Token gesture

The man now running FTX is best known for tidying up Enron.^{4The BlockFTX files for Chapter 11 bankruptcy11 Nov 2022} John Ray III, a Chicago lawyer who oversaw that liquidation, took over as chief executive on Friday, when Sam Bankman-Fried resigned and FTX, Alameda Research and about 130 affiliated companies filed for Chapter 11 protection in Delaware.^{4The BlockFTX files for Chapter 11 bankruptcy11 Nov 2022,5Al JazeeraDistressed crypto exchange FTX files for bankruptcy11 Nov 2022} The petition lists assets of $10bn-50bn, liabilities of the same size and more than 100,000 creditors.^{5Al JazeeraDistressed crypto exchange FTX files for bankruptcy11 Nov 2022} Forbes put Mr Bankman-Fried’s wealth at about $17bn two months ago.^{5Al JazeeraDistressed crypto exchange FTX files for bankruptcy11 Nov 2022} Few fortunes have gone so fast.

The warning came on 2 November, when CoinDesk reported on a balance sheet of Alameda, the trading firm Mr Bankman-Fried also owned. According to CoinDesk, as reported by The Block, it showed $14.6bn of assets and liabilities of about $8bn, $7.4bn of them loans.^{1The BlockBinance to sell FTX token holdings, Alameda CEO says leaked balance sheet is incomplete6 Nov 2022} The largest line was $3.66bn of “unlocked FTT” and the third-largest $2.16bn of “FTT collateral”.^{1The BlockBinance to sell FTX token holdings, Alameda CEO says leaked balance sheet is incomplete6 Nov 2022} FTT is a token issued by FTX. Roughly two fifths of the assets of a firm meant to trade other people’s coins were therefore a coin its sister company had printed. Caroline Ellison, Alameda’s chief executive, replied that the document covered “a subset of our corporate entities” and that Alameda had ”> $10b of assets that aren’t reflected there”.^{1The BlockBinance to sell FTX token holdings, Alameda CEO says leaked balance sheet is incomplete6 Nov 2022}

Then came the run. On 6 November Changpeng Zhao, boss of Binance, said his firm would sell its FTT, which it had received when it exited its FTX equity the year before.^{1The BlockBinance to sell FTX token holdings, Alameda CEO says leaked balance sheet is incomplete6 Nov 2022} By 8 November FTX had “effectively paused” withdrawals, and Reuters reported about $6bn of net withdrawals in the days before.^{2The BlockFTX 'effectively paused' withdrawals, CEO Sam Bankman-Fried tells employees8 Nov 2022} Binance briefly agreed to buy FTX.com, then walked away after about 24 hours of due diligence, according to a Nexo co-founder.^{2The BlockFTX 'effectively paused' withdrawals, CEO Sam Bankman-Fried tells employees8 Nov 2022,5Al JazeeraDistressed crypto exchange FTX files for bankruptcy11 Nov 2022} Its statement said “the issues are beyond our control or ability to help”.^{3Bitcoin MagazineBinance will not buy FTX9 Nov 2022} Mr Ray’s own verdict was drier. “The immediate relief of Chapter 11 is appropriate,” he said, and promised “diligence, thoroughness and transparency”.^{4The BlockFTX files for Chapter 11 bankruptcy11 Nov 2022}

The lesson is not that crypto needs a new regulator. We are sceptical of regimes written in a panic, and the principle here is not new. A customer who deposits money with an exchange is entitled to expect that it sits apart from the firm’s own bets and is not lent to an affiliate or swapped for the house’s own token. That is the oldest rule in custody, and A.P. Giannini would have recognised it. How far FTX respected it is not yet clear. The first duty of the authorities is to find out, and to apply existing law to the answer.

The market, to be fair, did a good deal of the work. A leaked balance sheet, a rival’s sale of tokens, a run and a competitor’s inspection of the books took nine days to expose a firm that had raised money from sophisticated investors. The objection is that depositors paid for the lesson, and so they did: the cost will fall on the 100,000-odd creditors. That is the argument for sharper enforcement of custody rules. It is also an argument for investors, who treated a famous founder as a substitute for a balance sheet.

Diligence is a lot cheaper before a petition than after. Binance needed a day.