While the details are still unfolding, we wanted to provide an update on recent events relating to the collapse of crypto-exchange FTX, the impact on Motus Digital Growth, and our understanding of contagion risks, regulation, and other impacts moving forward.
First and foremost, the actions of Sam Bankman-Fried, FTX/Alameda and related parties is tragic for their customers, employees not involved in the actions that caused this, and the companies, protocols, etc. that trusted FTX to safeguard their assets. Many of these parties will experience material losses due to Sam Bankman-Fried and Alameda’s actions. We hope the best for them, and none of the commentary below is meant to detract from their loss.
Additionally, these actions are a black eye (maybe two) for crypto at large. We believe this is more akin to a wildfire clearing brush than a complete fail, but in either case, these events diminish the work the good guys do. Fortunately, the good guys are the majority, and will keep building during and after this passes.
And last, let us all keep this in perspective. Amazon, has lost more in market cap this year than the entire market cap of crypto. This “systemic” risk being presented by the talking heads is complete nonsense.
Impact to Motus Capital Management From FTX
Motus Capital Management broadly has zero direct exposure to FTX or Alameda, and have never had any direct exposure to FTX or Alameda. To put it nicely, for years we believed Sam Bankman-Fried (‘SBF’) to be of questionable moral character. SBF focused on amassing personal power and wealth, was not good for crypto at large, and Alameda, the trading firm he created, had material conflicts of interest with FTX users. Alameda’s strategy was to rip-off retail by both frontrunning their trades (using FTX’s orderbook), and to manipulate the price of tokens they acquired in large size that had low float. Sam Bankman-Fried defrauded investors, politicians, regulators, bank CEOs, and retail investors at a scale of Bernie Madoff. The cross-collateralization of users’ deposits from his FTX exchange to backfill holes in his sister trading firm Alameda was a blatant violation of both trust and terms of service. After Alameda’s balance sheet leaked, the market sniffed this out, and the mere possibility of truth led to a bank run at FTX and collapse within days. This fraud was pulled off in plain sight with many suspicious for some time, yet somehow SBF was held up as the face of the market, and even the “white knight” during May-June when other centralized crypto companies failed (Three Arrows Capital, Celsius, BlockFi, etc.). Based on our research, it was more likely that FTX was the reason some of these companies failed, and that it was inevitable that FTX/Alameda would cause significant damage to the crypto ecosystem.
We find it hard to believe that anyone performed sufficient due diligence on FTX given what we now know included misappropriation of customer funds for the purposes of levered investments at Alameda. FTX did not have a CFO, a board of directors, or any risk oversight structure. They did not disclose their assets. They had a highly complex entity structure that seems excessive unless there is foul play involved. Yet, traditional and crypto VCs lined up to give FTX money, CNBC put SBF on air as much as they could, regulators invited SBF in to help craft regulation, and politicians accepted donations from SBF. They had Tom Brady, Giselle, and Steph Curry as marketers and equity holders. They all failed.
In addition to avoiding FTX directly, we actively avoided any assets that SBF or Alameda were involved in. If they had a large stake in something, even if it had attractive attributes, it was a non-starter, full stop. This includes Solana (SOL), Serum (SRM), and most definitely their exchange token FTT. These assets have suffered the greatest losses over the past week. While on the topic, in addition to avoiding FTX/Alameda:
Celsius – We met their CEO, and immediately concluded we would not do business with them
BlockFi – We met their institutional lending team, and immediately concluded we would not do business with them
Terra LUNA – We were early investors in LUNA personally prior to Motus, were well-aware of the risks of the project, and exited at profit once the main risk of the project began coming to fruition
Three Arrows Capital – We did not interact with them, but never understood why successful FX traders all of a sudden became VCs
We limit net exposure to 100%, and will never be net short. We limit leverage to hedging strategies, covered positions, sold puts at entry points, or small short-term tactical trades.
We limit the amount of assets we hold on exchange. We believe using institutional decentralized infrastructure, with defined processes, checks, and safeguards reduces these types of risks.
Maybe it is our time spent at large banks understanding the importance of prudent risk management, maybe we know the history of traditional finance blowing up in similar ways, or maybe we know a cesspool when we see one. Either way, good riddance to all of these companies who used and profited off a lack of education and proper regulatory regime in a burgeoning industry to damage both confidence and newer investors allocating to them. We will continue to avoid red flags when we see them, we will continue to follow proper risk management, and we will maintain our belief that excessive leverage in this market leads to downfall.
