Tuesday, November 22, 2022

What You Need to Know about the Colossal Mess of FTX

 BY JIM GERAGHTY | National Review

Founder of FTX Trading Limited, Sam Bankman-Fried, speaks during a hearing on Capitol Hill in Washington, D.C., December 08, 2021.(Jabin Botsford/The Washington Post via Getty Images)

On the menu today: Over the course of November, you’ve probably noticed increasingly dramatic coverage of the collapse of the cryptocurrency exchange FTX. It turns out that the disheveled young so-called genius running one of the world’s biggest cryptocurrency exchanges and a major cryptocurrency hedge fund — a man once touted as the next Warren Buffett — was making it all up as he went along, like Bluto Blutarsky in Animal House. In other words, the cryptocurrency titan who was previously the Democrats’ second-biggest donor after George Soros now looks like a younger, nuttier Bernie Madoff.

Sam Bankman-Fried: Crook, Nut, or Both?

I haven’t written one of these explainers since the GameStop brouhaha. If I’m writing an “explainer,” there’s a good chance I needed the subject explained to me.

Let’s start at the very beginning, because as Maria Von Trapp reminded us, that’s a very good place to start. A cryptocurrency is a money-like asset that is designed to be used on computer systems and electronic banking, but that is not backed by anything like a government or a bank. Theoretically, anything could be used as currency. Back in grade school, you probably used Halloween candy as a lunchroom currency in early November — two small bags of M&Ms equaled one Snickers bar. Unlike the shell beads, coins, paper, and other objects used as currency throughout history, cryptocurrency is not tangible or physical; it only exists electronically. But if two people agree that the cryptocurrency has a particular value, they can use it to buy or sell goods or services. Or someone can buy a cryptocurrency and hold onto it like a stock or other asset, hoping it rises in value.

Right now, the most widely held cryptocurrencies are Bitcoin, Etherium, Tether, USD Coin — which, as the name would suggest, is pegged to the dollar — and BNB.

Back in 2017, Sam Bankman-Fried noticed that Bitcoin was bought and sold at significantly different prices in different countries’ markets — sometimes 60 percent more than the lowest priced markets. He bought Bitcoin in the markets where it was the cheapest, and then resold it in South Korean markets at a much higher price, what he nicknamed “the Kimchi Premium.” After a month, he launched his own trading house, Alameda Research.

Bankman-Fried founded FTX, which is short for “Futures Exchange,” in 2019. “In creating FTX, I wanted to build a platform for professional traders like me, while also bringing crypto trading to the mass market and first-time users,” he later said. He and his team had considerable experience with a lot of other big-name financial firms and tech companies such as Optiver, Susquehanna, Google, and Facebook. In other words, those who invested in and with the exchange believed that this team knew what they were doing.

As a cryptocurrency exchange, FTX allowed customers to trade cryptocurrencies for other assets, such as conventional — some would say, “real”– money or other cryptocurrencies. As with all currencies, the value of any given cryptocurrency is determined by what people — the market — collectively believe it is worth. If you have bought your morning coffee with U.S. dollars for your entire life, you likely feel confident that the coffee shop will accept payment in U.S. dollars tomorrow.

Every currency is maintained by a sufficiently widespread belief that the currency is currently worth something and will continue to be worth something in the foreseeable future. A currency’s value crashes when people no longer believe it is worth much, or worth anything at all.

FTX grew spectacularly fast. By March 2021, FTX had bought the rights to rename the home of the NBA’s Miami Heat as the “FTX Arena.” You may recall the Super Bowl commercial from this past February featuring Larry David, with the joke being that David didn’t understand cryptocurrency and thus was passing on investing in the next big thing — a pretty funny irony in light of recent events.

In August, Sam Bankman-Fried was on the cover of Fortune magazine, with a headline asking if he was the next Warren Buffett. He was touted like the other tech-industry boy-wonder geniuses, the next Steve Jobs, Bill Gates, or Mark Zuckerberg — a disheveled and casual wunderkind who had apparently discovered some key business secret or truth that had eluded the rest of us.

Sam Bankman-Fried does not look like the most powerful man in crypto. Friendly and rumpled, with an unruly halo of curly hair, the 30-year-old widely known as SBF has an affinity for League of Legends, fidget spinners, and other trappings of nerd culture. But underneath the goofy facade is a trading wunderkind whose ambition knows no limits.

An MIT physics grad, SBF honed his trading skills at renowned quant shop Jane Street Capital before launching a successful firm of his own, Alameda Research. In 2019 he founded crypto exchange FTX, hailed by some as the best derivatives platform ever built.

As recently as September, FTX was believed to be worth $32 billion. In addition to running the cryptocurrency exchange FTX, Bankman-Fried continued to run Alameda Research. This is like having the same person running the New York Stock Exchange and Bridgewater Associates, to pick a market and a hedge fund that are familiar to most people.

If you’re like me, you’ve felt like you didn’t really understand what the heck cryptocurrency was and didn’t bother investing in it. Well, our inability to understand these things really paid off in this case.

At the beginning of November, the website CoinDesk reported that “Bankman-Fried’s trading giant Alameda rests on a foundation largely made up of a coin that a sister company invented, not an independent asset like a fiat currency or another crypto. The situation adds to evidence that the ties between FTX and Alameda are unusually close.”

This may not be legal; reportedly, “the U.S. Department of Justice and the Securities and Exchange Commission are examining whether FTX improperly used billions of dollars of customer funds to prop up a trading firm that he also founded, Alameda Research.” In other words, people gave money to the FTX exchange thinking they were investing in various cryptocurrencies, and it was instead being used to support the bottom line of the cryptocurrency hedge fund.

