This issue is brought to you by:

The first 250 Permissionless tickets drop this Thursday! Get notified to know when they go on sale. They'll be 250 limited tickets for $199.

“Learning to tell a story is critically important, because that’s how the money works. The money flows as a function of the story.”

— Don Valentine, founder of Sequoia Capital

The Worst Bank in the World

Day 7: The fog of financial war is starting to lift.

While we wait for Sam Bankrun-Fraud to spell it all out for us — possibly one letter at a time — we now have enough information to start piecing things together ourselves.

The bank-run fraudster told the New York Times, for example, that the two biggest things he wished he’d done differently are “the poorly labeled internal bank-related account, and the size of customer withdrawals during a run on the bank.”

Self-serving as that statement is, the first step on the road to redemption is being honest with yourself, and this is a start.

He’s confessing at least that FTX was a bank, which is progress. His website still says, “FTX is a cryptocurrency exchange.”

He concedes also that the FTX bank was managed unprofessionally, citing “the poorly labeled internal bank-related account,” which blew a hole in the comically inadequate balance sheet he released to the FT.

So the story now goes, FTX was a bank — we should have spotted that — and it was a bad bank. Bad banks happen. (See: The Big Short.)

A failed bank because of an $8 billion oversight in a spreadsheet is ridiculous and negligently unethical, but maybe not criminal.

But then we get to Alameda CEO Caroline Ellison’s interview with the New York Times: “Over recent months, she said, Alameda had taken out loans and used the money to make venture capital investments, among other expenditures.”

You don’t make venture investments with borrowed money.

That’s nuts.

And it gets nuttier: “Around the time the crypto market crashed this spring, Ms. Ellison explained, lenders moved to recall those loans, the person familiar with the meeting said. But the funds that Alameda had spent were no longer easily available, so the company used FTX customer funds to make the payments.”

That’s fraud.

And it’s a fraud that transformed FTX from a bad bank into the worst bank in the world: All banks have asset/liability duration mismatches of some sort, but no sane banker would ever pair venture capital assets (typical duration of five or 10 years) against demand-deposit liabilities (duration of zero!).

Why’d they do it?

Because things at both FTX and Alameda were much worse than these self-serving explanations let on.

The Worst Hedge Fund in the World

The origin story of FTX is that SBF, a brilliant quant, made so much money arbing the bitcoin market in Japan that he started an exchange on which his hedge fund, Alameda, would be able to make tighter markets than anyone else because he was such a brilliant quant.

It now appears that none of that was true.

This post from the anonymous Milky Eggs makes a compelling and comprehensive case that Alameda is not what we thought it was.

Alameda may have squandered its Japan arb profits — which likely weren’t all that big to start with — on directional YOLO trades before even getting FTX off the ground.

After they started making markets on FTX, Alameda may have had multiple algo disasters which never came to light because FTX swept them under the rug. (Note: custodians should never be market makers.)

And if Alameda ever had any quant edge at all, they probably lost it quickly as smarter, bigger, and more sensible competitors got into crypto.

That happens all the time, of course. Normally, the surpassed fund would quietly close its doors while the fund managers go rediscover their love for photography or snorkeling or something.

But Alameda couldn’t close its doors because it was at the heart of FTX’s value proposition: As the “prosumer” exchange of choice for professional crypto traders, FTX needed Alameda to continue making markets, even at a loss.

Without Alameda backstopping FTX’s liquidation engine, there was no reason for anyone to trade on FTX.

So, while we all assumed Alameda’s privileged relationship with FTX was a license to print money, it may well have been the exact opposite: Their not-very-good algos were probably subsidizing all of FTX’s other professional customers.

For a while, those losses were more than offset by the gains Alameda racked up by being levered long SOL and DOGE and dumping tokens received in VC investments.

That all came to an end with the LUNA blow-up, in which Alameda appears to have given up all its previous gains and after which it had no way to offset the losses its algos made trading on FTX.

We’re only finding out now because SBF was able to keep up appearances for this long by fraudulently siphoning off customer deposits to plug an ever-growing hole at Alameda.

Alameda, it turns out, was not a good hedge fund at all.

The Worst Video Game Player in the World?

