FTX Trading presentation explains 'the mechanics behind' the Alameda debacle

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FTX Trading said it had “uncovered the mechanics behind how Alameda Research” had the ability to borrow “effectively unlimited amounts” from FTX customers without providing any collateral.

The company also said it uncovered a feature of the company’s operations that provided to a “small group of individuals … the ability to remove digital assets from the [company’s] exchange without being recorded on the exchange ledger.”

The additional information was contained in a 20-page presentation used by the company during a Jan. 17 meeting to update the unsecured creditors’ committee in the case on the company’s efforts to locate assets that could be used to fund distributions to creditors.

An attorney for the company disclosed at a recent hearing that the company had recovered or identified roughly $5.5 billion in assets, and in a news release in connection with the meeting with the committee, the company provided a number of additional details on the recovered assets, including that the recovered assets comprised $1.7 billion of cash, $3.5 billion of crypto assets and $300 million of securities. The company further reported that it had identified roughly $1.6 billion of digital assets at FTX.com, the company’s international exchange, and $181 million of digital assets at FTX.US.

The follow-up bankruptcy court filing provided additional information on assets recovered from Alameda, a hedge fund affiliated with FTX, as well as the various avenues the company is continuing to explore to locate additional assets.

As widely reported, losses incurred by Alameda on its leveraged trading positions led to the collapse of FTX when it came to light that Alameda had borrowed billions from FTX without posting the collateral typically required for such loans. While the scope of losses is yet to be determined, Alameda’s former CEO Caroline Ellison and FTX’s former chief technology officer, Gary Wang, have already entered guilty pleas for fraud in connection with the scheme, and the company’s founder and former CEO, Sam Bankman-Fried, has been indicted on charges of fraud and money laundering, among others, in Federal court in Manhattan.

Bankman-Fried has pleaded “not guilty” to the charges.

One early mystery was how Alameda was able to borrow such huge sums from FTX without raising concern, given the borrowing limits and collateral requirements that FTX placed on margin accounts. Indeed, according to the company’s presentation, the code governing trading on FTX exchanges prevented most users from trading on margin without posted collateral by forcing automatic liquidations of positions once an account showed a negative balance.

The presentation shows, however, that the code also exempted certain users from the auto-liquidation feature and permitted them to maintain a negative balance in their accounts up to a specified credit limit, a feature primarily used for market makers to receive loans from FTX.

Alameda was among the exempt users, with a borrowing limit apparently set at $65 billion, resulting in, effectively, an unlimited ability to borrow customer funds.

The presentation also said that a “small group of individuals” had the ability to move crypto assets off of the company’s ledger “by accessing the private keys to initiate a direct on chain transaction.” The presentation does not identify the individuals who were able to utilize this feature, which the presentation calls “God Mode,” or even whether it resulted in any wrongdoing, but said, “Investigation is underway to determine whether any off-ledger misuse of this ability to withdraw assets occurred.”

The presentation also provided additional details on the assets recovered by the company to date and ongoing efforts to recover additional assets.

Among other disclosures, the company said it had been hacked to the tune of $415 million of crypto assets, with $323 million hacked from FTX.com, the company’s international exchange, and $90 million from FTX.US.

The $3.5 billion in crypto recovered by the company only includes positions deemed to be liquid, with $1.953 billion recovered from Alameda, $1.612 billion recovered from FTX.com, $181 million recovered from FTX.US, and $140 million held at FTX Japan that is segregated in cold wallets 1:1 for Japanese customers, “some of which may be available for the company” (the total figure of $3.5 billion excludes the $415 million of crypto known to have been hacked).

Based on prices as of the petition date of Nov. 11, 2022, $685 million of the recovered crypto is in Solana tokens (SOL), $529 million is in FTX tokens (FTT), and $268 million is in Bitcoin (BTC), among other cryptocurrencies, while $1.27 billion is held at third-party exchanges at which the company said it has “limited visibility into the token composition.” The mix also includes $245 million of stablecoins, which are crypto coins designed to be pegged to the value of the dollar.

For reference, following a recent crypto rally, the price of SOL was $25.33 at the time of publication on Jan. 20, compared to $15.97 at Nov. 11, and BTC had risen to $22,640.67, from $16,886.52 on Nov. 11. The price of the FTX token at the time of publication was $2.33, compared to $2.44 on Nov. 11.

Not included in the recovered crypto total are an additional mix of crypto tokens that are deemed illiquid, either because the market cap and volume of the coins is low or because FTX holds a significant position in the tokens such that any attempt to liquidate them would affect their market value. In any event, according to the presentation, the value of those coins was roughly $3.8 billion.

Other potential sources of recoveries for creditors would be the company’s proposed sale of Embed, LedgerX, and its Japan and Europe businesses, which are currently being marketed according to bankruptcy court-approved bidding procedures, the potential monetization of the company’s venture investments, which the presentation said have a book value of around $4.6 billion, but which the recoverable value is “likely to be materially lower,” and the sale of 36 properties in the Bahamas, primarily condos and private residences, with a cost basis of $253 million to be marketed in a joint process with the liquidators appointed by the Bahamian authorities.

Last, but not least, the presentation states that the company is “reviewing all historical transactions conducted by prepetition management,” presumably in order to determine whether any prepetition transactions can be unwound as preference or other avoidable transactions. Among the transactions cited by the company as under review are more than $2 billion of loans to insiders between the first quarter of 2020 and the fourth quarter of 2021, a $2.1 billion payment to Binance in the third quarter of 2021 to repurchase Series A shares, political donations of $93 million between March 2020 and November 2022, about $400 million invested in Modulo Capital in the second half of 2022, and certain shares in the online broker Robinhood allegedly pledged as collateral for outstanding Alameda loans.

An item of significance to creditors of both FTX and Voyager Digital, which is also in Chapter 11, that is also under review is $446 million transferred to Voyager Digital during the “preference” period (the period 90 days prior to the FTX Chapter 11 filing) to repay certain loans.

The presentation said “hundreds of M&A and other transactions” were also under review.

Featured image by Rob Byron/Shutterstock

This article originally appeared on PitchBook News