FTX Update
Below is an e-mail I shared with our investors on November 9th.
Dear Investors,
I wanted to update you on the evolving FTX saga and how it impacts your investment. There are more questions than answers. A few bullet points if you'd like to get on with your day:
FTX, the 3rd largest crypto exchange, is insolvent after seemingly gambling away user deposits.
The fund has no direct exposure
The fund has no leverage
This too shall pass. Crypto has seen exchanges go under before and come back stronger.
No Direct Exposure
Crypto Native Capital has no direct exposure to FTX. We do not have an account with the exchange and have never held the exchange token, FTT. The fund does not currently hold any crypto on exchanges as we let the liquidity crunch work through the system. The fund does not use debt/leverage and never will.
Indirect Exposure
The fund has indirect exposure through holdings in Solana (roughly 4% of AUM as of this morning). FTX was an early investor in SOL. This has created significant sell pressure on SOL and is down roughly 30%. While nothing fundamental has changed about the SOL protocol I will be following developments closely and managing the position accordingly.
What happened?
FTX, the world's 3rd largest crypto exchange, appears to be insolvent after freezing customer withdraws yesterday morning. FTX was led by, Sam Bankman-Friend, known as SBF for short, and was a media darling for the crypto industry. He raised more than $2b with a peak valuation of $32b in just a few years from top-tier VC firms including Sequoia, Paradigm, Multicoin, Altimeter, Temsaek Tiger Global, and more. FTX will likely be written down to $0.
SBF previously worked as a quant trader at Jane Street before starting Alameda Research, a quant crypto fund that arbitraged bitcoin across exchanges. The lines between FTX and Alameda are blurry as Alameda served as a market maker for the exchange despite claiming an arms-length relationship. A leaked balance sheet from Alameda recently showed they were levered with risky, low-float assets that served as collateral, including the exchanges’ own FTT token. This put downward pressure on the price of FTT and caused a bank run on FTX leading to a death spiral for both FTX and Alameda as the loss of customer funds was revealed.
While there are more questions than answers it appears there was nefarious activity with customer deposits to the point where no one wants to step in to assume liabilities rumored to be in the $5-10b range. So where did the customer deposits go? The best guesses are bad loans to Alameda, bad investments, political lobbying, and marketing partnerships. There will likely be a criminal investigation and I would not be surprised if multiple folks end up in jail.
This too shall pass
Let me be clear - I would rather FTX not blow up. It's not good for consumers, investors, and the crypto sector. Customers were lied to about the use of funds, laws were likely broken. It will take work for crypto to regain trust.
In 2014 the largest bitcoin exchange, Mt Gox (70%+ of volume), was hacked for over 7% of the bitcoin supply. Months ago LUNA collapsed, and Celsius and Voyager declared bankruptcy after gambling with customer deposits. These incidents were not fundamental flaws with the protocols but rather poor decision-making by centralized entities. While painful, these crises are what catalyze change and push the industry forward. It’s hard to see now but crypto will be stronger for flushing out the excess and paving the way for stronger roots to take hold. Tough times breed creativity and I've never seen more smart people entering crypto than today.
The need for decentralized money and a world computer has never been greater. A few months ago, Ethereum had the largest upgrade in blockchain history and will set the foundation for scaling blockchains to billions of people. This event will also present opportunities. The fund will be patient as opportunities arise.
Please be on the lookout for a Q3 LP letter in the coming weeks.
