It came out of nowhere. In just one week, FTX went from the most trusted player in the crypto universe to its most reviled as it lost over $8 billion of customer’s money in less time than it took for Elon Musk to fire everybody at Twitter.
From Bahamian banquets to bankruptcy, FTX’s Sam Bankman-Fried is now the poster child for the collapse of the crypto industry.
Did what happen really happen due to revelations of a lack of simple due diligence that caused a spat between Bankman-Fried and Binance CEO Changpeng Zhao as Zhao expressed skepticism about FTX’s financial stability?
Quickly, with the speed of a drought ignited California forest fire, investors lost confidence in the exchange and a good old fashioned run on Bankman ensued. As FTX had no way to pay those jumping ship, they sought help from Binance, who initially agreed to bail them out, but then, backed away. This simple series of events threatens to damage the entire industry for years to come. It only takes one match to light a fire when you have plenty of fuel and transparency hasn’t rained in years.
But where did the money go? First, large chunks went to pay off risky bets made by Alameda Research, and to increase the finger pointing, Alameda is a hedge fund started by FTX’s founder Bankman-Fried. Criminal fraud charges were brought against Alameda CEO Caroline Ellison and FTX co-founder Gary Wang by the U.S. attorney for the Southern District of New York (SDNY). This means somebody will have a lot of ‘splaining to do, as Bankman-Fried has agreed to be extradited to the U.S. from the Bahamas to face trial in New York City. The bail? $250 million. It just gets richer.
But at the core of the collapse is what can be construed as reliably grifty Ponzi scheme. The collapse of the highly controversial TerraUSD stablecoin may have started a chain reaction that brought down FTX and Alameda. The level of high risk speculation, non-existent bookkeeping, and bad management will make it almost impossible for FTX customers to get their money back.
But the blockchain has a memory, and crypto investigators have been on the trail of FTX’s missing billions by tracking transactions and have discovered that after the already shifty TerraUSD collapsed, hundreds of millions of crypto dollars were transferred from FTX to major crypto lenders.
Political donations and Bahamian real estate empires were the diversions Bankman-Fried engaged in, but it appears those expenses paled in comparison to Alameda’s debts following the Terra crash. If, when and how customer deposits linked to the defunct Alameda get repaid remains a mystery.
So, again, where’s the money?
Regulators already know part of the answer: The Commodity Futures Trading Commission (CFTC) alleges in November that most of the lost customer deposits ended up being used to cover risky bets and debts for Alameda Research.
The clear trail of obfuscation starts in 2017, with Bankman-Fried’s founding of the trading firm Alameda Research (nice touch adding of the noble word “Research”) that made big bets on the crypto ecosystem. Those bets created a fair amount of noise in the market which attracts the first wave of irrational exuberance, formerly called “dumb money.” FTX was founded in pre-pandemic 2019, and allowed investors to buy cryptocurrency and took deposits, much like traditional financial institutions do. Nothing to see here, please move on, or so they thought.
FTX and Alameda were supposed to operate separately from one another, but investigators found evidence that the companies have been commingling without protection since FTX’s inception, with funds flowing lugubriously between them, one pocket replacing what was in the other pocket, and vice versa. Alameda Research used FTX’s funds as an unlimited line of credit, but Alameda was the only account that was allowed to have a negative balance, according to the CFTC. The crypto sleight of hand was at once slick and stupid.
The co-mingling of funds between Alameda and FTX was not on purpose, Bankman-Fried claimed, but resulted from the misreading of “confusing internal labeling.” This is the billion dollar “Oops, I didn’t know!” defense. In the crypto bull market, where digital bulls run freely, billions of dollars flowed, the exuberance was great, and Alameda’s use of FTX funds went largely unnoticed. But then, May 2022, the less-than-stablecoin TerraUSD collapsed, causing a domino effect that wiped out over $400 billion in value in the crypto ecosystem.
