Original Article FTX Found the Money, compiled by Odaily Planet Daily jk.

Original Author: Matt Levine is a Bloomberg Opinion columnist responsible for financial reporting. He was an editor at Dealbreaker, worked at Goldman Sachs' investment banking division, was an M&A lawyer at Wachtell, Lipton, Rosen & Katz, and served as a law clerk for the U.S. Court of Appeals for the Third Circuit.

Today's situation is FTX… insolvent but still able to pay off debts? This is truly shocking:

Cryptocurrency exchange FTX has accumulated tens of billions of dollars more in customer funds than it lost when it collapsed in November 2022, allowing customers to receive full compensation plus interest, a very rare outcome in U.S. bankruptcy proceedings.

Junior creditors usually only receive a small portion of their held assets, but FTX has benefited from the strong rebound of cryptocurrencies, including Solana. The company has also sold many other assets, including various venture capital projects, such as its stake in the artificial intelligence company Anthropic.

FTX's current CEO, John Ray, said, "This is an incredible outcome in any bankruptcy case." He took over the company when it collapsed.

Yesterday, Ray's restructuring team submitted the latest bankruptcy plan and disclosure statement, estimating that "customers and digital asset loan creditors will recover 118% to 142% of the value of their claims as of the petition date." A highly simplified but intuitive summary of FTX would be:

• When FTX went bankrupt in November 2022, its customers on the platform had approximately $8 billion worth of cash and cryptocurrencies. Meanwhile, its assets were mainly composed of many cryptocurrency tokens related to FTX and Bankman-Fried, which were very valuable two weeks ago, but then plummeted in value. Selling all of these tokens could not recover enough funds to repay customers, who wanted their money back immediately.

• The bankruptcy application prevented customers from immediately withdrawing their funds. That's the purpose of bankruptcy. Pre-bankruptcy, FTX was a cryptocurrency exchange that nominally allowed customers to withdraw funds on demand. Bankruptcy transformed all customer demand deposits into long-term loans: you cannot withdraw your funds on demand, but must wait for the bankruptcy process to end. This process is still ongoing. Therefore, FTX had about a year and a half to use customer funds without having to meet withdrawal demands.

• Long-term funds are more valuable than short-term funds. For example: in November 2022, FTX held a large amount of Solana tokens. The trading price of Solana was approximately $136 per token in April 2022, but by mid-November, the price was around $12 per token. These Solana tokens were not enough to repay all customer debts, especially if you had to sell them all at once. But if you waited until March 2024, the price of Solana reached $200.

• FTX did indeed wait, partly for strategic reasons, but also because the bankruptcy process was inherently slow. A new management team, not particularly adept at cryptocurrencies, took over FTX. They conducted a lengthy investigation to understand the company's situation and locate all of FTX's tokens. Ultimately, it decided to sell these tokens, but needed court approval to do so. It wasn't until September 2023, 10 months after the bankruptcy application, that it obtained approval. Then, it hired an investment manager to "sell, hedge, and collateralize" its cryptocurrency tokens. This strategy worked well: as of March 31, FTX raised about $50 billion by selling tokens and is expected to raise another $44 billion in the coming months. By freezing everything—assets, liabilities—for about a year, FTX obtained more funds for its cryptocurrency tokens than it would have had to sell to meet customer withdrawals in November 2022.

This is not the whole story: FTX also recovered funds through the sale of businesses, sale of part of its venture capital portfolio, confiscation of real estate and Robinhood Markets Inc. stock purchased by SBF and others, recovery of donations and investments, and so on. But the basic form is, "FTX used customer funds for long-term investments, which was foolish, these investments lost value, customers demanded their money back, so FTX declared bankruptcy and entered a year-long hibernation, after which these investments generated enough returns to repay customers," this summary seems basically correct.

Indeed, FTX's situation is a challenge for customers: the funds they thought they could withdraw at any time may actually be locked up for two to three years. FTX sympathizes with this complaint and hopes to pay interest to customers. The interest rate is set at 9%, which is roughly how the recovery rate of 118% or 127% was calculated over the two to three-year bankruptcy process. Typically, bankruptcy does not operate this way, but FTX has sufficient funds. From the disclosure statement:

The debtor is not solvent, and the Bankruptcy Code typically prevents the payment of post-petition interest to customers and other unsecured creditors. However, the debtor recognizes that these Chapter 11 cases have deprived creditors of their funds since November 2022, and this situation will continue until distributions are made. In fact, all of the debtor's customers and creditors have been forced to lend to the debtor during these Chapter 11 cases, and in the view of the Joint Board, they should receive a fair rate of return.

