FTX Was Never Really Bankrupt

Originally published at Project-Syndicate | Jan 26th, 2024

The prosecution in Sam Bankman-Fried’s criminal trial drilled into the jurors’ heads that FTX customer losses exceeded $8 billion, but never substantiated that claim. In reality, the crypto exchange had sufficient assets to make creditors whole all along – a fact that would likely change the public’s perception of its founder.

NEW HAVEN/STANFORD – Last November, FTX founder Sam Bankman-Fried’s closely watched criminal trial ended with his conviction on seven counts of fraud and conspiracy. According to the prosecution, Bankman-Fried stole “billions of dollars” from the crypto exchange’s customers “out of sheer greed.”

One key issue was how much money FTX’s customers lost. During the trial, the prosecution and its witnesses repeatedly – in fact, 97 times – put that number at $8 billion. Although no proof to substantiate this massive figure was ever offered, the prosecution clearly wanted it to stay in jury members’ heads.

In fact, the figure is misleading. Instead of measuring loss, the $8 billion reflects the temporary shortfall in cash and other liquid assets needed to cover FTX customers’ remaining redemption requests after FTX’s chief competitor triggered a run on the exchange in November 2022.

At the same time, the presiding judge barred the defense from introducing any evidence to support Bankman-Fried’s claim that FTX was solvent – that it had enough assets to cover all its liabilities to customers – at every point before Bankman-Fried relinquished control to John J. Ray III, a bankruptcy lawyer, shortly after FTX collapsed. The defense was also prohibited from showing that the value of FTX’s assets had grown steadily after crypto markets rebounded.

To date, no independent party has examined the accuracy of these claims. A federal appellate court decision last week ordering the appointment of an independent auditor in the FTX bankruptcy – requested by a government watchdog and opposed by Ray – should provide, in the words of the court, “much-needed elucidation.” For example, a recent report valued Anthropic, one of Bankman-Fried’s AI investments, at $18.4 billion, which would add roughly $2.5 billion to the FTX estate. And that is just the tip of the iceberg. Extrapolating from the numbers in Ray’s September 2023 report to creditors, the assets in the estate right now are sufficient to make whole all creditors, including customers, lenders, and investors.

Consider that in the September report, Ray valued the estate’s assets at $6.7 billion and its liabilities at $10.6 billion, suggesting that FTX was insolvent. This reflects the bankruptcy team’s decision to count only the most liquid assets held by FTX, such as cash and big-name cryptocurrencies like Bitcoin. They ignored what Michael Lewis, in a book about Bankman-Fried, described as a “dragon’s hoard” of valuable assets assembled by the FTX founder.

Among the many assets that Ray and his team did not count were FTX’s portfolio of 416 venture investments (including Anthropic and Genesis Digital Assets, a leading Bitcoin miner), FTX’s holdings of 1,300 less liquid tokens (Ray valued the top 20 alone at $1 billion); and miscellaneous other token holdings and non-debtor assets that cost FTX $1.3 billion.

Including these assets would add billions to Ray’s estimates of value. Since last August, the market value of FTX’s crypto holdings has grown by about $5 billion. This has been largely driven by the five-fold increase in the market value of Solana, FTX’s largest holding, as well as a 50% increase in its remaining top ten tokens. Indeed, some FTX account holders are now objecting to a proposed pricing of their claims that is based on the lower US dollar value of cryptocurrencies when FTX filed for bankruptcy in November 2022.

As friends and colleagues of Bankman-Fried’s parents, we have relied exclusively on figures published by Ray and publicly available market prices to avoid any appearance of a conflict of interest, and have tried to estimate appropriate discounts for selling into illiquid markets. While some of these valuations could be significantly off in either direction, the overall picture is clear: the current assets held by the bankrupt estate are more than sufficient to repay all creditors with interest and still have billions left over – if only the bankruptcy team would distribute them.

Whatever else might be said about Bankman-Fried, he was a brilliant businessman. In four short years, he built two companies from scratch that had a combined market value of $30-40 billion and annual revenues of more than $1 billion. Absent the liquidity crisis and the Chapter 11 team’s decision to shut down FTX’s international and US exchanges, the companies could be worth twice that amount today, given the crypto market’s recovery.

The biggest financial loser by far would appear to be Bankman-Fried, who owned a majority interest in both exchanges. The biggest winners will be the lawyers and financial advisers representing FTX, who together billed in excess of $400 million by the end of 2023, a fact that may explain the sluggish asset distribution. At an average billing rate of $1,230 per hour, Sullivan & Cromwell alone has billed at least $180 million to the FTX estate.

As a legal matter, the correct measure of losses will likely be raised on appeal. But as a practical matter, the public would view Bankman-Fried very differently if they realized that FTX had sufficient assets to make whole its customers and other creditors all along. The prosecutors must have understood this, which explains why they went to such great lengths to persuade the jury through sheer repetition that FTX’s customers lost $8 billion, and to prevent the defense from introducing evidence to refute that claim.

Ian Ayres: Is Professor of Law at Yale University.

John Donohue: Is Professor of Law at Stanford Law School and a research associate at the National Bureau of Economic Research.

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