This should not have happened, because a stablecoin is supposed to be tied to the value of the U.S. dollar. They are crucial to the stability of the crypto ecosystem. They provide traders with the option of parking volatile crypto assets in a more stable currency. This makes sense and is part of the governance process aimed at creating confidence in crypto. But TerraUSD wasn’t backed by dollar value, it was purely algorithmic, meaning it relied on market activity and sheer belief to keep it pegged to the dollar. And we all know, there is nothing like investing in sheer belief. In short, the Bankman-Fried system was about as stable as a radioactive isotope of Tritium. Ka-Crypto-Boom!
The fallout was immediate. Major industry players like Three Arrows Capital and Voyager Digital filed for bankruptcy. Many crypto lenders were forced to call back their loans. Alameda was forced to pay up but did not have the cash on hand to service its debts. Worse, in May or June, Bankman-Fried directed Alameda to pull several billion dollars’ worth of FTX user funds to pay off its debts. This is like a magician promising to pull a rabbit out of the hat but makes off with your watch instead.
FTX’s books showed that Alameda owed $8 billion to FTX. To hide this admission, investigators discovered that FTX put it into a folder called “our Korean friend’s account.” This could be a reference to Do Kwon, the co-founder of TerraUSD and Luna. Regardless, because of this change, the debt no longer showed up on FTX’s ledgers.
But wait! There’s more!
When investigators and analysts tracked money flows from FTX to Alameda, they published their findings in an extensive report illustrating the frantic transactions that FTX made following the TerraUSD crash. FTX transferred hundreds of millions of dollars’ worth of cryptocurrency, first to Alameda and then to the trading firm Genesis, which had served as a major lender to many crypto companies. The pants now had three pockets, and the wearer had four hands.
Whatever is outside the blockchain ledger is what the investigators call a black hole, but the evidence strongly suggests FTX user funds (Peter) were deployed to pay off a debt to Genesis (Paul). You know the saying about who was robbing who to pay whom. The assumptions on the part of investigators seem to be logical and linear.
But Bankman-Fried was a busy boy, as the NY Times reported that federal prosecutors are investigating whether he manipulated the markets of TerraUSD and Luna. He, of course, denies that, as he does most of his actions, but the Times cites an unnamed source alleging that it was Bankman-Fried’s cryptocurrency trading firm that shorted Luna, or placed a giant bet against it, thus causing TerraUSD and Luna to crash and setting off a slew of ripple effects that led to FTX’s demise and the main player in that week’s Breaking News.
Under New Management, Recovery Begins
Now under new management, FTX, with federal agencies, are working to recover funds that can be returned to customers. They claim they have already recovered $1 billion in assets, but this is a lot less than the more than $8 billion missing. To add insult to injury, more than $3 billion is owed to the company’s top 50 creditors. Extremely challenged, potentially sleep deprived and newly appointed CEO John Ray III says FTX could owe money to more than one million people and businesses. Ouch.
A former federal prosecutor, Timothy Howard, now a partner in law firm Freshfields, says that getting money back from third parties to customers is possible but complicated. “The Department of Justice is committed to providing restitution to victims of fraud. If assets go to third parties and are proceeds of a crime, they’re potentially forfeitable,” he says. “But third parties can exert an innocent owner defense—if they weren’t involved in the crime or had no knowledge or reason to know they were receiving proceeds of a crime—to dispute forfeiture.” Bankman-Fried has repeatably claimed the “Oops, I didn’t know” defense, so the promise of his prosecution could be empty.
In a congressional hearing, Ray alleged that Alameda already spent the money it received from FTX users, making it harder for the money to be returned. “At the end of the day, we are not going to be able to recover all the losses here,” Ray said. “There was money spent that we will never get back.”
Congratulations. You’ve been FTXed!
Howard Davidson is the CMO of Almond FinTech
Almond FinTech is a blockchain-based funds transfer network connecting financial institutions globally. Almond’s infrastructure, is built for speed, security, and accessibility, enabling users worldwide to send money across borders using their existing financial institutions. Additionally, Almond uses a combination of psychometric and financial data to provide fast, low-risk, ethical loans to communities with unconventional or limited credit histories.
