Jan 20, 2023 - Economy

The SEC's Mango Markets case illuminates the FTX collapse

Illustration of the statue of Justice holding handcuffs in place of a scale

Illustration: Sarah Grillo/Axios

Mango Markets was a crypto exchange built on the Solana blockchain that looked a lot like the now bankrupt FTX.

Driving the news: The SEC brought charges Friday against Avraham Eisenberg, a trader who exploited the same weakness on Mango Markets that ultimately brought down FTX: a token that was designed to become more valuable the more people used its underlying exchange.

  • Eisenberg had previously been charged with commodities fraud and commodities manipulation.
  • He was arrested on Dec. 26, 2022, and is being held in Puerto Rico.

Quick take: If you had a beat up 2001 Toyota Corolla and someone offered you a $20,000 loan using that car as collateral, would you even bother making the first payment?

  • If you understand that dilemma, you can understand the following exploit.

How it worked: Mango Markets was an exchange — both for spot markets and futures — and it was a money market. All these things worked together, which is crucial to Eisenberg's exploit.

  • Mango Markets sold a token called mango (MNGO), a governance token meant to give users control over development on the platform. As the SEC suit explains, thousands of people bought it, but the creators effectively held a controlling stake.
  • The mango token was cheap and didn't get traded much. Nevertheless, Mango Markets permitted futures positions on the token to be used as collateral to borrow other cryptocurrencies that users deposited to earn interest.
  • So, Eisenberg took out a $5 million long position and a $5 million short position on mango on Mango Markets.
  • Then he went onto the open market and started buying mango aggressively on three different exchanges.

Zoom in: MNGO price shot up from $0.0382 to $0.91, or 23X. This made the value of his futures bet go up 13X.

  • Using that futures position, he was able to borrow all the money available to borrow on Mango's money market, worth about $116 million at the time.
  • Without more trades on the market, the mango token's price plunged back down to its expected levels. Which meant that Mango Markets could foreclose on his collateral.

Yes, but: He had already withdrawn the cryptocurrency.

  • And his collateral wasn't worth anything any longer anyway (remember the 2001 Corolla?). So he just kept the crypto he had "borrowed," accepting the foreclosure.

The intrigue: Eisenberg then proceeded to negotiate a deal with the Mango Markets team where he would give back just enough that all depositors could be made whole.

  • This still allowed him to walk away with what was, at the time, $49 million in cryptocurrency.

Of note: Eisenberg has admitted to the events described by the SEC (and the CFTC). What his attorneys are likely to dispute is whether or not those activities should be considered illegal.

Zoom out: Similarly, FTX's troubles began when Binance announced it would sell a large position of its exchange token, FTT, on the market.

  • Knowing that the exchange allowed traders to use its token as collateral, FTX users got spooked and withdrew billions of dollars quickly.
  • Which revealed the deeper weaknesses at the firm.
  • In other words, both operations were brought down by giving too much power to a token invented in house that not many people cared to trade or hold.

Flashback: Eisenberg previously managed to gain control of several million dollars out of a DAO running on another blockchain, Avalanche.

The bottom line: The SEC's case hinges on its argument that mango is a security, just as its case against FTX's co-founders does. It's been making this argument more specifically of late.

  • The SEC is seeking disgorgement of profits, civil penalties and blocking Eisenberg from trading securities in the future, among other things.
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