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Financial Crime: A framework for fraud: How FTX was a scam from the very beginning

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When Sam Bankman-Fried launched his crypto currency exchange FTX in 2019, it was an immediate hit.

Building off the success of his proprietary trading firm, Alameda Research, he was soon attracting top venture capital investors and, more importantly, customers to his crypto derivatives exchange.

But the problems that would lead to FTX’s spectacular collapse a little more than three years later were baked into the company right at the beginning, regulators say.

When customers began sending money to FTX to open accounts on the exchange, those funds were being directed into bank accounts that were controlled by Alameda. What at first seemed like an accounting oversight, rapidly ballooned into major fraud, according to a lawsuit filed by the Commodity Futures Trading Commission.  

FTX would eventually create its own accounts for customers to make deposits, but those early deposits into Alameda’s bank accounts plus money those customers would later put in, would eventually contribute to an $8 billion hole in FTX’s books, the CFTC suit said.

Making matters worse, Alameda was allowed to borrow as much capital as it wanted from FTX, drawing mostly from customer deposits.

In the end, that money was wiped out through risky bets made by Alameda and by Bankman-Fried himself, who treated the funds as his own to buy luxury homes, private jet rides and make political donations. That money was what FTX used to buy ads during the Super Bowl and to pay for the naming rights for the arena where the Miami Heat play, the CFTC said.

Fruit of a poisoned tree

The porous relationship between FTX and Alameda lay at the heart of the crypto exchange’s collapse into bankruptcy, causing the loss of untold billions to the company’s customers all over the world, the CFTC, the Securities and Exchange Commission and the U.S. Department of Justice have said.

Now Bankman-Fried faces criminal securities and wire fraud charges, as well as counts of money laundering, conspiracy and campaign finance violations. He was held without bail in the Bahamas on Tuesday and has suggested he would fight extradition to the United States.

His lawyers have said he is reviewing all his legal options. 

What may be most damning for Bankman-Fried is that he seemed fully aware of the problem despite repeatedly making public statements that the two companies were operated entirely separately. 

But according to the lawsuits and criminal charges filed against him by the U.S. government on Tuesday, Alameda was always deeply intertwined with FTX.

At the beginning, Alameda served as the primary market maker for the exchange, operating as an always available buyer and seller for FTX’s customers and providing key liquidity for the business.

To that end, margin restrictions placed on regular customers were lifted for Alameda, effectively allowing it to operate without any limits whatsoever, the CFTC suit said. FTX’s systems were programmed to allow Alameda to make trades even when it didn’t have the money to do so, the suit said.

When Alameda once surpassed a previously set debt limit, the CFTC suit said Bankman-Fried ordered his subordinates to raise its limits to a figure in the tens of billions of dollars that was unlikely ever to be reached.

Currency games

Another key component of the two company’s relationship revolved around FTX’s coin FTT, which it offered at discounts to customers who opted to use it to keep their assets on the exchange. In order to prop up the price of FTT, the CFTC suit said FTX would continually take a portion of the available coins out of circulation and place them on Alameda’s books.

Alameda, in turn, would use the inflated FTT to overvalue its books in order to receive greater margin limits from outside financial institutions, the CFTC suit said.

This perilous structure started unwinding in late spring as the prices for a variety of crypto currencies began falling. As the value of FTT dropped, it triggered some of Alameda’s margin limits. To counter that, FTX began acquiring more FTT to prop up the coin’s price, but Alameda was forced to use more FTX customer money to meet its debt obligations, the suit said.

Mindful of how apparent this would soon become on FTX’s books, Bankman-Fried ordered that the Alameda liabilities to be moved to a phony customer account that he regularly referred to as “our Korean friend’s account” or “the weird Korean account.”

In September, a month before it all collapsed, Bankman-Fried began discussing with other FTX and Alameda executives the possibility of shutting Alameda down completely. He ultimately chose not to, as he determined that FTX relied on Alameda too much for its liquidity and that the two companies were far too intertwined to separate, the CFTC suit said.

“Given the amount that Alameda is doing, we can’t really shut it down,” the suit quoted Bankman-Fried as saying. 

The fall of a crypto empire

In FTX’s final days, the company’s demise was triggered first by a report by CoinDesk reporting on internal Alameda documents showing how much of their holdings were in the FTT coin. That was followed a few days later by a tweet from the head of competitor, Binance, saying he was going to unload all his holdings of FTT “due to recent revelations that have come to light.”

That sparked a run on the bank, as spooked customers sought to get their money out of FTX. But FTX now didn’t have the money to cover the withdrawals. For a few days, Bankman-Fried ordered Alameda to sell anything it could to amass the capital necessary to cover the withdrawals while he also sought outside financing to fill the gap.

But the hole was too big. After Binance backed out of a deal to buy FTX out, the company had no other choice but to declare bankruptcy, Withdrawals were halted, leaving hundreds of thousands of customers without access to their money,  and Bankman-Fried out of a job.

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