This is a positive step. If interest is not paid, where will this money go? The obvious answer is "if there is any remaining money after paying all the creditors in bankruptcy, it will go to the shareholders," but after all this, it would be inappropriate for FTX's shareholders (SBF may still be the largest shareholder) to receive any money back.

The situation here is not just about customer claims; there are also tens of billions of somewhat vague tax and penalty claims from the Internal Revenue Service and the Commodity Futures Trading Commission. They are actually the residual claimants here: if there is any remaining money after repaying customers, the U.S. government will find a way to get that money. FTX contacted the government, politely asking if it could also pay interest to customers, and the government agreed.

Moreover, for cryptocurrency exchanges, this is indeed very difficult for customers. If you had $100 in your FTX account in November 2022, your money was locked up for two to three years, but in the end, you will receive about $118, which is some return. But if you had 10 Solana tokens in your FTX account when it filed for bankruptcy, which were worth about $143 each at the time, you will receive about $170. Meanwhile, today, 10 Solana tokens are worth about $1,480. If you had one Bitcoin in FTX, you will receive about $19,600; whereas today, one Bitcoin is worth over $62,000. FTX's way of obtaining enough funds to repay customers was partly by freezing its liabilities at the low point of the cryptocurrency market on November 14, 2022, while allowing its assets to appreciate. After the cryptocurrency market recovered, the value of the assets increased, while the liabilities remained frozen.

I'm not sure how big of a problem this is; SBF listed about $8.9 billion in liabilities in FTX's last financial report, of which about $6 billion is denominated in dollars, euros, or USDT (Tether stablecoin), which will indeed receive more than 118 cents on the dollar. But there are at least $2 billion in Ethereum and Bitcoin liabilities, which will receive far less than this level when denominated in these currencies.

This is how bankruptcy operates; from the disclosure statement:

The plan distributes value among creditors based on the relative value of their claims as of the petition date, as required by the Bankruptcy Code. This manner of distributing among creditors is not a matter of the debtor's discretion, but is a cornerstone of the Bankruptcy Code, recognized by the bankruptcy court and the Supreme Court of the Bahamas, as well as the Special Committee, the Official Committee, and the Bahamian JOLs. In the factual background of the FTX case, there is no other fair way to share in the recovery of investments.

While some creditors may hold different opinions, it is indeed difficult to propose an alternative system. FTX did not happen to have enough Solana/Bitcoin/other assets to repay all Solana/Bitcoin/other claimants' creditors—this is the crux of the bankruptcy! Therefore, selling all assets and distributing the proceeds in dollars may be the best course of action.

Indeed, the situation could have gone entirely the other way. In November 2022, with FTX's collapse, it seemed possible that all cryptocurrency investments related to FTX—even possibly the entire cryptocurrency market—could go to zero. If you were told in November 2022 that your funds would be locked up at FTX for two to three years, and any recovery of funds depended on a rebound in cryptocurrency prices, you might reasonably have given up hope. Bloomberg noted that shortly after the bankruptcy, many of FTX's "claims traded for as little as three cents on the dollar."

However, isn't this like a trade? For a cryptocurrency exchange, bankruptcy (1) converts all of your customer deposits to dollars at the current price, and (2) gives you a few years to repay. If you think cryptocurrency prices are cyclical, highly volatile, but generally rising over time, then this choice seems very valuable. Cryptocurrency prices drop, you say "Oops, we're bankrupt," you freeze your customers' dollar deposits, and then you have two years to see if the prices recover. If they do, you sell your cryptocurrency, repay everyone, and keep the rest. This is not a choice for FTX, but it was a possibility in the Mt. Gox bankruptcy case ten years ago. Eventually, someone will figure out how to do it. Not getting arrested is a key part of this trade, and so far, no one has been able to do it.

Finally, what about Sam Bankman-Fried? He was sentenced to 25 years in prison for causing FTX customers to lose tens of billions of dollars. He argued for a reduced sentence on the grounds that he did not cause any losses (Bitcoin customers lost funds) and legally (if you use customers' money to buy a house for yourself, then the bankruptcy estate reclaims the house, you still shouldn't take the money). But more broadly, he has argued since the moment of FTX's collapse that FTX faced a liquidity problem, not a solvency problem, and if given another week or two, there was enough money to repay all customers. They did not give him the time. But John Ray had another 18 months to find the funds, and he did.

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