Most disconcertingly, it appears SBF was not even any good at video games.

The FT reported that, despite playing 1,000+ games, he’s only achieved a rank of Bronze III with a 41% win ratio.

That seems hard to square with his MIT physics degree, Jane Street pedigree, and oft-professed love for League of Legends.

But it’s not so hard to square with his professed affinity for stimulants and self-medication, his increasingly disheveled appearance in recent months, and his strategic use of storytelling.

The man is not who we thought he was.

SBF told us a story — nearly all of it fabricated — and we bought it, hook, line and sinker.

Many billions of dollars flowed in his direction as a result.

And now that the story has gone poof, the money has, too.

— Byron Gilliam

P.S — Find this newsletter helpful? Share it!

Was this newsletter forwarded to you? Sign up here.

Top Stories

Can We Solve the Crypto Exchange Liquidity Problem? [Sponsored] — Blockworks
Ineffective Altruist: The Philosophical Movement Tainted by Bankman-Fried’s Downfall — Blockworks
What Is Proof of Reserves and Can It Build Back Trust? — Blockworks
Golden State Warriors and Miami Heat Axe FTX Deals — Blockworks
BlockFi Eyes Bankruptcy as FTX Fallout Continues: Report — Blockworks
Celebrities, Investors Scramble To Erase Evidence of SBF Ties — Blockworks
SBF Hopes for a Hail Mary, Attempts To Raise Funds — Blockworks
Valkyrie Shrinks Staff to 16 People After Latest Cuts — Blockworks
FTX Contagion’s Next Victim: A Japanese Exchange — Blockworks
US Politicians Donate Bankman-Fried Cash to Charity — Blockworks

This issue is brought to you by:

Algorand, the most secure, scalable, and sustainable blockchain, is hosting Decipher — the must attend event for all things blockchain and Web3.

It is in Dubai, the crypto capital of the world and is from Nov 28 - Nov 30.

Hear from visionaries like Jon Vlassopulos, the Napster CEO who is transforming the streaming platform into a decentralized music-first ecosystem, and Silvio Micali, Algorand founder and renowned cryptographer famous for co-inventing zero knowledge proofs.

Connect with experts from DeFi, sports, gaming, and the metaverse and take advantage of unparalleled networking opportunities.

We're Hosting

Webinars

Blockworks Research: 2022 in review

How to protect against DeFi hacks

Watch the replay

Back To Basics

It's time to go back to fundamentals. At Permissionless, we'll focus the conversations on transparency, decentralization and ownership.

Tickets drop this Thursday.

Don't miss it. Get notified when tickets drop.

This issue is brought to you by:

The era of real yield is officially here. Become a member to get in early.

Goldfinch, the DeFi credit platform championing real-world lending, announced a new membership program that lets you,

Receive boosted yields on your investment

Access exclusive Exclusive communication channels

Get Aligned incentives for Goldfinch’s growth & expansion

Learn more about Goldfinch membership and Join the waitlist today.

Blockworks Research Alpha

Lido’s post-Merge APR has been skyrocketing in lieu of market volatility brought on by the FTX and Alameda bankruptcies.

When Ethereum block space demand picks up, validators have greater MEV opportunities and receive a greater amount of tips. For the first time since the Merge, execution layer rewards are greater than the consensus layer.

Receive more insights from the Blockworks Research team.

What's Trending

Expanding the SVM to more ecosystems beyond Solana (thread) — Blockworks Research
Inflation is heading lower, but watch out! (thread) — Andreas Larsen
What stops the growth of DeFi industry? (thread) — DeFi Made Here
Everything you need to know about the DOT SWOOSH announcement (thread) — Sekure
Let’s do the SEC job for them (thread) — Genevieve Roch-Decter

We're Watching

In this episode of Empire, Kristin Smith and Jake Chervinsky join us to discuss how FTX's collapse will impact crypto regulation.

Watch Empire on: Youtube, Spotify and Apple Podcast.

Was this email forwarded to you? Join over 175,000 investors who read this newsletter. Sign up for free.

Update your email subscription preferences here.

Written by @bgilliam1982.

Produced by @gmmiguelcruz.