After FTX: Explaining the Difference Between Liquidity and Insolvency

Sam Bankman-Fried continues to argue that FTX was solvent. No one is buying this of course but Frances Coppola offers a useful reminder on the difference between illiquidity and insolvency. If you take only one thing away from her article it is to understand the way in which the accounting definition of insolvency can contribute to the confusion.

The confusion between liquidity and solvency is partly caused by the generally accepted definition of “insolvency,” which is “unable to meet obligations as they fall due.” This sounds very much like shortage of cash, i.e., a liquidity crisis. But shortage of cash isn’t necessarily insolvency.

When Frances uses the term “generally accepted) I think she is alluding to Generally Accepted Accounting Principles. I have had the liquidity versus solvency debate more times than I can count and this issue was often the core source of confusion when trying to explain the concepts to people without a Treasury or markets background.

If you want to dig deeper into the solvency versus liquidity question I had a go at the issue here. Matt Levine also had a good column on the topic.

Tony – From the Outside