The Breakdown - The Hole on the FTX Balance Sheet Remains Gaping

Episode Date: March 4, 2023

In this week's “Weekly Recap,” NLW looks at the latest from the FTX bankruptcy estate and stirrings that Democrats in Congress aren't fond of SEC Chair Gary Gensler's regulatory methods. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   - “The Breakdown” is written, produced and narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: Hermann Mueller/ Getty Images, modified by CoinDesk.  Join the discussion at discord.gg/VrKRrfKCz8.   Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26-28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com.  

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is produced and distributed by CoinDest. What's going on, guys? It is Saturday, March 4th, and that means it's time for the weekly recap. A quick note, before we dive into that, there are two ways to listen to the Breakdown podcast. You can hear us on the Coin Desk podcast network feed, which comes out every afternoon alongside other great CoinDisc shows. Or you can listen on the Breakdown-only feed, which comes to the Breakdown-on-on-on-week, which comes out a few hours later in the evening.

Wherever you're listening, if you're enjoying the show, I would so appreciate it if you would take the time to leave a rating or review. It makes a big difference. All right, friends, happy Saturday. Let's catch up with some news we missed from earlier in the week. And let's start with FTX. In a presentation filed in the FTX bankruptcy case on Thursday, bankruptcy lawyers said that the firm has a, quote, massive shortfall in assets,

amounting to $8.9 billion worth of customer funds. The presentation walked through the assets recovered so far, stating that $2.2 billion in cash and crypto have been identified in the wallets owned by FTX, valued at spot prices on the date of bankruptcy. Of this, only $694 million was made up of what the bankruptcy estate is calling category A assets, which includes liquid assets including fiat, stable coins, Bitcoin, Ethereum, and other liquid tokens. Other assets include $385 million in payments due from customers, as well as a massive claim against Alameda research. The presentation showed that Alameda had $9.3 billion in net borrowing from FTX at the time of bankruptcy. Essentially, the entire shortfall is attributable to loans made to Alameda.

Although, of course, we're using the word loan very, very loosely. FTX U.S. also showed a shortfall in customer assets of around $116 million. FtXU.S. accounting also showed that Alameda research was owed a net of $107 million from the U.S. exchange. Unauthorized transfers were detected from both exchanges after the bankruptcy filing. And here's an interesting little detail. Unauthorized transfers were detected from both exchanges after the bankruptcy filing, with 139 million from the U.S. exchange and 293 million from the international exchange. Now, this FTX U.S. shortfall is something that I think is pretty notable,

given that Sam has continuously said that FTX was solvent, despite the fact that Carolyn Ellison said that Sam instructed Alameda to, wire millions of dollars to FTX US during that week that everything was happening in order to shore it up. I'm not a lawyer, but that doesn't sound like solvency to me. Anyway, in a press release, bankruptcy CEO John J. Ray III painted a picture of just how much of a mess he has been staring at since he took over the exchange. Quote, it has taken a huge effort to get this far.

The exchange's assets were highly commingled, and their books and records are incomplete and in many cases totally absent. For these reasons, it is important to emphasize that this information is still preliminary and subject to change. We believe it is more important to provide transparency to stakeholders by making this information public now than to wait until we can achieve certainty. Now, as for the international exchange, the FTCS team identified almost $7 billion owed to customers offset by only $694 million in cash assets and a further $310 million in payments due from customers. FTX had a deficit in every token treated as a Category A asset like we just discussed,

which included every reasonably liquid token right down to Solana, Tron, and Maddic. Each category B asset, the tokens with insufficient liquidity to realize at book value, had a significant surplus. This category mainly contained the so-called Samcoins like FTT, Maps, and Serum. As a particularly egregious example, the recovery so far has found one million in Bitcoin held on the FTX.com balance sheet against $1.6 billion in customer deposits. And this is obviously one of the biggest points of this whole thing. It's quite clear that in addition to just shipping assets off to Alameda to do whatever the

hell they wanted to with them, part of the fraud that Sam was perpetrating was that he was trading real assets for bullshit assets that he had invented. Effectively, the FTX balance sheet was just a giant hedge fund for coins that he had a disproportionate share of. The presentation also included a brief timeline of the work that has been undertaken to verify customer data. On the day of the bankruptcy filing, FTCS appeared to be the target of a cyber attack, with the website being disabled and customer balances because,

becoming inaccessible for users. According to FTX, their data team undertook a three-week-long customer balance review in December, and this process uncovered, quote, significant balance issues. A subsequent review was then performed in a collaboration with TRM Labs. FTC said that this process involved reviewing 120 billion rows of user transaction data, 14 million wallet addresses, and revealed, quote, abnormal internal user accounts. Now, one of the big questions in all of this is, what's Alameda side of this equation? Wasi lawyer tried to do. dig in a bit on exactly that. They write, Today, FtX released a preliminary analysis of the asset and liability position on FtX.com and

