark assumes a chairman position, so still acts as an advisor. So when we shift, he does a complete shift away. Obviously, still long-term to Meta, but in a less aggressive fashion. So it just allows the company to breathe under a new perception of a new structure and order. Do you think that provides some more longevity to the belief of the pivot that's happening that Facebook is trying to engineer? How important is someone like Zuckerberg?

The difference is that the business model has failed and so the new plan is, to spend more money than anybody's ever spent to try and win the market share of this virtual world that might exist in ten years' time.

Okay, so let me rephrase the question. If this was a regular CEO, which he brought in, and not a founding member or the founder, Mark Zuckerberg would he not be fired by now? Isn't it time the shareholders moved him on?

Yeah, I would say so. I do think they need to radically reduce the crazy spending that they've outlaid. Now either he needs to finally take that point on board and act or he needs to get out because if he's not careful this Facebook story, which was a phenomenal one, will turn into the biggest rise and fall of a giant in corporate history. 

Well he's just cut 11,000 staff so maybe he's got the point now and maybe he's going to start to reduce spend. But what else are they going to do though other than this long shot for Meta?

It's interesting actually the different personalities at these big tech firms because you'll get someone like Zuckerberg and he'll apologize, and take accountability, he made the wrong call which you would never get from a Bezos or from an Elon Musk. Then you've got Nardelli, the head of Microsoft who you never hear anything from apart from the fact that Microsoft just kills it every single time!

It's funny how these different organizations are run from a leadership visibility perspective quite differently but that probably speaks a lot to the volatility as well to a certain degree. Though I suppose that I could be wrong here; Tim Cook is quite visible, isn't he?

He is. Businesses like Apple, Amazon, Google, and Microsoft, are businesses that are behemoths with the momentum you just can't stop. They've got business models that are bulletproof and are futureproof.

But the big difference with Facebook is that's not true. They peaked in with business idea Number 1 which was phenomenal. It's just now it's a bit outdated and it's just decided to A - go for the super long shot, but B- spend more than anyone's ever spent in history to try and get there but it's just too much, it's too risky. The market has spoken because the share price has collapsed. 

Next, let’s jump straight to a quick take on the midterm elections and then we'll talk a little bit of football. So Joe Biden says he wants to run for a second term in the White House and will make a final decision earlier next year about his political prospects.  Well, he was boosted by the Democrats who didn't lose as badly as people thought. The red wave never materialized. Democrats avoided sweeping defeats in Congress but still risk losing control of both chambers. there are still quite a few that are yet to come through that will be decisive for that matter. They did deal a big blow though to Donald who was obviously counting on victories of Republican candidates he endorsed to power his way back through into a run on the White House for 2024. Markets haven't even blinked at this event. One thing I did read from some bank research was talking about beyond the short term, what was going to be interesting potentially is about the ability to deploy further fiscal policy, the implications for the economy, and thus then influencing the Fed's rate pass. But definitely not in the midst of a week of a US inflation report like what we've just seen. That's much more long-term thinking. Any thoughts on that?

Again, it's deflationary. On the one hand, whilst the Republicans didn't have that massive win they were hoping for, it's still the case that the Democrats will lose control of the House of Representatives. What happens in Congress, we're not quite sure yet, but it doesn't matter because now the Democrats don't have the clean sweep and so for Biden to get policy through Congress is now basically blocked, meaning no more stimulus because the Republicans will block it in the House. So that's deflationary. Biden cannot pump in any more money. That's number one. Was it a victory for the Democrats? They lost, but was it a victory? I would say it's more of a fail by the Republicans.  John Fetterman, the Democrat Senator was the guy who had a stroke six months ago and then it was all about whether he was fit in terms of health-wise to do the job. And then the Republican guy was going to ride in and, and win the seat. But he had anti-abortion and anti-abortion mandates and so actually there was a massive female vote against the Republican candidate, which meant that the Democrat, Fetterman, who'd had a stroke with big health issues, still won. That was the seat that said maybe Trump and the Republicans have gone too far right. That's the most interesting takeaway from this and it might mean that Donald won't be back in the White House in two years' time.

