A Nuanced Approach to Estimating Mark-to-Market Crypto-Asset Values

Introduction

The reasons for the monumental collapse of FTX still aren’t entirely clear. There are numerous theories that speculate on what went down. Yet, nothing can be said with absolute certainty. That said, several pieces of this puzzle have been uncovered, and there’s one that stands out clearly.

It is now widely believed that Alameda incurred huge losses during the market downturn in Q2/Q3 2022. The situation seems to have been so dire that they had only two options: borrow more money or shut down. To avoid the latter, Alameda allegedly posted illiquid tokens such as FTT, OXY, FIDA, MAPS, etc., to borrow USD (or equivalent) from its sister company FTX.

In other words, Alameda transferred their illiquid book to FTX in exchange for liquid customer funds.

Imagine this:

• Alameda has $100M of an illiquid token, XYZ, that trades at $1. They can’t liquidate XYZ for $100M due to liquidity constraints. But, they do need $100M to conduct their business.

• Alameda reckons they can borrow $100M against their XYZ token, cover the losses, and repay the loan. Borrowing against risk assets is not uncommon, but it potentially puts the lender in trouble if liquidity conditions for the collateral asset depreciate. A maximum loan-to-value ratio needs to be set in stone based on this. More importantly, the ratio needs to be adhered to.

• If the value of the collateral drops such that the loaned XYZ token is now valued at $75M, then FTX can ask for more collateral or liquidate Alameda. This plays out smoothly as long as the mark-to-market (MTM) value of the collateral equals the USD value of the loan.

• The scenario works unless the value of the collateral drops significantly or there is a bank run on FTX. In an unfortunate turn of events for Alameda and FTX, both of the mentioned scenarios played out.

• A statement issued by Caroline Ellison supports the claim that Alameda used illiquid assets as collateral to obtain a loan from FTX. Per The New York Times: “She said Alameda had taken out loans and used the money to make venture capital investments, among other expenditures…lenders moved to recall those loans…but the funds that Alameda had spent were no longer easily available, so the company used FTX customer funds to make the payments.”

• To further cement this claim, the testimony of John J. Ray III (current CEO of FTX) reads: “First, customer assets from FTX.com were commingled with assets from the Alameda trading platform. Second, Alameda used client funds to engage in margin trading which exposed customer funds to massive losses. Thir