FtX U.S. So, here is a quick analysis brought to you by a hentai anime penguin in a suit that woke up at sunrise to attend a poorly scheduled meeting. Headline figures are as follows. FtX.com has 11.2 billion of customer receivables versus 2.15 billion of located assets in FtX's control, which means you're looking at a net shortfall of about $9 billion. The shortfall is attributed to a massive loan to Alameda as expected. Of the located assets, only about one-third of it is in cash or liquid cryptocurrencies. The remaining two-thirds is in Samcoins, including the astounding $1 billion in Maps. The whole is a net position of about $9.3 billion owed to related parties, mainly Alameda Research. FTCS are better off, with about $335 million owed to customers and $190 million

in located assets. There are some customer receivables for both FtX International and U.S., but I am not considering those as assets unless there is a set-off position, i.e., nobody is paying that back into FtX. These numbers are all preliminary, of course, but so far, what it does tell us is that there are sufficient records to reconstruct the FtXU.S and FtX.com positions, so we may not get substantive consolidation. That is, FTCS international creditors, may get less than U.S. So this is good news for FTXU.S. creditors, that it does sound like there's a possibility that the separate legal entities are going to be respected. But what we are missing here is Alameda's position, because most of the remaining recovery is contingent on Alameda. To recap, if we are respecting the existing

corporate structures, it means we are going to have to follow the intercompany positions in order to establish which silo recovers what. The first big intercompany position takes us from FTX International into Alameda. Alameda owes FTX International almost $9 billion, so we need to figure out how much FTCS international can recover on this intercompany loan. In order to establish this, we need to know what creditors Alameda has other than FTCS and what assets it actually has as well. Although this presentation doesn't specifically cover Alameda, it notes that Alameda has 956 million of Solana and Aptos, 820 million at third-party exchanges, 185 million of stables, and 169 million of Bitcoin.

Not sure how they value the Salana Aptos bags, but let's assume optimistically about $2 billion in all. So assuming Alameda has no other assets and no other creditors, we would only be able to add about $2 billion to the FTX International Estate, bringing the FTCS international whole to about $7 billion. But Alameda almost certainly has other assets. What are they? I suspect they are either equity or token investments and or receivables from Paperbird Inc. To recap, Paperbird Inc. is Sam's holding company that owns FTX Ventures, and there is a loan between Paperbird and Alameda. In plain English, this means that Alameda lent assets onward to Sam's holding company

that was likely injected into FDX ventures. So Paperbird owes Alameda money, and to get money back from them to pay FTX International, Alameda needs to recover this money from Paperbird. This would be achieved by paperber liquidating the Ventures portfolio and paying back amounts owed to Alameda. Alameda can then use these proceeds to pay its loan to FTX International. So the million or rather billion dollar question is, how much is everything worth? If the FTX International whole after accounting for all crypto is $7 billion, can we reasonably expect the liquidation of the Ventures portfolio to return $7 billion? Probably not, unless there are some absolute winners in there.

But the amount deployed is allegedly $5.2 billion across all Alameda and Ventures investments. The biggest investments are in Genesis Digital, a mining outfit that doesn't seem connected to DCG, Anthropic, and some funds. Long story short, we are going to find out a lot more when the Alameda liability position arises. If it turns out Alameda owes significant sums to creditors other than FTX, then we can expect recoveries to take a significant hit. There are other pockets of recovery.

It is clear that the estate is looking at clawbacks from insiders, SPF, Gary and Ashott, etc. And they were previously looking at whether certain transactions could be avoided. It would be cool to see where they are on this. But more interestingly, FTCS is looking at the deposits and withdrawals in the 90-day period before FTX went into Chapter 11, which sounds to me like they are at least going to try clawbacks. So the TLDR from all of this is that we really need to know more about where Alameda is, what other creditors it has, and what the actual value of its illiquid Ventures portfolio is,

before we know how much of a recovery FTX creditors can expect. I think overall my feeling on this was pretty well summed up by Adam Cochran, who wrote, This hole was clearly massive, and SBF is going to get the book thrown at him, and he goddamn deserves it the little narcissistic twerp. But with that, we move on to a few bits of regulatory news. Join CoinDesk's Consensus 20203, the most important conversation in crypto and Web3, happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3,

and the Metaverse. Immerse yourself in all that blockchain technology has to offer. for creators, builders, founders, brand leaders, entrepreneurs, and more. Use code breakdown to get 15% off your paths. Visit consensus.coindesk.com or check the link in the show notes. The chairman of the newly formed House Financial Services Subcommittee on Digital Assets,