I know it's going to be a painful conversation to finish because we're going to talk about the mighty Liverpool FC, but why are we talking about that? Well, to give it a bit of a corporate finance finish, Goldman Sachs and Morgan Stanley are working with Fenway Sports Group to sound out potential interest in the English Premiership football club Liverpool. To give it a bit of background, Fenway Sports took over Liverpool for about £344,000,000 in 2010. Analysts are suggesting the club could fetch north of 5 billion; recent precedents being Chelsea. Just wanted to get your feelings about maybe the deal and perhaps you could explain the bank's involvement from a technicality point of side for education and also bout how do you feel about the high-profile takeovers of English Premiership clubs.

Well, are you implying that the ownership of English football clubs is now moving into foreign hands?

Testament to the beautiful game of English football. It creates such worldwide viewership and therefore money.

Except that I agree with that. Except that Chelsea was owned by a Russian dude and it was sold to some Americans. Liverpool is owned by Americans. And who's it going to get sold to? Almost certainly an international buyer. I can't see a UK buyer being able to afford Ford 5 billion. Maybe I'm wrong. Newcastle is the only one that went from English ownership. Mike Ashley the JD sports guy. Blogged it. He's going to be kicking himself. He sold Newcastle United $409,000,000.

The Chelsea deal this summer has changed the game because that's why Liverpool is up for sale, because Chelsea went and got a price tag of £4.2 billion. And that was an insane valuation. So Liverpool, the owners who bought the club for 300 million ways like “We can flog this north of 5 billion. We bought it for 300 million.” And there are two things here maybe they're thinking has Jurgen Klopp’s era peaked? They've obviously had phenomenal success in the last five years, but this year, it's just all the wheels have come off a bit. They're down around 7th or 8th in the league. So maybe there's something in that, but it's more the Chelsea deal that got done in the summer that interested Feng way sports. Now they've taken the much more proactive step of going instructing some banks to actually get this show on the road. So Goldman's and Morgan Stanley - and the way this works is Fenway Sports will be once they've made that decision try and run a process and try and sell. And if you want to sell anything well, obviously you want to sell for the highest price. Well, how do you get the highest price? Well, we need the most potential buyers we can find. The more bidders we have, the higher the price is going to be. How are we going to get more bidders? Right, well, let's speak to people who know how to do these processes and get the banks involved. So what will happen is then they'll either go directly to a bank or two that they know already, maybe they've dealt with them in the past. Feng Way Sports have bought a load of clubs. So they've done a lot of deals. I'm not sure who works on their previous deals, but I'm guessing probably Goldman and Morgan Stanley. So it could be they're returning to the banking partners they've used in the past.

So for these investment banks then,  actually this is a bit of a saving grace surely? Because I read this week that Barclays and Citi have their IBD fees down something like 60 and 45% respectively. They've laid off a bunch of staff and Goldmans have already laid off a bunch of bankers. But then you've got a 5 billion+ deal that could be on the table here.

Yeah, it's huge.  This is like a hen's teeth in terms of big deals in 2022. So banks will be desperate for this thing. So I don't know if they said, right, let's get banks into pitch and they've got to win the mandate, or whether they've used Goblins and Morgan Stanley in the past. But normally they'd run a process, they'd choose a bank or two. This is obviously going to be a monster deal, so you need more than one. And then these banks will have teams that have worked on Sports club  M and A deals in the past and they'll have formed relationships with investors who are interested in this type of asset. So basically they've got their black book of clients and this is what female sports want to tap into. So Goldman and Morgan Stanley will now get out there and start raising a bit of informal awareness as to whether or not there's a demand to snap up Liverpool along the valuation lines that Chelsea saw back in the summer.

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