Broader Market Impact
Hedge Funds – Now the contagion speculation begins. What we do know is that a handful of large funds held significant assets at FTX that will likely be unrecoverable for some time, if at all. One in particular is Multicoin Capital run by Kyle Samani. Multicoin rose to one of the largest crypto funds globally in large part due to an early investment in Solana (SOL). Solana was also the largest holding of FTX/Alameda/SBF. In the early days, SBF made a public bid to buy any amount of Solana at $3. He became the hero to his followers as SOL subsequently rose to over $250. In reality, Alameda amassed a large percentage of the float of the Solana ecosystem token, and used their public influence to amass a large following of copy-traders or zealots. Alameda repeated this “trading strategy” with other tokens in the Solana ecosystem. Multicoin sent out a letter highlighting their exposure to FTX – a large portion of fund assets held on FTX (now frozen), Solana as the top position in the fund, a Solana ecosystem token “Serum” under a 7-year lock, etc. SOL is currently -93.5% from the high, with large VC unlocks still to come.
There is a pattern of successful funds getting too large to the point that the strategies and processes that made them successful can no longer be implemented due to liquidity constraints. They then seek higher concentration, more leverage, and more “manufactured” returns, all with higher risk. We expect to see several once prominent hedge funds close given redemptions and NAVs significantly below water marks. At Motus, our number 1 rule is “Don’t be (redacted)”. While we’ll redact the fund’s name out of courtesy, this rule serves as a reminder to stick to our roots from traditional asset management as fundamental investors, and never partake in the types of activities that led to these crypto-native funds’ failures. We wholeheartedly believe that we can deliver the most value, and reduce our risk, by limiting the size of our fund in order to execute the strategy we have a proficiency in. These events just provide another example of why that is the right approach for our investors.
Protocol Treasuries – Decentralized protocols raise funds in order to pay for things like developer talent, product development, and other incentives to attract liquidity and users. In some cases, these protocols will custody those assets on centralized exchanges. We know that some protocols custodied their treasury at FTX, particularly in the Solana ecosystem. We are currently assessing the location of protocol treasuries for assets we hold, and for assets we don’t, as any material treasury assets held on FTX will likely be materially negative to the protocol token price. At this point, we do not believe we have any material exposure to FTX via the assets we have invested in.
Traditional VCs – SBF was the “golden boy” for VCs, crypto native and traditional alike. Just recently, FTX raised funds at a $32B valuation. Those that participated will now write down that investment to $0. Notable investors included: Sequoia, BlackRock, Tiger Global, Multicoin, Paradigm, Temasek, SoftBank, Paul Tudor Jones, VanEck, and Ontario Teachers’ Pension. In total, VCs committed $1.8B to FTX across various funding rounds.
Crypto Companies – fortunately, following the deleveraging that occurred as a result of unsecured loans to Three Arrows Capital in May-June, many of the prominent market-makers that engage in these types of loans tightened up their lending processes. However, a few had some assets at FTX to service their market making activities. Genesis has disclosed $175MM of assets on FTX, stating it does not impair their ability to continue operations. Galaxy Digital also had small exposure that seems manageable. However, BlockFi once again is in distress and has halted withdrawals. In June, BlockFi failed as a result of unsuccessful trading activities, and had to be bailed out by…..SBF and FTX! FTX provided a $400MM credit facility in a buyout of the company. This allowed BlockFi to continue operations, but….they held all their assets on FTX.
This is not a piece to call out certain tokens, funds, companies, etc., but a window into the scope of participants that jumped aboard the SBF train. The full fallout is still to be seen, but as mentioned earlier, we have continued to subscribe to proper due diligence and risk management, and have no exposure to these failing or fraudulent companies aside from general market volatility as this unfolds. Additionally, as mentioned in our October recap, we entered this month defensively positioned.
Crypto Needs More Regulation!
Yes, we agree. It is also important to note, that crypto exchanges operating in the US are highly regulated. We are highly regulated. Unfortunately, the lack of clear policy direction in the US has driven many of these companies and users offshore. Additionally, the focus from regulators has been on how to classify tokens, and how to regulate decentralized finance (‘DeFi’). It has been our view, and should be abundantly obvious now that the focus of regulation should be on these centralized companies that continue to hurt their customers directly and indirectly.
DeFi has not experienced any of these issues. Once again, any loans that were provided from DeFi have been paid back in full. No depositors have lost funds in DeFi. The reason is because they are governed by code that enforces risk management. DeFi cannot be corrupted by greed or excessive risk taking, it just does what it is designed to do, and protects all users involved. Even when it comes to hacks, money laundering, blah blah blah, that gets all the media attention, DeFi performs leaps and bounds better than centralized institutions. DeFi is all “on chain”, meaning it is transparent to everyone. This is why anyone that has “stolen” funds has returned them or been caught. Alternatively, centralized institutions can be used to obfuscate this transparent tracking. Very apparent with FTX was the inability for anyone to track the movement of funds within their walls. This is why they need to be regulated, so that anyone who transfers funds to them is KYC’d, appropriate safeguards are in place for customer deposits, oversight exists to catch or disincentivize bad behavior, and bad actors lose the ability to offload assets obtained in nefarious ways.
