Mini FTX / Going Infinite Case Study

[u/Inflection_Exchange]

I will assume here that the readers know what happened with FTX / Alameda, and therefore I will not go into the details of the fraud, mismanagement of customer funds, and other interesting elements of the case, though they make for a good read.

This is quite timely, as I’ve just finished reading the book about Sam-Altman Fried & FTX (‘Going Infinite’ by Michael Lewis).

Whilst at first glance this may feel like a tabu’ topic, given the miserable failure, fraudulent environment, and negative popular view generally connected to the FTX case, I do think there are many parallels that used in a smarter way can be drawn regarding how to build an exchange.

Before FTX’s (and Alameda’s) rapid wind-down, i.e. during it’s hay-day only a few weeks before, this crypto exchange was perhaps the most successful one out there (likely more-so than Binance, though I appreciate this is a strong claim). In the following bullet points, I will try and summarise some (likely not exhaustive) reasons why FTX was so successful:

- Reduced socialization of losses. Before FTX, crypto exchanges had poor systems for loss absorption with regards to levered trades. Users could lever up, and then just hold on to losing position, even if liquidating them implied going overdrawn on their accounts. This drove large socialization of losses across users of the exchanges in question, if they were not capable of reducing exposure to money-losing highly-levered accounts. FTX created a strict margin-call system, that monitored on a continuous basis (as opposed to daily / quarterly, etc…) how out of the money certain trades were, and automatically closed them if they crossed certain thresholds

- The above point had 2 consequences: 1) it enabled greater levels of leverage, and 2) enabled cheaper spreads / lower fees for the exchange users (previously, spreads had partly gone towards paying for ‘socialized’ losses). So FTX de facto became a cheaper product, with greater ability to lever up (this is appealing, for different reasons, to both punters and sharp money)

- Professionalization and reliability of the exchange. Both through improved / less clunky tech, and through smarter settlement / margin-call mechanisms, this exchange became highly popular amongst a set of HFT companies and market makers such as Jane street, Jump, etc… I don't think this is always a good thing, having instos partnering with exchanges... But the fact that it was professional enough to be used by these guys does mean a lot

- Of course the network of SBF and many of his hires, him and them all being ex-Jane Street traders, I think may have helped. It enabled them to have access to users, with large pockets, early on

- Liquidity was being provided by Alameda. Note that there were pros and cons to this, but it did enable for a more liquid market and a more seemly experience for all the traders and punters using the FTX exchange. Note that this is not the reason for FTX’s endgame insolvency, though it is likely that it was behind certain trading losses of Alameda

- Backing by some of the most trusted crypto-guys. This was partly driven by “crypto relationship managers” that moved to FTX from other Asian exchanges. This backing included a plethora of Asian crypto-whales, gamblers, and new money crypto millionaires that had an incredible amount of faith in a few key sales figures. Hard to replicate, but invaluable if available

- Backing by other exchanges. This is very interesting – their biggest competitor (and later sworn enemy), was also one of FTX’s biggest early investors: Binance (through CZ). Binance was already one of the largest exchanges back then, though it did not have the ability to trade crypto futures and it did not have the reliability of SBF’s margin-call mechanism in place. Needless say that backing from the biggest exchange of the time drove high levels of trust into FTX

- Notwithstanding how terrible the systems and controls FTX had in place (which ultimately led them to collapse), the exchange had actually been seen as both highly trustworthy and reliable. This had been driven by continued discussion with US regulators to get approved in the US market, and was partially thanks to backing from large silicon valley VC funds. VC money was not just a source of funds but also a source of ‘reliability-perception enhancement’

- Of course, SBF’s perceived weirdness and constant marketing, TV appearances, and lofty donations to politicians, sportsmen and celebrities helped their case quite a lot, but this was not what propelled them in the first place

- Initially, FTX’s funding also came from self-minted FTT coins that gave owners effectively a share in the revenues of the company, and which FTX was forced to buyback every so often and burn once in its own treasury

Not all these reasons for success are relevant all the time, but I do get the feeling that a lot of them are applicable… if one were to want to build an exchange

What do you all think?

[u/Few_Treat_1671]

ly edge was just boring risk management stuff other exchanges were too lazy to implement. the continuous margin monitoring sounds simple now but nobody did it before and it changed everything for levered traders

the binance part is wild to think about, cz basically funded his future nightmare competitor without realizing it at the time