The collapse of FTX was criminal, not accidental

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Despite the fact that Sam Bankman-Fried’s cryptocurrency enterprise was exposed as a fraud in recent weeks, CoinDesk argues mainstream media outlets and commentators have frequently failed to provide readers with a clear analysis of what transpired. Many important details concerning the affair have been revealed by institutions like the New York Times and Wall Street Journal, but they have also often seemed to play down the details in ways that softened Bankman-intention Fried’s and responsibility.

It is now obvious that what occurred at the FTX cryptocurrency exchange and the hedge fund Alameda Research involved a number of deliberate and intentional fraud attempts meant to defraud both investors and users of their money. Because of this, a recent New York Times interview received harsh criticism for appearing to blame FTX’s downfall on poor management rather than criminal activity. A Wall Street Journal story lamented the loss of FTX’s charity contributions, possibly supporting Bankman-Fried’s pretensions to strategic philanthropy. By attributing Bankman-Fried’s funds to aiding Democrats in the 2020 elections, Vox co-founder Matthew Yglesias, a court chronicler of the neoliberal status quo, appeared to cover up his own involvements while avoiding the possibility that the funds were actually embezzled.

This was not a bank run

The most egregious aspect of this is that, despite Bankman-Fried’s repeated insistence that the company was merely overleveraged and mismanaged, several media sites have labeled what happened to FTX as a “bank run” or a “run on deposits.” The misuse of consumer funds, which is the main problem, is obscured by both of these attempts to characterize the aftermath.

Because they are clearly in the business of lending client funds out to produce returns, banks are susceptible to “bank runs.” If everyone withdraws at once, they may run out of cash temporarily, but there won’t be any long-term issues.

FTX and other cryptocurrency exchanges are not banks, though. Even a very sharp rise in withdrawals shouldn’t put a strain on liquidity because they don’t (or shouldn’t) engage in bank-style lending. Customers who entrusted their crypto to FTX exchange were specifically assured that the company would never lend out or otherwise use the cryptocurrency.

Actually, the money was transferred to the closely related trading company Alameda Research, where it appears that it was simply gambled away. To put it simply, this is stealing on a level that is almost unheard of. According to a bankruptcy document, even though the overall damages have not yet been calculated, up to one million customers may be affected.

In less than a month, reporting and the bankruptcy process have discovered a long list of further choices and actions that, even in the absence of crypto-specific regulations, would have been considered financial fraud if FTX had been a U.S. regulated corporation. These schemes are nonetheless subject to legal action in U.S. courts to the extent that they made it possible for American people’ property to be effectively stolen.

The list is really lengthy.

The extensive wrongdoing of FTX and Sam Bankman-Fried

The link with Alameda

The relationships between Bankman-Fried’s cofounded hedge fund, Alameda Research, and FTX, the exchange that lured ordinary speculators, are at the core of his scam. A hedge fund like Alameda aims to generate money by actively trading or investing funds it controls, as opposed to an exchange, which eventually profits from transaction fees on assets owned by users.

Alameda and FTX were regarded by Bankman-Fried as “wholly different” organizations. In order to support that perception, Bankman-Fried left her position as CEO of Alameda in 2019. However, it has come to light that the two businesses were still closely linked. FTX and Alameda executives sometimes shared a penthouse in the Bahamas, and Bankman-Fried and Alameda CEO Caroline Ellison had a love relationship.

Those conditions probably made Bankman-Fried’s cardinal sin possible. Days after FTX started to show indications of deterioration, it was discovered that the exchange had been sending customer assets to Alameda for use in trading, lending, and investment activities. Up to $10 billion in user payments may have been transferred from FTX to Alameda, according to a startling revelation from Reuters on Nov. 12. It was estimated that as low as $2 billion of those cash may have vanished after being routed to Alameda at the time. The losses now seem to have been significantly greater.

It’s still not clear why exactly those cash were transported to Alameda or when Bankman-Fried first crossed the line to betray the confidence of his depositors. According to on-chain research, the majority of FTX to Alameda transfers happened in the latter half of 2021, and bankruptcy documents show that FTX and Alameda collectively lost $3.7 billion in that year.

