One of the most depressing revelations coming out of the FTX trial was that Sam Bankman-Fried directed Caroline Ellison to sell customer bitcoin to keep the price under $20,000.

Depressing and sordid, but not surprising.

Crypto exchanges have been honeypots for thieves and scammers for more than a decade with light or non-existent regulation, with executives and owners having access to highly liquid pools of assets.

It doesn't help that hackers infest the industry like locusts and are almost tolerated by the industry, with ransoms happily paid after almost every hack.

North American crypto exchanges run the risk of being litigated out of existence (Coinbase and the SEC have been suing each other now for months).

Off-shore exchanges? All of the above. Plus, more than a few of them seem to have been run by criminal sociopaths, like Sam Bankman-Fried

Let's go over the incentives that crypto exchanges have to run down the price of bitcoin.

First and foremost, if they are running a derivative exchange on their platform, or even have accounts on other future exchanges, it's easy money.

If you have enough Bitcoin in customer deposits to move the market, you can sell your customer's Bitcoin to drive down the price, and then buy it at the cheaper price.

If the derivatives market is leveraged to the long side, you can liquidate the longs which will ensure the price of bitcoin stays low long enough to cover your short.

If you don't want to get your hands dirty, you can even lend out the customer deposits for a fee to somebody else who will do the dirty work (just hope you get paid back).

Is that illegal? If the exchange is operating in an off-shore country (like Barbados), it COULD be illegal of you are playing with the funds of US citizens.

But as long as you are making money and honouring redemptions, the chances of you getting caught are very, very low.

However, there is one problem with this strategy. Lots of people play that game, and because Bitcoin is on the public blockchain, it's hard to hide your tracks.

Eventually, other traders will figure out what you are doing, and watch for it. Then the game gets more risky, with other whales pooling their cash to bid against you. That's what seems to have happened at Alameda (plus, it turns out that Sam was a lousy, horrible, sloppy trader).

However, there is another way to fill your bags if you are an exchange. And that's to mint your own token.

FTX had its own token, called FTT. It still trades today.

At its peak, the token was worth $80 USD, for a market cap of more than $26 billion USD! Even today, the token has a market cap of $325 million with a trading volume of more than $5 million a day.

For an exchange, the playbook is simple:

1. Mint a token.
2. Create trading pairs of the token so your customers can trade it.
3. Use customer funds to create the liquidity pools to back the trading pairs.
4. Incentivize other exchanges to offer your token, by outright bribes or offering to provide liquidity so they make money off trading fees.

The great advantage of this game (besides the fact you have created a huge financial asset out of nothing) is that it's hard for traders to play against you.

You can easily control the price of your token by locking up a large amount of the supply, announcing token burns, and dumping the token whenever you feel like it, although the last method is somewhat crude.

In the case of FTX, they created an asset worth billions of dollars on paper and then offered it as collateral. That is to say, they borrowed against it.

It was a beautiful con and it should have worked. But two things happened to screw it all up.

First, the bear market, caused in no small part by FTX and other exchanges getting too enthusiastic in fleecing the retail customer.

The second was that other players started to see through the con game, which was becoming so outrageous that they went public rather than “keep in the family.”

The trigger was pulled when Changpeng Zhao (known in the industry as CZ), the CEO of Binance, called out SBF on public Twitter

That caused depositors to ask for their money back, which caused a liquidity crisis, which brought down the whole house of cards.

First FTX, Now Binance

For the rest of 2022, we had “cascading liquidations” with multiple crypto entities (BlockFi and Gemini holdings just to name two) having to pause withdrawals.

But now all eyes are on Binance because:

1. It's an offshore private company so it is subject to way less regulatory oversight compared to North American crypto exchanges like Coinbase and Kraken.
2. It has its own coin, called the Binance token or BNB.

It's well-known that Binance has been paying a lot of their overseas staff in BNB tokens, so they are HIGHLY incentivized to keep the price as high as possible.

Is it the average retail customer that is keeping the BNB token at more than $200, or it is Binance selling assets to support that price level?

And then, if they are selling assets like Bitcoin and Ethereum, where are they getting them?

But before we run to the exits, there are important differences between FTX and Binance.

First of all, there is a stark contrast between SBF and CZ.

There has been a lot of dirt thrown at CZ, but nobody thinks he is a sociopath hooked on Adderall.

In contrast, we have the court testimony about SBF, and it's brutal.

Secondly, the SEC has been breathing down the neck of Binance for almost a year now, and they still haven't shut down the business. Even though Binance.us is now a shell of a company, Binance.com is still operating day in and day out.

There has been no bank run on Binance, despite huge amounts of negative publicity for more than a year.

What can we make of all of this?

Two Conclusions

One, there is no substitute for self-custody,

Whether you buy Bitcoin or Ethereum or any other type of coin or token, you need to move it to your wallet and write down the seed phrase. You should even consider getting a hardware wallet like Ledger.

Time and time again, leaving your assets on an exchange has been proven to be a bad idea.

Two, the shell game can't go on forever. The run on FTX deposits caused Bitcoin (and Ethereum) to go down. But they recovered.

If crypto exchanges want to "go bad" and sell customer deposits, they can cause a lot of damage. But eventually, they get found out, and the price of Bitcoin will go up, again.

FTX did its best to keep Bitcoin under $20k, but in the long run, they failed.

If Binance is doing shady stuff (and lots of people are throwing dirt out there), it won't last forever, and you can make it through the turbulence.

Because you followed rule #1 (see above).

Play the long game.