Instead, the SEC is focusing on categorizing tokens as securities to increase their turf, and fining celebrities for promoting tokens. Interestingly enough, SBF met with Gary Gensler (head of SEC) earlier this year. The purpose of the meeting? To help SBF navigate the regulatory landscape in order to do more business in the US. So much for protecting consumers.
SBF also emerged as a significant political donor, becoming the 2nd largest donor to Democrat candidates in this year’s mid-term elections. Previously, he pledged to commit up to $2B to the 2024 Democrat Presidential campaign. To us, this appeared to be an attempt to buy political influence in order to promote policies that improved his business prospects. Perhaps as a result of this, over the past few months SBF actively engaged Senators to craft a bill to regulate crypto – the Digital Commodities Consumer Protection ACT (‘DCCPA’). The original draft of which drew ire from much of the crypto community, in part because it focused on regulating DeFi to a degree that would impair material benefits it provides to users. The largest beneficiary of that passing? Centralized exchanges. This was exposed on a public stage just a few weeks ago in a virtual debate between SBF and Erik Vorhees. At the crux of the pro-DeFi stance is the fact that DeFi should not be regulated like centralized institutions, because it inherently addresses many of the risks existing regulation is designed to prevent. We agree. Unfortunately, it looks like the DCCPA will continue forward, even though its main crypto backer has proven to be a complete fraud. The updated draft has yet to be publicly made available, but we expect there to be more debate on reshifting the focus to centralized crypto companies.
Moving Forward
Bitcoin and Ethereum continue to add block after block to their ledger. Battle-tested Decentralized Finance applications continue to process borrowing, lending, collateral liquidations, and trading flawlessly and transparently. NFT communities continue collecting and building new digital ecosystems. We have stated before that central players with poor risk management are not the same as “crypto.” The creation of Bitcoin alone was literally to enable the trusting of code versus human decision making, providing a censorship-resistant alternative to existing physical assets controlled by one authority. This recent collapse of FTX is likely to cause damage to the industry’s image, but the fact is an offshore shady person defrauded a significant amount of people in the pursuit of personal profit, and has no bearing on the potential of the technology itself. In fact, had FTX been either regulated in the US like Coinbase, or even better decentralized on-chain like Uniswap or GMX, investors would have had a full picture of their balance sheet at all times and this could never have happened. We view this as a long-term catalyst for adoption of decentralized alternatives to central decision-making, shifting the Trust from profit-seeking scam artists to audited, open-sourced code.
In the short-term, this is clearly not good for crypto adoption, particularly given the abundance of inaccurate reporting and mischaracterizations we keep seeing. On the flip side, what we have already seen occur is a rush to decentralized protocols, all of which posting record volumes and fees over the past few days. These are the protocols we are interested and invested in, and we look forward to them repricing to reflect their place as the trusted platforms of choice. We would also not be surprised to see a large traditional player(s) view the near-term price action and risk aversion to acquire cheap infrastructure and become a dominant player in this market. We welcome these entrants, with their traditional pedigree and risk management frameworks, as a much-needed replacement of these bad actors that have effectively been eliminated.
We also believe this will cause a consolidation of activity to the Ethereum and Cosmos ecosystems, including the “Layer Two” protocols built on-top of Ethereum, namely Arbitrum. This is where the bulk of our investments have been made. Without the support of the Solana ecosystem by SBF and related funds, we believe the value of the network could potentially fall to a level where its security is compromised, and its strong developers are being courted by Ethereum ecosystem companies. This, in addition to supporters being burned by SBF, could drive current Solana and other Ethereum-competitors’ users to migrate to these more proven ecosystems.
Thank you for your continued trust in us to navigate these types of events, and we remain steadfast in our commitment to find attractive opportunities across the crypto ecosystem with risk at the forefront of our decision making.
Please do not hesitate to reach out with questions, comments, or feedback!
Sincerely,
Motus Capital Management
Past performance is not indicative of future results. This communication does not constitute an offer to sell or solicitation of an offer to buy the Interests in any jurisdiction where, or to any person to whom, it is unlawful to make such offer or solicitation in such jurisdiction. This communication is being provided solely as a high-level overview and is not intended to be relied on for the terms of any offering.