The crypto world is reeling from the implosion of FTX, the second-biggest exchange in the ecosystem. As a result, Crypto is discredited, venture capital is bruised and dented, and billions and billions of investor wealth have evaporated.
FTX and SBF have entered the pantheon of fraudsters and failures like Bernie Madoff, Enron, and Lehman Brothers.
Cryptocurrency is new and developing. The math-based system is learning all the lessons of traditional financial systems. But at warp speed. Its growth spurts are recapitulating the booms and busts of the last several centuries, compressed into months over a few years.
It’s not a smooth ride. It is a sh*t storm of epic proportions.
But for all these growing pains, the rationale for cryptocurrency is proved by government actions, fiat currency regimes, and inflation.
For all its innovation, Crypto relies on traditional financial reporting: the financial statements.
We hear CZ and Binance moved away from a rescue effort when they uncovered a supermassive black hole in FTX’s Balance Sheet.
The contagion is spreading.
A big concern is how many other dominoes will fall because of intertwined Balance Sheets.
Meanwhile, Coinbase, a major exchange, has its CFO going on media interviews, differentiating itself by touting its strong Balance Sheet.
The Balance Sheet shows the financial position of an entity on a specified date, usually the last day of an accounting period.
Among other information, a balance sheet states • What Assets does the entity own, • How it paid for them, • What it owes (its Liabilities), and • What is the amount left after satisfying the liabilities (its Equity)
Balance Sheets are a presentation of what is known as the Accounting Equation: Assets = Liabilities + Owners’ Equity.
Think of a Balance Sheet in terms related to everyday life. For example, homeownership, when you have a mortgage, is represented as a Balance sheet. Your home ownership has three components of Asset, Liability, and Equity.
The Asset is the house’s value, and an appraisal determines this. An appraisal considers recent sales of homes in the area and compensates for differences like the number of bathrooms and bedrooms, the size of the lot, etc.
The Liability is the mortgage loan, how much you owe against the house. Equity is the difference between the Asset’s value and the Liability amount. So, for example, if your home is worth $200,000 and you have a remaining mortgage balance of $150,000, then you have $50,000 in Equity.
If your mortgage balance is more than the value of the home, then you are considered “upside down” or “underwater.” The same principle applies to a business: if the value of its Liabilities is more than the value of the Assets, then the enterprise is insolvent and probably headed for bankruptcy. This scenario is what happened with FTX.
Equity is what the owners actually own. Equity is Assets less Liabilities. Equity is shown below the Liabilities because Debt has senior claims on the assets. Therefore, in liquidation like bankruptcy, the debt holders get paid from selling assets first, and then anything left over goes to the equity holders.
Google examples of Balance Sheets to get an idea of the format; notice that the Total Assets equals the Total Liabilities plus Equity. Then look at a Balance Sheet in a 10K on the sec.gov website.
Now you are on your way to becoming a savvy business person and investor!
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