Representative French Hill said that his group intends to work with the House Agriculture Committee to craft a crypto regulatory framework. Speaking at a Digital Asset Symposium on Thursday, Hill said, quote, we're going to do our best to work in tandem with House Ag on this process because I think that is effective. Now, of course, the House Ag Committee has oversight over the CFTC, which has a key role in regulating crypto. Hill was clear that he viewed the subcommittee's goal as creating a regulatory framework for crypto, but was hesitant to recommit to focusing on Stable Coins first, which had been the approach of the previous Congress. He said, my instinct might say if we pick up

where we left off on Stable Coins first, but I'm not sure if I can do that. Part of that is where is this administration on constructive work with Congress on a framework. It seems what Hill is referencing is the fact that ultimately Patrick McHenry and Democrats led by Maxine Waters just weren't able to come together on a stable coin bill. In fact, last year during the work on that legislation, McHenry partly blamed the Treasury Department for holding up talks between the two parties on what was intended to be bipartisan legislation. Wherever they start, let's hope they get something together because in the meantime, Gary Gensler is running wild. Two weeks ago, the SEC proposed a controversial rule that would require registered investment advisors, including pension funds and some VC firms,

to custody their crypto assets with qualified custodians. While the rulemaking was to be generally applied to all assets, commentary around the proposal made it clear that it was targeted squarely at existing crypto businesses. In an appearance at an investor advisory committee meeting, Gensler doubled down, stating that crypto exchanges should not be considered safe under those guidelines. Based upon how crypto trading and lending platforms generally operate, investment advisors cannot rely on them today as qualified custodians. To be clear, just because a crypto trading platform claims to be a qualified custodian

doesn't mean it is. Now, most people took this to be a thinly veiled shot at Coinbase, who came out following the proposal to remind clients that it has a qualified custodian within its corporate group. Cryptosec writes, this is going to have very big implications if crypto exchanges like Coinbase do not meet the requirements for the new qualified custodian policy. Gary is not only looking at blocking U.S. retail from crypto, but also institutional investors. James Murphy at Met a Lawman took issue with another part of the statement.

He said Gary Gensler just stated that he believes the SEC has jurisdiction to make rules concerning custody of, quote, all of an investor's assets, not just their funds or securities. Let that sink in. Now, one of the questions that keeps coming up is whether there is anyone that is going to reign this dude in. Well, for a little more on that, we turn to Ron Hammond, the Director of Government Relations at the Blockchain Association. He writes each week a little thread about crypto in DC, and this week's had some pretty interesting insights. He writes, this week in Congress in Crypto,

the crypto carpet bombing continues. There are a number of regulators involved in this crackdown, but none more prominent than the SEC. Gary Gensler's aggressive approach has caused several Democrats to vocally express concerns. Relentless. That is how best to describe the current regulatory crackdown. It seems like almost every day there is some sort of enforcement action, policy statement, proposed rulemaking, or notable speech. Many times these actions have vague language hinting it more to come. Everyone in the industry is reading the tea leaves of each action to see if and how it could affect their business. This exercise is exhausting, and many times inconclusive in terms of finality. Many in the industry are now asking if they

should just domicile elsewhere. This is what regulation by enforcement looks like, and sadly, this has been happening for quite some time. The intensity of the regulatory action has irked several folks in Congress, including many Democrats, which is an important thing to monitor. In a split Congress, legislation is always hard to get across the finish line. The party in power doesn't want to give wins to the opposition. At the same time, the party that doesn't control the presidency will always be on the attack to show the public they would be better. It is rare for the party in control of the administration to receive flack from their own camp. However, Gensler's actions have received public and vocal criticism from a number of Democrats and the list keeps growing as he pushes forward.

This could be problematic for him in the future. Some recent examples. Senator Kirsten-Jillibrand said two weeks ago, quote, I have many concerns about Chairman Gensler and his approach to this crypto space. Senator John Hickenlooper penned a letter to Gensler calling for a, quote, transparent notice and comment regulatory process rather than the status quo. One of the most damning lines came from House Financial Services and Progressive Representative Richie Torres, who bluntly said, quote, my sense of Gensler is, he strikes me as a politician pretending to be a regulator. There are others who hold this view in Congress but aren't as vocal. There are many more examples in the House, but the Senate Democrats are important because

they can cripple Gensler politically if he doesn't have all the Democrats in his camp. They can block Senate confirmation of potential SEC officials or future nominations for Gensler himself. Recall Gensler received an 88 to 6 vote for his 2009 nomination for the CFTC. For the SEC in 2021, he received a margin of 53 to 4. While politics has gotten more partisan since 2009, and SEC is a more polarizing role, it is apparent favor in the Senate is not as strong for him. The last thing to keep in consideration is that this backlash from Democrats is just for crypto actions. There are a whole host of other areas where Gensler and the SEC are also being aggressive.

ESG, clawbacks, SEC staff union, and more. Each fight has a political cost. Congress has several unique ways to accomplish policy goals outside of passing legislation. To have this many Democrats publicly calling out their own is telling. The question is, how long can this aggressive approach to regulation go on until he becomes a political liability? We are far past the point where a few Democrats squawking about Gensler is going to be enough to get me excited.

Until there's some real threat behind the words and real political costs for Gensler, he has clearly decided that this is better for his career than running in the opposite direction. And that means more pain for the crypto industry, continued lack of clarity around definitions, continued lies about the ease of registration, and of course, more of these stupid, inane videos. Luckily for all of us, it's Saturday, and we don't have to think about it any longer. Thanks as always for listening, and until tomorrow, be safe and take care of each other. Peace.