November 29, 2022 - 2:11pm

The unravelling of Sam Bankman-Fried’s trading empire FTX this past month has exposed the shortfalls of crypto as the supposed solution to the excesses, conflicts and trust issues of core finance. With the impending collapse of crypto lender Blockfi it appears crypto may even be equally prone to the sort of contagion the financial sector experienced in 2008. 

What has prevented the crisis from spiralling into a fully systemic episode for the global economy — at least so far — is crypto’s still largely contained nature and much smaller size, relative to that of the traditional financial system.

Yet those keen to assert that the debacle is evidence of core finance’s clear superiority to crypto underplay the role of central banks themselves in stoking and propagating the rise of the crypto market.

The point of quantitative easing, after all, was always to lubricate the market and create the conditions for excessive risk-taking. By design.

The best evidence of this is the inadvertent truth revealed by the “secret” text message brought to light by a new media outlet, Semafor, in its obsessive drive to debunk Elon Musk’s assertion that his “bullshit meter” was going off when SBF first approached him to invest in Twitter back in March 2022.

Bankman-Fried happens to have been a key investor in the media group, a conflict that Musk was quick to pick up on in his response to the article. Semafor’s piece had focused on Musk’s supposed hypocrisy and manipulation of the truth, since — in their estimation — by May of this year he was back tapping SBF for money for his “take Twitter private” deal. This allegedly resulted in SBF maintaining a small stake in Twitter, worth approximately $43m, a fact backed by publicly disclosed FTX bankruptcy filings.

Musk denied the assertion, claiming that SBF had been given the opportunity to roll his legacy Twitter share into the private structure, but had not carried through. With the truth now a function of one billionaire’s word against another’s, Ben Smith, Semafor’s co-founder, finally coughed up the evidence. This proved to be the counterpart text message to one of Musk’s — the latter having already been disclosed in the legal documents related to the Tesla billionaire’s attempt to renege on the Twitter deal.

The text, however, was hardly conclusive. All it revealed was that SBF had decided to withdraw from the investment round because of his own regulatory issues but remained interested in rolling his legacy investment if possible. Musk’s response was ambivalent at most, and certainly not indicative of someone desperate for SBF’s investment. 

The bigger factor missed by almost all covering the story was the relevance of the dates in the tit-for-tat squabble. SBF’s decision to walk away from the Twitter financing round came on 5th May, two days before the dramatic market collapse of the Terra Luna crypto stablecoin on 7th May. This is relevant because Terra Luna’s collapse is now largely seen as the most probable trigger for the fall of the SBF empire.

But there’s another date that needs to be factored into the FTX collapse puzzle: what happened on 4th May. This was the day the Federal Reserve finally — after much market anticipation — officially raised interest rates on US dollar funding by 50 basis points. These rates would become effective in the market from 5th May, the very same day SBF officially walked away from the Twitter deal.

That the Fed ultimately played a role in FTX’s collapse, by puncturing more than a decade’s worth of irrational market exuberance it had itself fuelled with cheap central bank money, is arguably the real key to this story. It implies more than anything that SBF’s entire empire, rather than being a crypto phenomenon, was mostly built on the excesses of cheap dollar funding and massively over-leveraged business models.

The culpability of the Fed in stoking these bubbles, however, is strangely not getting the attention it deserves.

Izabella Kaminska is the former editor of FT Alphaville and founder of The Blind Spot.