SBF Warns: Some Crypto Exchanges Already “Secretly Insolvent”

We have both good news and bad news for you this week...

The good news is that there hasn't been any other noteworthy (i.e. Celsius, 3AC, Terra/Luna, etc.) blow ups as a result of the recent liquidity crisis. This has, for the most part, kept crypto asset prices relatively flat since our last issue as seemingly everyone in the space is trying to find their footing again.

The bad news is that, at least according to FTX's Sam Bankman-Fried (SBF), there are many others still scrambling for liquidity and last-minute bailouts. In other words, this crisis may still be far from over...

In a recent interview with Forbes, SBF stated that "there are some third-tier exchanges that are already secretly insolvent,” suggesting that more crypto exchange failures are coming. He continued by saying...

“There are companies that are basically too far gone and it's not practical to backstop [bailout] them for reasons like a substantial hole in the balance sheet, regulatory issues, or that there is not much of a business left to be saved.”

While SBF declined to name any specific crypto exchanges, two things come to our minds on the matter.

On one hand, this shouldn't come as a surprise to anyone, as there is a glut of exchanges – both centralized and decentralized(?) – that are mainly just copies of one another. Just a quick visit to Nomics or CoinMarketCap exchange listings will show you that there are several exchanges still putting around, many of which we've never even heard of.

Making matters worse, these "third-tier" exchanges are essentially a regulatory minefield. They have less oversight and can often get away with more, say fraudulent, practices. And, as you can imagine, these exchanges have higher liquidity risks as volumes aren't anything substantial. So again, these types of exchanges crumbling alongside prices shouldn't be a surprise.
On the other hand, there are very few people in the world of crypto that understand the inner-workings of crypto exchanges like SBF. We have little doubt that he's making false claims here.

At a time when voices all over the internet are screaming "buy the dip," it's worth keeping tabs on today's liquidity crunch. If bitcoin were to ever fall another 50% from here – which is totally possible in times like these – that's when the fecal matter will really start hitting the fan.

While these exchanges that SBF is likely talking about are relatively small, the trickle down effect – if we have learned anything over this past month – still has the potential to impact millions.

Stay safe out there. Because this wash out isn't over. Not yet.

FTX to buy HOOD?

On Monday, Bloomberg reported that FTX was internally exploring ways to acquire stock trading app, Robinhood (HOOD). Immediately, Robinhood’s stock rose more than 14% to $9.12.

Astute readers will remember that in early May, FTXs founder and CEO, Sam Bankman-Fried (SBF), personally acquired a 7.6% stake in Robinhood worth ~$479 million. If the leader of FTX is passionate enough about the business as to put half a yard on the line, there's no doubt he would be willing to use his company's deep coffers to make a bet as well.

There is only one problem... SBF responded to the report by stating that FTX is not currently in any M&A conversations with Robinhood:

“We are excited about Robinhood’s business prospects and potential ways we could partner with them... That being said, there are no active M&A conversations with Robinhood.”

By early morning the next day, HOOD was trading down 3.6% to $8.79. Regardless, it is still trading up ~5% from where it opened on Monday.

We won't go into all the reasons why FTX might want to control Robinhood (we covered that in the newsletter here and in a tweet storm here), but it is worth taking note of the wording used in both the Bloomberg report and SBF's response.

Bloomberg reported that: "FTX is deliberating internally how to buy the app-based brokerage"
SBF responded that: "there are no active M&A conversations with Robinhood"

These two things can both be true, but it doesn't mean that FTX won't reach out to the company in the future. Simply put, FTX might still acquire Robinhood.

Now, it is true that Robinhood’s co-founders collectively own more than 50% of the company and would need to agree to any sort of M&A, but with the company's stock price down 85% from its high, shareholders (including SBF remember) might push for a deal.

Regardless, any deal would most likely have to be significantly higher than Robinhood's current market cap of $7.5 billion. In our opinion it would have to be double... if not more.

We still believe that our prediction in May is the most likely option:

"SBF wants to integrate Robinhood and FTX somehow... That slowly, overtime, SBF will exert influence over Robinhood to integrate with FTX rather than a competitor."

Acquiring Robinhood may be a good trade, but could also be a regulatory headache. Just this week, the US House Financial Services Committee released a report about the last week of January 2021 when meme-stocks like GameStop took off.

The report spends a significant amount of time on Robinhood, and more specifically about how the mania almost blew up the company. The report has some great quotes from Robinhood execs such as the COO writing, "Huge liquidity issue," or the gem when the company's Financial President wrote, "we are to[o] big for them to actually shut us down.”

If Robinhood is too big to fail, what would an acquisition make FTX?

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DEEP DIVES

Introducing... Crypto Phones!

If mobile phones are the gateway to widespread crypto adoption, then Solana (SOL) just got a huge head start.

Solana Mobile, the mobile phone subsidiary of Solana Labs, was announced last week at an event in NYC. Along with the announcement came the reveal of their first two products: the Solana Mobile Stack (SMS) and the Saga Android phone.

The Products:
The Solana Mobile Stack, or SMS for short, is a mobile application toolkit for developers. Basically, it allows developers to easily build crypto applications on a smartphone. Crypto applications have historically been built for desktop browsers, and those that are on mobile phones are clunky and buggy. By fixing this, the SMS opens a new frontier for crypto adoption.