The CoinDesk report also led to lots of people in the financial and tech sectors wondering how much of FTX and Alameda’s financial assets were based on non-crypto, tangible financial assets. The fear was that the company’s financial assets were largely cryptocurrency, and thus capable of losing value quickly and with little warning.

About a week later, FTX entered negotiations with the world’s largest cryptocurrency exchange, Binance, seeking to be acquired by the larger exchange. The initial assessment from Binance was that FTX still had value, but it had a “liquidity crunch” — it couldn’t turn its cryptocurrency assets into real-world-currency assets fast enough. But about a day later, Binance suddenly changed its mind, backing out of the deal and ominously declaring that, “The issues are beyond our control or ability to help.”

That was a giant flashing neon sign that FTX had some sort of terrible problems lurking beneath the surface.

FTX has since filed for bankruptcy, and John Jay Ray III, who is running what’s left of the company, declared in the bankruptcy filing that basically no one at FTX left any records of what they were doing, and may well have never understood what they were doing when they were actually doing it. Ray wrote:

I have over 40 years of legal and restructuring experience. I have been the Chief Restructuring Officer or Chief Executive Officer in several of the largest corporate failures in history. I have supervised situations involving allegations of criminal activity and malfeasance (Enron). I have supervised situations involving novel financial structures (Enron and Residential Capital) and cross-border asset recovery and maximization (Nortel and Overseas Shipholding). Nearly every situation in which I have been involved has been characterized by defects of some sort in internal controls, regulatory compliance, human resources and systems integrity.

Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.

Remember, this is the guy who cleaned up Enron!

Bankruptcy filings are not often entertaining reading, but this one stands out because it basically makes FTX look less organized, professional, and disciplined than the fraternity in Animal House. Where the institution doesn’t look chaotic, it looks like a giant scam:

  • “Many of the companies in the FTX Group, especially those organized in Antigua and the Bahamas, did not have appropriate corporate governance. I understand that many entities, for example, never had board meetings.”
  • “The FTX Group did not maintain centralized control of its cash. Cash management procedural failures included the absence of an accurate list of bank accounts and account signatories, as well as insufficient attention to the creditworthiness of banking partners.”
  • “The FTX Group’s approach to human resources combined employees of various entities and outside contractors, with unclear records and lines of responsibility. At this time, the Debtors have been unable to prepare a complete list of who worked for the FTX Group as of the Petition Date, or the terms of their employment. Repeated attempts to locate certain presumed employees to confirm their status have been unsuccessful to date.”
  • “Employees of the FTX Group submitted payment requests through an on-line ‘chat’ platform where a disparate group of supervisors approved disbursements by responding with personalized emojis.”
  • “Corporate funds of the FTX Group were used to purchase homes and other personal items for employees and advisors. I understand that there does not appear to be documentation for certain of these transactions as loans, and that certain real estate was recorded in the personal name of these employees and advisors on the records of the Bahamas.”
  • “The FTX Group did not keep appropriate books and records, or security controls, with respect to its digital assets.”
  • “One of the most pervasive failures of the FTX.com business in particular is the absence of lasting records of decision-making. Mr. Bankman-Fried often communicated by using applications that were set to auto-delete after a short period of time, and encouraged employees to do the same.”

That last one makes you wonder if Bankman-Fried didn’t want to leave any paper trail of what he was doing with other people’s money. The much-celebrated wunderkind now looks like either a crook, or a nut, or both:

“Mr. Bankman-Fried, currently in the Bahamas, continues to make erratic and misleading public statements. Mr. Bankman-Fried, whose connections and financial holdings in the Bahamas remain unclear to me, recently stated to a reporter on Twitter: “F*** regulators they make everything worse” and suggested the next step for him was to “win a jurisdictional battle vs. Delaware”

Many on the right are wondering if Bankman-Fried got away with it for so long because he was exceptionally generous to the Democratic Party, and lots of people on the left wanted to believe the image he offered.

In August, Politico described Bankman-Fried as “one of the biggest donors in Democratic politics. . . . [He’s] one of just a handful of donors who spent $10 million-plus backing President Joe Biden in 2020, and in the last year, he’s hired a network of political operatives and spent tens of millions more shaping Democratic House primaries. It was a shocking wave of spending that looked like it could remake the Democratic Party bench in Washington, candidate by candidate. Looking ahead to the 2024 election, he has said he could spend anywhere from $100 million to $1 billion.”

When you have $1 billion, you can buy a lot of friends who don’t want to look too closely at how you made your fortune. NBC News reported:

In just two years since Bankman-Fried’s first political donation, his money hired dozens of top-flight lobbyists and political operatives, made major investments in newsrooms like ProPublica and Semafor, and made him the second-biggest Democratic donor of the 2022 midterms, behind only the 92-year-old financier George Soros. He said $1 billion would be a “soft ceiling” for his spending in 2024.

Apparently, there’s no proof to the rumor that the Ukrainian government invested heavily in FTX, with some folks on social media spinning a conspiracy theory that the Ukrainians gave to FTX, Sam Bankman-Fried gave money to Democrats, and Democrats and the Biden administration sent U.S. aid to Ukraine. FTX was a partner in helping the Ukrainian government convert donated cryptocurrencies to fiat money.

But the story is bad enough as is, without crazy rumors of elaborate global money-laundering. It is believed that more than a million people have lost the money they invested in FTX, an estimated $8 billion or so.