Perhaps the most puzzling aspect of the Bankman-Fried tale is that his businesses suffered severe financial losses before the bear market in cryptocurrencies in 2022 ever got underway. They might have been embezzling money before Terra and Three Arrows Capital went bankrupt, which killed so many other leveraged crypto players.

FTT-collateralized loans

The CoinDesk article on the component of Alameda’s balance sheet made up of the FTX exchange token, FTT, was the initial flame that lit FTX and Alameda Research on fire. Although FTX produced this instrument, the majority of it was held by FTX and Alameda, with just a small percentage of it being sold on open markets. As a result, those holdings were inaccessible for sale at the open market price. The value was nevertheless recorded by Bankman-Fried at that artificial market value.

The usage of FTT tokens as security for loans, including loans of client funds from FTX to Alameda, is seen to have been much riskier. Here is where FTX and Alameda’s close relationship turned toxic: had they been legitimately independent businesses, using the FTT token as collateral may have been considerably more difficult or expensive, lowering the danger to consumer cash.

It is appropriate to compare this exploitation of an internal asset as collateral for loans between secretly affiliated firms to the accounting fraud carried out by executives at Enron in the 1990s. For their misdeeds, the executives were sentenced to up to 12 years in prison.

Margin liquidation exemption for Alameda

Alameda Research was said to have special user status on FTX, including a “hidden exemption” from the platform’s liquidation and margin trading restrictions, according to legal documents filed by the new CEO managing FTX’s bankruptcy and liquidation.

Like other cryptocurrency platforms, FTX provided its members with “margin,” or loans, which they could use to execute transactions. But most of the time, consumers of these loans put up other money or assets as collateral to support their borrowing. The user’s collateral will be sold by the exchange and the proceeds will be used to repay the initial loan if the value of that collateral declines or a margin trade loses enough money.

Maintaining the viability of asset markets requires the liquidation of poor margin holdings. Alameda would greatly benefit from being exempt from these requirements, while other FTX customers would be subject to significant hidden dangers. While competing users were shut out, Alameda could have maintained losing positions until they turned the situation around. Alameda was also theoretically free to lose more money on FTX than it was able to recover, resulting in a gap where the funds from the customers once were.

Numerous factors could lead one to criminalize the exemption. Above all, it implies that FTX was deceptively marketed as a whole. It was a barrel full of customers rather than the level playing field an exchange is supposed to provide.

Alameda insider trading knowledge on FTX listings

Strong circumstantial evidence suggests that Alameda Research had access to information about FTX’s plans to list specific tokens, according to the crypto analytics company Argus. Alameda was able to purchase significant quantities of these tokens prior to the listing and then sell them following the listing bump because an exchange listing typically has a positive effect on a token’s price.

If these allegations are true, they would likely be the most blatantly criminal and obviously unlawful of the alleged affairs between FTX and Alameda. Even though the tokens in question aren’t formally classified as securities, the actions could still be pursued under insider trading laws, leaving jurisdictional issues aside.

An employee of OpenSea was charged with wire fraud in a comparable circumstance earlier this year for allegedly purchasing assets based on early listing information… or insider trading. That employee could spend up to 20 years in prison for the simple offense of front-running monkey JPEGs.

Enormous personal loans to executives

Alameda Research is said to have provided executives at FTX with loans totaling $4.1 billion, including sizable personal loans that were probably unsecured. Bankman-Fried received an astounding $1 billion in personal loans, as well as a $2.3 billion loan to a company called Paper Bird in which he had a 75% ownership interest, according to information from bankruptcy proceedings. While co-CEO of FTX Digital Markets Ryan Salame received a $55 million personal loan, director of engineering Nishad Singh received a $543 million loan.

There are more smoking guns in the FTX situation than at a Texas shooting range, but this one might as well be called the smoking bazooka because it is such a blatantly evident indication of criminal intent. Although it’s yet unknown how the majority of those personal loans were used, recovering the costs will probably be a significant challenge for liquidators.

The loans to Paper Bird were maybe even more concerning because it appears that they may have encouraged additional structural fraud by establishing yet another connected third company to transfer assets between.

According to Forbes, Paper Bird invested hundreds of millions of dollars in various outside businesses and may have used some of its cash to purchase a portion of Binance’s share in FTX.

Many of the same venture capital funds who sponsored FTX were among those backing this. Determining whether this financial incest amounted to criminal fraud will take some time. But it undoubtedly fits the larger pattern by which Bankman-Fried falsely inflated the value of various assets via covert flows, leverage, and funny money.

