Bitcoin
Bitcoin and the bankruptcy of FTX
NEW YORK, NEW YORK – AUGUST 11: Former FTX CEO Sam Bankman-Fried arrives for a bail hearing in… [+] Manhattan Federal Court on August 11, 2023 in New York City. (Photo by Michael M. Santiago/Getty Images)
Getty Images
Let me share the background story and mechanics of Bitcoin and FTX.
Short selling Bitcoin is not possible in the US due to securities regulations. This is one aspect of securities law that has left me somewhat perplexed. Overall, shorting Bitcoin is the worst financial decision for any investor, given that Bitcoin is the best performing asset of the last decade. At the same time, individuals must have the ability to express any opinion they wish in the financial markets. Therefore, the current ban on selling Bitcoin in the US is a mistake.
It is permitted to sell stocks in the US as accredited investors can do so through their brokerage accounts. As Bitcoin matures as an asset class, regulation will change and eventually Fidelity will allow long and short positions. But we’re not there yet. Outside the US, it is possible to sell Bitcoin short. This explains why exchanges like FTX were domiciled in the Bahamas. The exchange handles all the details of handling short positions on the back end, similar to how stock exchanges today handle stock lending, where short sellers borrow shares and buy them back later.
Bankruptcy and asset freeze
When FTX collapsed, all of its depositors lost access to their funds. My opinion is that FTX depositors got what they paid for. They did not exercise the necessary due diligence before holding their funds on a cryptocurrency exchange. Moving your Bitcoins to cold storage would have avoided all the problems with freezing FTX assets. So the big takeaway here is that Bitcoin fixes this natively. By its very design, Bitcoin has built-in encryption and security that ensures the safety of funds. This is the main point.
The recovery
When FTX filed for bankruptcy, all assets were dollarized. This means that the bankruptcy estate converted the value of all deposits to their dollar value at the time of the petition. Therefore, if John Doe had a bitcoin valued at $20,000 at the time of bankruptcy, the estate would file its claim as $20,000 rather than 1 BTC. This is the amount that the estate will seek to recover for John Doe, knowing that the assets it uses for this recovery are still bitcoin. Two things happened since the bankruptcy filing that caused the value of the bankruptcy estate to increase.
First, Sam Bankman-Fried (SBF) has invested in a number of ventures outside of cryptocurrency. In fact, that was the problem: he took deposits from customers and made all kinds of investments without their consent. Most of these investments were worthless, but he invested $500 million in Anthropic, a generative AI startup. This is a huge investment for a startup and it has paid off as this startup is now worth several times the initial investment. In this strange turn of events, generative AI saved FTX from collapse.
Second, the value of bitcoin (and many other cryptocurrencies) has increased since the time of the bankruptcy filing. Depending on when you purchased, bitcoin increased 2 to 3 times from the date of bankruptcy. And so the property is now worth more and is therefore able to recoup its original depositors.
There’s an interesting wrinkle here. Ownership subsidizes returns between different cryptocurrencies. Since you pay in dollars, your obligation is only to the dollar value of the initial shares. So in John Doe’s example, the estate owes him $20,000, not one Bitcoin. If that Bitcoin doubles to $40,000, then the equity can use the excess profits to cover the losses of other depositors who invested in the worst-performing cryptocurrencies. This peculiarity of the bankruptcy code allows strong currencies to subsidize weaker ones.