Today's Matt Levine's Money Stuff

https://www.bloomberg.com/opinion/articles/2022-11-28/ftx-s-...

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One lesson of traditional finance that crypto is learning these days is: “If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.” For instance:

1. There is a small opaque crypto lending platform that is rumored to be in trouble.

2. Its depositors want their money back.

3. It doesn’t have their money, either because the money is locked up in long-term loans or because it lost the money or some combination or otherwise.

4. There is a “run on the bank.”

5. To solve the problem, the lending platform agrees to take a desperation bailout from some bigger, more stable, better-known crypto exchange. The big exchange agrees to guarantee the lending platform’s customer deposits, or at least gives it an ample line of credit to pay out depositors. In exchange, the exchange gets to take over the lending platform, and its existing owners get more or less nothing.

6. The run on the bank stops. The depositors don’t want their money back, because now instead of being depositors at the small lending platform, they are depositors of the large stable crypto exchange. Their money is safe, backed by the deep pockets of the large exchange, and they can go back to earning crypto interest or whatever.

If you can get a big enough line of credit, you never need to draw on it, because your depositors were worried about your liquidity, and the line of credit resolves those worries.

In some rough sense this describes the bailouts this summer of BlockFi Inc. and Voyager Digital Ltd. by Sam Bankman-Fried’s crypto exchange FTX and its affiliated trading firm Alameda Research. 1 BlockFi and Voyager looked risky after some of their borrowers collapsed, so customers rushed to withdraw their money, and BlockFi and Voyager didn’t have enough to give them.

And then FTX/Alameda showed up and said, well, we’ll take over your customers. In the case of BlockFi, FTX gave it a line of credit to cash out customers, and got an option to buy the company for some nominal amount of money. In the case of Voyager, it filed for bankruptcy, and FTX offered to come in, move Voyager’s customers to FTX, and cash out anyone who wanted out. In either case the basic point was that FTX had enough money to cash out everyone, so no one needed to cash out. These small rickety crypto firms were rescued by a big safe crypto firm, so the customers could let their money ride.

Oops! That was all wrong; FTX had been misplacing tons of its customers money, and did not in fact have enough to bail out everyone else; FTX filed for bankruptcy earlier this month. And today:

BlockFi Inc. filed for bankruptcy, the latest crypto firm to collapse in the wake of crypto exchange FTX’s rapid downfall.

BlockFi said in a statement that it will use the Chapter 11 process to “focus on recovering all obligations owed to BlockFi by its counterparties, including FTX and associated corporate entities,” adding that recoveries are likely to be delayed by FTX’s own bankruptcy. Chapter 11 bankruptcy allows a company to continue operating while working out a plan to repay creditors. …

Citing “a lack of clarity” over the status of bankrupt FTX and Alameda Research, the Jersey City, New Jersey-based company earlier halted withdrawals and said it was exploring “all options” with outside advisers.

FTX US is listed in the company’s petition as one of its top unsecured creditors, with a $275 million loan.

The company’s largest unsecured creditor, Ankura Trust Company, is owed about $729 million, according to the petition. Ankura acts as a trustee for BlockFi’s interest-bearing crypto accounts, according to its website.

BlockFi in July received a capital injection from a now-collapsed FTX US, and also had collateralized loans to Sam Bankman-Fried’s trading firm Alameda Research.

It is early yet, and hard to know exactly what happened, but I think it’s something like “as long as people assume you have a bazooka you don’t need to use it, or have it.” When FTX was a $32 billion company that ran a well-regarded crypto exchange, had raised billions of dollars of equity from big investors and was handing out nine-digit credit lines like candy, everyone was like “ah well if FTX is here then everything is fine,” and it was. When FTX was bankrupt and couldn’t fund its credit lines, its beneficiaries quickly collapsed along with it.

Here is the bankruptcy docket, and the bankruptcy petition with the list of top creditors. At the top is Ankura, which is the trustee for BlockFi’s crypto interest accounts; if you put your crypto at BlockFi to earn interest, what you have is an unsecured claim on whatever BlockFi has left. In fourth place, owed $30 million, is the US Securities and Exchange Commission, for what’s left of a $100 million securities settlement from happier times this February. In February, BlockFi thought that it was such a good idea to offer interest-bearing crypto accounts that it agreed to a $100 million settlement with the SEC to find a path to legalizing those accounts. In February, the biggest problem with BlockFi’s interest-bearing crypto accounts was that they were not, technically, legal in the US. Now there are much bigger problems! And yet that problem was not small?

Meanwhile BlockFi owes FTX $275 million, presumably having drawn that much on its line of credit (and being unable to draw the rest). The details are a little unclear, but one weird little detail is that in FTX’s bankruptcy pleadings it has said that FTX US loaned BlockFi $250 million worth of its own FTT token.

We talked about the FTT token a few weeks ago, in tones of horror. Basically the FTT token is a cryptocurrency that is kind of like stock in FTX, a claim on the future cash flows of the exchange. When FTX was a good crypto exchange with a promising future, that claim was very valuable; FTT traded above $50 in March 2022, and was mostly above $25 this summer as BlockFi and Voyager were running into trouble. When FTX was bankrupt, that claim was not worth much; FTT was trading at about $1.29 at noon today.

It turned out that FTX’s balance sheet consisted largely of FTT and other, similar tokens that it had made up and that represented bets on the future of FTX’s businesses. Basically FTX took in a lot of real money and … lost it somehow … and convinced itself that the money was still there because it still had a lot of tokens that it had made up? And those tokens did have a market value; they traded in cryptocurrency markets, and so you could calculate how much FTX’s stash of those tokens were worth at their market prices. Of course if FTX had actually tried to sell all those tokens the price would have cratered, so that market value was not real, and now it has collapsed. FTX is not going to sell its stash of FTT and SRM and MAPS tokens for billions of dollars to make all of its customers whole; those tokens were worth billions of dollars when people had confidence in FTX, and now that confidence is shattered and so are the tokens.

But back over the summer, FTT was totally a thing! And so it is possible that when FTX extended a loan to BlockFi to shore up its customers’ confidence, it loaned BlockFi tokens. “Here, have some magic beans we made up, people really believe in them,” FTX could have said to BlockFi, and over the summer that would have been enough. “Ah, BlockFi has some FTX magic beans, everything is fine,” customers could have said, and the bank run would have halted. Now the beans no longer work, and BlockFi is bankrupt.