The Saga Android phone is built specifically for crypto. Because the Solana blockchain is integrated into the phone, users will be able to do everything with crypto that they can do on a browser. In addition to its crypto capabilities, Solana also believes the Saga is an all-around good phone. It comes equipped with the full set of Google apps and services and a powerful hardware system. Planned for an early 2023 release, the Saga phone can be pre-ordered for $100, which will be applied to the anticipated final cost of $1,000.

A Burgeoning Market
Smartphones have been an untapped market for crypto. Perhaps it is due to fear following the failed 2018 Finney phone from Sirin Labs. In any case, smartphones are a huge opportunity for crypto with almost 7 billion people owning a smartphone worldwide, and smartphone usage outpacing that of desktop usage in 2021.

By making the first foray into this market, Solana is making a major move to both bolster themselves and crypto adoption in general. Right now, about 100 million people worldwide have used cryptocurrency. That sounds like a lot, but pales in comparison to the 2.5 billion people who use Android phones worldwide. If just 10% of those people buy a Saga, that’s 250 million more crypto and Solana users. If SMS expands beyond just the Saga, then that number will likely be much higher.

This looks like a well-placed bet by Solana.

BlockFi Up For Grabs

There's currently a tug-of-war going on for crypto lender BlockFi. But before we get to the juicy bits, let's quickly back up and take a look at a timeline of events for the company over the past year or so:

March 2021: BlockFi raises $350 million in Series D funding round at a $3 billion valuation
July 2021: BlockFi is reportedly "days away" from closing a $500 million Series E at $5 billion valuation and is pursuing plans to go public
February 2022: BlockFi pays $100 million to the SEC to settle investigations into its interest-generating accounts
May 7-12, 2022: Terra/Luna blow up occurs
June 6, 2022: BlockFi attempts to raise down round at $1 billion valuation
June 12, 2022: Celsius pauses withdrawals; BlockFi CEO states: "Our risk management systems are operating normally"
June 13, 2022: BlockFi cuts staff by 20%
June 16, 2022: Financial Times reports that Three Arrows Capital fails to meet margin calls
June 21, 2022: BlockFi receives $250M credit facility from FTX to bolster balance sheet due to exposure to Three Arrows

Okay, now that we have that out of the way, let's take a look at what's occurred in the last week.

Days after giving BlockFi the $250 million line of credit, the Wall Street Journal reported that FTX was also in talks to acquire a large stake in company.

The FTX and BlockFi deal comes with a catch though. According to a leaked call from investment firm Morgan Creek Digital, which led BlockFi's $50 million series C fundraising round, the deal would provide FTX the option to buy BlockFi "at essentially zero price."

If FTX were to exercise the rumored option, it would wipe out all of BlockFi’s existing shareholders, including management, employees with stock options, and all investors from previous rounds.

Why would BlockFi take this deal? Well according to the leaked call, of the several emergency financing offers BlockFi received, FTX’s offer was the only one that would not subordinate client assets to the rescuer. As SBF tweeted: "Backstopping customer assets should always be primary. Everything else is secondary."

Now, many existing (smaller) shareholders seem happy to put customer deposits over equity holders, but still, we're sure they'd like to figure out a solution where they aren't wiped out.

Therefore, in response to the potential FTX deal, Morgan Creek set up emergency calls to figure out a way to counter the FTX deal. According to the leaked call, BlockFi is currently being valued at less than $500 million, so one would assume Morgan Creek needs to come up with a competitive $250 million to take control.

Our Take:
Once again, there seems to be just too much leverage and contagion in the system...

Although it hurts to see a company like BlockFi have issues, and venture investors potentially being wiped out, we are glad to see that there is major concern first and foremost for customer deposits. Remember, in crypto there isn't an FDIC backing up your deposits.

What ultimately unfolds with the BlockFi fiasco will have a lasting effect for everyone in the ecosystem.

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REGULATORY FRONT

Crypto Tax Cheats Likely to Get Relief as US Crackdown Hits Snag

Under a law passed by Congress last November, crypto brokers and exchanges are supposed to begin recording their clients’ detailed transaction data at the start of next year. The move would not only help the IRS catch "tax cheats" – which will likely have large impact on the nation’s growing tax gap – but also make crypto tax reporting for the industry as a whole a bit more "standardized."

The data these crypto firms will supposedly have to send to the IRS will include customer names and addresses, gross proceeds from sales, and any capital gains or losses.

Now, if you think these legislations put a massive burden (and headache) on crypto firms, you're not alone... From the beginning, industry executives have pushed back, complaining that the legislation was drafted too broadly. Furthermore, executives have repeatedly asked for more time to prepare and update their software programs.

Well, thankfully, it appears that these executives have gotten their wish with Bloomberg reporting that the implementation of these rules are likely to get pushed back.

According to our go-to regulatory crypto beat-writer, Jake Chervinsky, this news, if true, is a very good thing, especially as we are on the precipice of more regulatory clarity.

“Given the broad scope of the tax provisions, uncertainty around implementation, and the short time line before these new rules are set to take effect, we encourage the Treasury Department to extend the deadline for compliance.”

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