Energy has Enron. Telecom has WorldCom. Real estate has Countrywide. Healthcare has Theranos. And now cryptocurrency has FTX. As with other implosions, the spectacular fall of FTX had more to do with accounting manipulations, misuse of funds (i.e., fraud), and a founder’s ego (and possibly slippery ethics) than with the product per se. It’s a lesson high-flying startups with innovative processes seem destined to learn over and over.
Binance is exploring acquiring FTX. If the deal is completed, Binance would control about 80% of the world’s cryptocurrency market. (Coindesk)
The cryptocurrency market lost about $100 billion of its capitalization in a single day when FTX filed for bankruptcy. (Finbold)
Crypto market valuation had been falling steadily from its high of $3 trillion on Nov. 10, 2021, to $837 billion on Nov. 14, 2022. (Statista)
The Financial Times recently published a leaked version of FTX’s spreadsheet that showed the company had $8.9 billion in liabilities but only $900 million in liquid assets. The balance sheet contained three asset categories: the $900 million liquid group already referenced, a less-liquid group ($5.5 billion) and an illiquid group ($3.2 billion). The category that has caused accountant eyebrows to shoot up is the “less-liquid” group. When analyzed, it turns out that founder Sam Bankman-Fried (SBF) was counting FTX’s own exchange tokens and cryptocurrencies of the Solana ecosystem, which were heavily supported by FTX, as “less liquid,” which implies there is a relatively decent chance of receiving the assumed valuation in a sale. The primary problem with assigning its tokens and cryptocurrencies to a less-liquid category is that FTX was also acting as the exchange. If FTX’s exchange went down (as it has), the company would find it difficult to sell or redeem the assets on the open market at anything near current valuation. Simply put – these assets weren’t less liquid, they were likely completely illiquid.
Financial experts also questioned the amount of private equity investments listed as illiquid (which they are), as well as some not-so-great bets, such as $43 million in Twitter stock and nearly $7.4 million in TRUMPLOSE tokens, which were used to create a betting market on the outcome of the 2020 presidential race. The entire balance sheet is (was) way too illiquid for best practices accountants and managers.
On top of this, FTX had a certainly unethical and possibly illegal relationship with the crypto trading fund Alameda Research, which SBF had also founded. The machinations between the firms included Alameda purchasing tokens before they were listed publicly on FTX’s exchange, and thus benefiting from the typical price jump, and SBF moving $10 billion in client funds to Alameda using backdoor accounting to avoid scrutiny. Reuters reports that somewhere between $1 billion and $1.7 billion of these transferred funds are now unaccounted for.
This was all too much for FTX’s investors, who began cashing out in droves and, in essence, created a run on the bank. With assets going out faster than they were coming in, FTX had no option but to file for bankruptcy protection. How this all plays out is still unknown, but as we write this, SBF is reportedly trying to raise cash to bring the company out of bankruptcy.
Is SBF a bad actor or simply caught up in his own hype? It’s hard to tell, but no matter how innovative a product is, innovative accounting always ends up badly. It can be argued that investors should have been more diligent. Evidence of smoke and mirrors was everywhere. But as humans, we want to believe. And we don’t want to miss out on the next Apple or Amazon. This probably won’t be the last spectacular crash we see in the crypto world, but just maybe investors will look past the product to how the company is run.
Photo courtesy of Visual Capitalist.