The “bailouts” of organizations via loans or FTT

Having said that BlockFi and Voyager Digital, two bankrupt cryptocurrency lenders, were among the entities Bankman-Fried suggested being bailed out of in the summer of 2022 if the crypto bear market persisted. We at CoinDesk were among those duped at the time, hailing SBF as a backstopper for the entire sector a la J.P. Morgan.

Bankman-Fried avoided the question of where FTX obtained the funds for these backstops in a now-famous interview with CNBC’s “Squawk Box,” referring to these choices as bets that may or may not pay off.
But it’s possible that wasn’t even what was happening. Bloomberg’s Matt Levine recently proposed the theory that FTX backed BlockFi using its FTT joke money. This Monopoly bailout may have additionally been designed to hide FTX and Alameda obligations that would have come to light sooner if BlockFi had declared bankruptcy. This scheme doesn’t even have a name, yet it is reminiscent of the last stages of numerous prior corporate frauds.

Purchase of a US bank in secret

Investigators have found that Alameda Research put $11.5 million, or more than quadruple the bank’s prior net worth, into the tiny Farmington State Bank community bank. Even if nothing else, this might be against the law: Alameda was required to pass a variety of regulatory requirements in order to buy a controlling stake in a U.S. bank as both a non-U.S. business and an investment firm.

The bank investment becomes “extremely ominous” in the bigger picture of the FTX affair after changing from “questionably legal.” Alameda and FTX could have carried out a variety of more heists if they had had control of a U.S. bank. For instance, contrast this with Pakistan-based Bank for Credit and Commerce International’s repeated attempts to acquire U.S. banks, which U.S. regulators successfully thwarted. BCCI turned out to be an even more evil organization than FTX, and it sought to acquire American banks to expand its network of international organized crime and money laundering.

Why the mainstream is incorrect

These fraud schemes are intricate and frequently sophisticated, replicating, it must be mentioned, well-known models from the traditional finance sector. Because of his anonymity, Bankman-Fried was able to pose as an honorable player and has probably contributed to milder media treatment even after the collapse.

Like other figures of the twenty-first century like Mark Zuckerberg and Adam Neumann, Bankman-Fried had also created a scruffy, nerdy persona that was difficult to reconcile with malicious theft. In interviews, he spoke incoherently about a field that is already rife with jargon and complex technology for snowjob outsiders. He created a web of clever donations and deceptive ideological claims to build his political and social influence.

Bankman-Fried has persisted in muddying the waters since his scam failed by painstakingly fabricating letters, remarks, interviews, and tweets. He has made an effort to present himself as a good-hearted but naive young man who got into trouble and made a few mistakes. This is a milder but more harmful variation of the crisis management strategy Roy Cohn, a black-hat mob lawyer, taught Donald Trump: Bankman-Fried has chosen to “confuse, dodge, and distort” as opposed to “deny, deny, deny.”

And it has, to a large extent, succeeded. One representative of the mainstream who continues to recite Bankman-Fried’s hypothetical talking points is Kevin O’Leary, who plays an investor on the reality series “Shark Tank.” Despite recent data suggesting enormous trading losses even during good times, O’Leary referred to Bankman-Fried as a “savant” and “probably one of the most experienced traders of crypto in the world” in an interview with Business Insider on November 27.

O’Leary’s involvement with FTX as an investor and previous paid spokesperson (we sure hope those checks clear, Kevin!) helps to explain why he still has a soft spot for Bankman-Fried in spite of mounting evidence to the contrary. But he is by no means the only one enhancing Bankman’s reputation. Fried’s At the New York Times’ DealBook Summit on Wednesday, the disgraced failed son of two Stanford University law professors will get the chance to make his case live on stage.

Bankman-Fried’s fraud and theft appear to be on par with those of Malaysian embezzler Jho Low and Ponzi schemer Bernie Madoff in terms of scope and intricacy. The deception also bears similarities to far bigger business crises like Worldcom and, particularly, Enron, whether done on purpose or through malicious incompetence.

The perpetrators in each of those incidents were either imprisoned or fled the country. Clearly, Sam Bankman-Fried deserves to suffer the same fate as them.

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