Actually, I do know why. It’s the same kind of impulse you have when you see a car careering all over the highway; you know there is going to be a crash, but you don’t quite know where the smash is going to be or how bad it’s going to be, so you don’t want to look but there is no way you are going to tear away your eyes. There is so much in this trial: crypto, embezzlement, fraud, treachery, mega-ego battles, computer code, beach pads, misogyny and bad sex.

At its peak, FTX was valued at around $32-billion and was the second-largest crypto exchange.  The result we know: the company is now bankrupt and Bankman-Fried is charged with fraud and money laundering. The defence haven’t even started presenting their case yet, but what you do see are business practices so bad, that I honestly never thought anything like this was humanly possible.

My father used to say, as a joke, as a joke! that every business needs three sets of books: one for the taxman, one for investors, and one for you so you more or less know what is going on. This is because from a tax point of view, you want your expenses high and profits low. From an investor’s point of view, you want your expenses low and profits high. And you? You want to know which is going to be your bigger problem: the former or the latter.

It turns out that in June last year, crypto prices were spiralling downwards and lenders to FTX’s associated company Alameda were calling in their loans. Sam Bankman-Fried asked his sometimes girlfriend and Alameda CEO to prepare financial information for one of its lenders, Genesis.
The relationship between Alameda and FTX was a key part of the scam; FTX essentially held cryptocurrency on behalf of people we could describe as “depositors”. The word “punter” might be more appropriate.

There is little actual profit in holding crypto on behalf of clients, but FTX did back crypto trading and tossed in its own homemade currency, FTT, to the long menu of crypto that punters could buy, hedge, bet against, etc.

So if you looked at FTX’s balance sheet at any point, there wasn’t really a lot to see: lots of tokens owned by other people. But, it gradually became clear that Alameda was borrowing money from FTX’s punters, without their knowledge, to make its own, even more risky bets. What could be more risky than crypto? Turns out, quite a lot. In the crypto boom of the early 2020s, there were cream cakes for everyone. But in the crypto winter of 2022, the cakes dried out.

So at this point in 2021, any business person would face an enormously demanding, existential choice: do I fess up, apologise, and go into bankruptcy? Or do I try to sign a sponsorship deal with Taylor Swift? And we know which way Bankman-Fried rolled.

But the downside of rolling that way does involve, at some point, approaching your ex-girlfriend and asking her to, well, fudge the books a bit. Which by the way she did, but feels guilty about it. And as it happens she presents not three options but eight. I am not making this up.

The tricky part was that Alameda had at this point borrowed about $10-billion from FTX customers, and loaned about half of that to FTX executives and affiliated entities. So how do you reflect this in the balance sheet?

Fortunately, Bloomberg columnist Matt Levine decodes this all for us. The main tab on the spreadsheet (the real position) showed $21.1-billion of assets, $14.9-billion of liabilities and a net asset value of $6.2-billion. The short-term liabilities consisted of $9.9-billion of “exchange borrows” (presumably, what was borrowed from FTX clients) and long-term assets, including $4.6-billion of “related party loans” (the loans to the execs).

The option that was sent to Genesis (option 7) deleted the related party loans entirely. That reduced Alameda’s assets to $16-billion. It then combined the “exchange borrows” with other longer-term borrowing, but with the deletion of the related party loans, coming up with only $8.2-billion in total loans. That kept the NAV the same at $6.2-billion but reduced leverage and increased liquid assets.

As Levine says, “I am not an accountant or anything but I will say that the good way to do a balance sheet is:

• Add up your assets.
• Add up your liabilities.
• Subtract the liabilities from the assets to get your net asset value.

And a bad way would be:

• Start with the net asset value you want.
• Add up your assets.
• Delete the embarrassing ones.
• Subtract the assets you have left from your net asset value to get your liabilities.
• Just make up some numbers for individual liabilities to get the right total.

My conclusion from this is that FTX was in fact extremely bad at accounting, but not in a charming innocent way.

The case, mesmerisingly, continues.

Happy investing,

Tim