Thursday, June 1, 2023

FTX: Wall Street might cover the liquidity issue but not its insolvency

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It appears that Sam Bankman-Fried has not heard of blockchain’s record-keeping capabilities. In a lengthy twitter thread on Thursday, the fallen cryptocurrency tycoon blamed the collapse of his FTX exchange on a clerical error. That looks odd.

SBF tweeted that he mistakenly believed that FTX customers had plenty of liquidity earlier this week to facilitate withdrawals. He was not aware of leverage within the FTX system. He could not have got it more wrong. Panicked FTX account holders were prevented from withdrawing their assets this week.

SBF insists that FTX is illiquid at the moment, but not insolvent. That is, its asset value exceeds that of liabilities. He seeks a multibillion-dollar cash infusion to bridge any cash flow gap. To some, giving FTX a lifeline at the moment might seem absurd. Never mind its highly opaque operations, severe regulatory and legal risks are mounting.

But a template for taking on such a risk might exist. Shares of Coinbase, the listed crypto exchange, have dropped 80 per cent in price this year as crypto trading volumes have plummeted. But it clearly lists its client assets and liabilities and cash. Moreover, it is not explicitly or tacitly lending out client funds, which FTX seems to have done.

Recall the financial crisis. JPMorgan bought Bear Stearns. Barclays took on Lehman Brothers. Mistakes were made. Private equity firm TPG invested $1bn into thrift, Washington Mutual, just months before it went belly up in 2008. Wall Street has plenty of specialist funds and strategic buyers that make swashbuckling wagers during panics.

This week venture capital powerhouse Sequoia wrote down its $214mn investment in FTX to zero. The Silicon Valley titan also noted, however, that in 2021 FTX had generated $250mn in operating profit. How much of that comes from fees and commissions, versus volatile trading gain, is not clear. But the former could be the basis of a restructured FTX.

During the financial crisis, distressed acquisitions occurred under a strong legal and regulatory regime that oversaw the process. Nothing that substantial exists in cryptocurrency.

The immediate task is unravelling the relationships between FTX customer accounts and apparent lending to SBF’s trading operation, Alameda Research. Its foolishness probably caused this week’s run on FTX. SBF had better pull together all the records he can find.

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