The FTT exchange token played a key role in the collapse of the crypto exchange FTX and the affiliated trading firm Alameda Research. It was the use of FTT to float the balance sheets of the two entities, reported by CoinDesk’s Ian Allison on November 2, that first raised suspicions that prompted the collapse.
FTT may have been central to another aspect of the FTX fraud, serving as notional (but actually worthless) “collateral” for loans of customer funds that FTX made to bail out Alameda.
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But what are forex signals? What role do they play for the exchanges that issue them? How should they be treated under modern accounting standards? And how do they advance the decentralization agenda of the crypto industry?
To answer the last question first: Tokens are mostly not decentralized, and, if anything, their goal is decentralization. They are, at bottom, an incentive to continue using the same centralized exchange. Holders can use them to get discounts on trading fees, rewards and early access to offers. Despite discussions on Twitter, the FTT token did not distribute a share of the FTX platform’s revenue or give governance rights to holders, and most of the tokens do not exchange.
Technically, forex signals are nothing special. FTT was tracked as an ERC-20 token on Ethereum, a type of token that almost anyone with limited technical skill can create. BNB, Binance’s token of exchange, is tracked on its branded BNB Chain, a blockchain that started as a fork of Ethereum but has been merged into a separate permissioned blockchain.
See also: Binance wants to revise its BNB Blockchain
That is in contrast to one of the concepts that may have inspired the creation of trading signals. Starting around 2016-2017, there was a lot of discussion in crypto about “utility tokens” that would be used to incentivize and pay nodes for decentralized computing services. Although the term seems outdated, current examples include the decentralized storage network Storj; the BitTorrent token now managed by Tron; and even Helium, the troubled Wi-Fi node project.
The appeal of utility tokens is that you don’t need any legal system for enforcing property rights or claiming a place in the “capital stack” – that is, the ordered list of obligations of an organization to counterparties including debtors and investors. That’s partly because there is no capital pile, but also because the value procedurally comes from the demand for services that are, in fact, directly connected to the blockchain.
In contrast, it is understood that the value of exchange tokens rests on a regulatory or legal system that in many cases does not exist. So-called “offshore” exchanges, such as FTX and Binance, issue most of all exchange tokens registered in light regulatory havens, for example, in the case of FTX, the Bahamas. In contrast, US-registered exchanges Kraken and Coinbase do not have their own tokens because they have access to standard equity markets (and the associated regulatory restrictions). Tokens are a way for offshore exchanges to raise money without that access.
“Binance was the first to launch, and it was very successful. And when you succeed, you get copyrights,” said Katie Talati, co-founder and director of research at crypto asset manager Arca. “Huobi, OKX, they all launched their own signal and, from now on, it was standard. FTX didn’t launch until the second half of 2019, and at the same time they launched their signal.”
But just because tokens can raise money as equity, doesn’t mean that. “Right now, these are not part of the capital stack and you can’t claim anything in bankruptcy, for example,” said Talati. “There’s no governance, you can’t say you want the exchange to do X,Y and Z.”
But in a strange kind of ontological mystery that is quite common in crypto, these tokens, issued by entities without strong regulators or even well-enforced property rights, are trading much like equity. Talati said a discounted cash flow model is one useful way to think about its value, “but there are a lot of inputs that we can’t model.”
This quasi-applicability to an equity model may have narrowed the path to Sam Bankman-Fried’s fraudulent finance. One aspect of the irritation was that FTT was what is known as a “low flow, high dilution value” signal. Only a very small fraction is publicly traded, but the public price for that fraction was assumed to be in the hundreds of millions of dollars of the token owned by FTX itself. This makes a rough sense if you think in terms of the “equity value” that a startup founder, for example, relies on after venture capital investors get theirs.
But the handling of the FTT tokens on FTX and Alameda’s balance sheets was not traced to normal equity accounting practices or, more importantly, to reality. When accounting for their own equity, or handling stock they bought back from public markets, companies do not add them to their valuation estimate or liquid assets, instead they are usually counted as “treasury stock” .
That’s because a company’s equity isn’t part of its total value, it’s a reflection of that value. Adding your own stock to your bottom line would be a bit like a snake eating its own tail.
This basic accounting fraud became a ticking time bomb when Bankman-Fried apparently began using FTT as collateral for loans between FTX and Alameda, as well as other related entities. As I wrote last week, these shenanigans bear no resemblance to Enron’s use of related entities and paper shifting to hide debt and pump up its own valuation.
FTT’s centrality to the worst crypto blowup ever has forced crypto leaders to clarify their position on accounting for exchange tokens and similar internal assets. Changpeng Zhao, CEO of Binance, took pains last week to clarify that Binance “BNB has never been used as collateral.” In Twitter Space last week, Ripple CEO Brad Garlinghouse clarified that his company not counting its large amount of XRP on its balance sheet.
See also: Binance Launches Native Oracle Network, Starting with BNB
This relatively unspoken norm helps explain why CoinDesk’s reporting on FTT flows was so explosive. It’s not the sort of asset that should be used the way it was, and no truly independent entity would have accepted it as loan collateral, or even that it was an “asset”.
Experienced crypto investors are on the alert to enforce that norm – and lose their shirts when they don’t. Talati is unequivocal on Arca’s position.
“When we look at [projects], many will have their own perspective on their balance sheet,” she said. “And we just cross that.”