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The Latest Developments in the FTX Debacle – January 2023

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FTX Debacle

It sent shockwaves across the crypto industry and beyond when on November 11th, 2022, the globally renowned crypto exchange ‘FTX' declared that it had filed for Voluntary Chapter 11 bankruptcy proceedings. The filing was for FTX, FTX.US, and Alameda Research.

Investors, industry analysts, and crypto enthusiasts were all taken aback, given that the exchange had seen its valuation going up to US$32 billion at the end of January 2022. Since then, a lot has happened, as one would expect from the fall of an industry behemoth. Here, we look at the events that have unfolded so far.

The Bankruptcy

Filing Chapter 11 bankruptcy in the US meant that the ‘bankrupt' entity would get a chance to restructure its debt rather than liquidating the assets. However, in a contrasting turn of events, FTX.US had frozen its withdrawals only to reopen later with US$600 million drained out of the wallet.

FTX claimed it had suffered a hack, only to be refuted later by specialist services who could not find any fraudulent act or breach done to FTX's wallet. First, a bankruptcy and subsequent reports of alleged fraud put FTX, and what remained of it, under increased scrutiny.

FTX Balance Sheet Revealed

The first breakthrough in the FTX case was achieved when Financial Times got hold of its November 10th balance sheet, just a day before FTX filed for Chapter 11 bankruptcy. The balance sheet was indicative of many anomalies and incompetentcies. For instance, it pointed toward the presence of US$8 bn in hidden and poorly labeled fiat accounts.

Although at the time of filing bankruptcy, the asset value of FTX exceeded liabilities by US$722 million, the exchange did not have sufficient liquid assets to pay for the withdrawals. Nearly 90% of FTX assets were tokens and participations that were either less liquid or illiquid. Its native token, FTT, also lost 90% of its value over only a few days. While Serum and Solana were the tokens with significant exposures on the exchange's balance sheet, Genesis and BlockFi owed US$200 and $215 million as creditors.

New CEO Appointed

At the end of November 2022, FTX saw the appointment of a new CEO. The job of John J Ray III, a veteran of Enron, was to dig deeper into what went wrong with the exchange. That duty included ascertaining funds that went missing or stolen, locating assets, and optimizing value for stakeholders by reorganizing or selling off the business.

The balance sheet led the newly appointed CEO to surprise as he was quoted saying he'd never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information.” In his submission to the US Bankruptcy Court for the District of Delaware, the new CEO stated that FTX failed to maintain “appropriate books or records, or security controls, with respect to digital assets.”

The Curious Case of Robinhood Shares

While the balance sheet appeared messy and indicated the complete lack of a properly implemented control mechanism, it also gave insights into some other aspects that have been proving crucial now. For instance, the balance sheet showed that FTX owned a 7.6% stake in Robinhood, an American financial company facilitating commission-free trades of stocks, ETFs, and cryptocurrencies, representing more than half of its assets.

In a court filing on January 5th, 2023, Sam Bankman-Fried, the ex-CEO of FTX, sought permission to retain control of the Robinhood stocks. Bankman-fried and his co-founder Gary Wang owned 56 million shares of Robinhood in principle through a holding company called Emergent Fidelity Technologies. The shares amount to around US$450 million now.

The argument that the founders have put forward is that the shares of Robinhood were purchased legitimately using money borrowed from the exchange's trading arm, Alameda Research. The borrowing was well-documented, they said. However, aimed at recovery and compensating stakeholders, FTX, in its counterclaim, demanded that the shares, nominally held by Emergent Fidelity, should be frozen until they are fairly distributed among the shareholders.

For now, a recent filing by the USDOJ has indicated that it has recently seized the roughly 55M shares in Robinhood, as various entities continue to lay claim.

Asking Back Donations

Speaking of recovery, the new management has also asked for the millions of dollars Sam Bankman-Fried, the ex-FTX CEO, disbursed as charitable donations. In response to this demand of FTX's new management, Bankman-Fried has pleaded not guilty, saying that the donations were from the trading profits and not the customers' deposits.

Besides charitable donations, the new management has also asked back donations that Bankman-Fried and other FTX executives made to politicians and political groups. As per the latest available information, FTX has pledged more than US$160 million to more than 110 nonprofits as of September 2022 through its charitable arm, Future Fund.

All That Happened in Between

During the time between FTX's filing for bankruptcy and the case proceeding being taken up in full swing in the New York courtroom, a host of other things happened.

After the newly appointed CEO explained to the authorities how grim a situation FTX had found itself in, reports came out of credible proof to suggest Bahamian regulators directing Bankman-Fried to gain unauthorized access to FTX funds and transfer it to the Bahamian Government.

While the reports of the Bahamian Government's involvement in the debacle came out on November 17th, it was only on December 12th that Bankman-Fried got arrested in the Bahamas at the US Government's request. Eight criminal charges were put against Bankman-Fried, including wire fraud and conspiracy to defraud investors.

After Bankman-Fried's arrest, FTX and its affiliated debtors filed a motion with the Bankruptcy Court to conduct auctions for four associated businesses: Embed, LedgerX, FTX Japan, and FTX Europe.

Immediately after Sam Bankman-Fried's arrest came the testimony of John J Ray III to the House committee, where he reiterated his earlier position that the discredited exchange did not have any record-keeping whatsoever.

Subsequently, Alameda Research CEO Caroline Ellison and Cofounder Gary Wong pleaded guilty on December 19th, 2022. However, on January 3rd this year, Sam Bankman-Fried appeared in a New York courtroom pleading not guilty to each of the charges against him.

Bidders for the Four Entities and the Hunt for SBF's Accomplices

As per the latest information, nearly 117 parties have expressed interest in buying LedgerX, FTX Japan, FTX Europe, and Embed. FTX has hired Perella Weinberg, an investment bank, to represent the fallen exchange in these sales. Kevin Cofsky, a partner at the bank, said that FTX had entered 59 confidentiality agreements so far.

In response to the DOJ's apprehension that the sell-offs might hamper user privacy and tamper potentially valuable assets linked to the allegations of wrongdoing, FTX said that it would not sell off any claims linked to Sam Bankman-Fried, Gary Wang, Caroline Ellison, and Nishad Singh, or their families.

While we know about all the senior executives of the exchange by now, Nishad Singh was the top engineer who came under the radar as the authorities' digging into the founder's inner circle increased. According to reports, all four executives mentioned above, including Singh, were aware of the exchange using customer funds to prop up its sister trading firm, Alameda Research.

It remains to be seen how much of these allegations stand the test of law.

Gaurav started trading cryptocurrencies in 2017 and has fallen in love with the crypto space ever since. His interest in everything crypto turned him into a writer specializing in cryptocurrencies and blockchain. Soon he found himself working with crypto companies and media outlets. He is also a big-time Batman fan.