TechScape: How do you slice a billion-dollar crypto bankruptcy pie?

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If you owe the bank a grand and can’t repay it, you’re in trouble. If you owe the bank a billion and can’t repay it, the bank’s in trouble. If the bank owes you a billion and can’t repay it, the system’s in trouble.

When the cryptocurrency exchange FTX filed for bankruptcy last week, it didn’t actually know how much it owed customers, the company’s new chief executive, John Ray III, said in a filing. “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” Ray wrote. That’s a weighty statement, given he worked on the Enron bankruptcy, the most notorious example of corporate fraud in recent American history.

FTX, Ray wrote, is expected to have “significant liabilities arising from crypto assets deposited by customers … However, such liabilities are not reflected in the financial statements prepared … under the control of Mr Bankman-Fried.” There is a vague justification for that choice: FTX, in its terms of service, insisted that crypto assets deposited on the platform remained the property of its customers. If it isn’t your property, it shouldn’t be recorded in your balance sheet, right?

FDIC pics

Unfortunately, the nature of a bankruptcy is that you have lots people who expect you to give them things – mostly money, but sometimes other things with names like “bitcoin”, “ethereum” or “a $40m mansion in the Bahamas” – and not enough things to give everyone what they want. A terms of service document which says you don’t own the assets that some of those people have deposited on your offshore cryptocurrency exchange could help them get their things back. But other people will have documents calling them things like “senior creditors”, which they also think will help them get their things back. And each of those groups think that if there isn’t enough stuff to go around, they should get all their stuff back first. The job of a bankruptcy court is, in part, to try and untangle those claims, and work out who gets all their stuff back, who gets some of their stuff back and who gets nothing back at all.

View image in fullscreenSam Bankman-Fried’s $40m Bahamian penthouse is reportedly on the market. Photograph: Twitter/FTX/Reuters

FTX being FTX, things can’t be that simple. In Delaware, where FTX has filed for bankruptcy, companies are usually expected to submit their 20 largest creditors. But FTX – or, more accurately, the FTX Group, a loosely connected web of more than 100 companies united by Sam Bankman-Fried – got permission to combine all of its bankruptcies into one case and all of its creditors into one document of 50 counter-parties. Annoyingly for us, it also got permission to keep those creditors secret.

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Nonetheless, we now know that the 50 largest unsecured claims held against FTX total a staggering $3.1bn (not including any insiders who may also be owed money and who are treated differently). All 50 of those were customers of the company, with the largest being owed $226,280,579 and the smallest only $21,344,561. There will be many others who are owed millions, or tens of millions of dollars by FTX who didn’t make it into the top 50. In Bankman-Fried’s versions of the company’s balance sheet, prepared two weeks ago to try to raise funding to save the business, he estimated that the company’s total liabilities were around $8bn.

Unfortunately, the document those customers have promising that none of their crypto is “the property of, or shall or may be loaned to, FTX Trading” is unlikely to help. FTX is not a bank, and depositors aren’t a special class of creditor: they are just, as the bankruptcy documents suggest, unsecured creditors. Worse still, another filing from the company’s financial advisor suggests that someone’s taking a haircut. Across the entire group, cash reserves total just $1.2bn. Crypto and equity value, as well as things like $121m of Bahamian property, will boost that somewhat, but it’s a big hole to fill.

FTX did, in fact, rely quite heavily on the fact that it wasn’t a bank to do lots of things that a regulated bank wouldn’t be allowed to do: things like print a token, FTT, that supposedly represented a right to a share of the company’s profits, and then transfer that token to its sister company Alameda to use as further collateral in loans and business transactions.

One of the first signs that things weren’t quite right at FTX was last August, when the company’s regulated American subsidiary received a warning letter from the FDIC, the US federal agency in charge of protecting consumer deposits at banks. The agency rapped FTX.US on the wrist for a tweet from its then president, Brett Harrison, that implied that the exchange benefited from that protection.

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Since the collapse of the exchange, which I wrote about in last week’s newsletter, there’s been renewed interest in the crypto sector in working out a way to offer deposit insurance to customers. Changpeng Zhao, founder of Binance, has pumped $1bn into SAFU, the “Secure Asset Fund for Users”, established in 2018 in an effort to provide some reassurance for retail investors. Since then, he’s also proposed “an industry recovery fund, to help projects who are otherwise strong, but in a liquidity crisis” – the equivalent of a lender of last resort, the Federal Reserve to the asset fund’s FDIC (Federal Deposit Insurance Corporation).

The proposals might help next time there’s a crisis in the space. But $1bn wouldn’t even touch the sides of the black hole in FTX’s finances; the fund’s going to have to get much bigger if it does anything other than shine a spotlight on the gulf between crypto’s ambitions and its achievements.

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Vox populi

View image in fullscreenThe Twitter office in Dublin. Photograph: Charles McQuillan/Getty Images

It is, at this point, an open question who’s destroyed more value in the last 30 days: Sam Bankman-Fried or Elon Musk. The FTX empire was worth $32bn at its peak; Twitter was worth $44bn when Elon Musk bought it. Twitter’s probably not worth $0 now – but it’s definitely not in a good shape.

Musk fired thousands of staff members on his first weekend as boss, and hundreds more resigned voluntarily over the next week, while contractors were also fired without notice. By the second weekend, he had decided to send an opt-out loyalty test to his workforce, compelling them to agree to work with him in “hardcore mode” or leave the company, then, when too many of them took the latter option, scrambled to find employees to reassign within the company who could be put in charge of critical infrastructure after entire teams bailed on the spot.

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In the process, Musk appeared to forget that Twitter is a global company, with employees scattered around the globe. In countries such as Britain, Germany and Ireland it is not, in fact, legal for an employer to fire staff, at will or whim, without reason or notice. But Twitter is having a go at it anyway.

The company has already received a letter from business secretary Grant Shapps “reminding” it of UK law around redundancies. But over the weekend, after the deadline in Musk’s loyalty pledge had come and gone, Twitter employees across Europe began to find themselves cut off from internal systems, despite allegedly having received no notice, been given no cause for the termination of employment and been given no chance to talk with the company about their options.

Employees in Germany have formed a works council and are suing; employees in the UK have been in touch with the union Prospect about recognition. Elon Musk has got away with a lot in his life, but it seems unlikely that this will be brushed aside by the courts. It might “only” be a very expensive error, once compensation is paid out to all former employees, but it would be the latest in a month of very expensive errors for the multibillionaire.

And all the time, hovering over Musk’s head, is the requirement for Twitter to pay around $1bn interest to the banks that helped finance the purchase of the company. Even before he scared away advertisers, that is only slightly less than the total profit the company made in 2018, one of only two years it has made a profit. Now, it’s the ticking time bomb under the whole acquisition. What will be more valuable by the end of the year: Musk’s stake in Twitter, or a lettuce?

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