What Happened to FTX?

Just a few months ago, Sam Bankman-Fried was on the top of the world. As the CEO of FTX, the world’s second largest cryptocurrency exchange, his net worth was an estimated 17.2 billion dollars. He was featured on the front cover of magazines like Forbes and Fortune and was hailed the “king of crypto.” Top venture capital firms such as Sequoia, Softbank and Tiger Global all rushed to invest in FTX. Celebrities like Tom Brady and Stephen Curry also endorsed the exchange. It seemed like no one could get enough of FTX.

Now, it appears that it was all a sham. In a stunning turn of events, FTX filed for bankruptcy in November. Bankman-Fried has since been charged with 8 counts of fraud, among them defrauding FTX customers and investors. In the words of SEC Chair Gary Gensler, “​​Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto.” Millions of FTX customers believe they have seen the last of their deposits on FTX. Equity investors, including numerous high-profile venture capital firms, hedge funds and pension funds stand to lose the entirety of their investments. 

So how did all this happen? 

The son of two Stanford law professors, Bankman-Fried was always academically gifted. He spent his high school summers learning in intense math programs for top students. After graduating from MIT with a degree in physics, Bankman-Fried worked as a trader at Jane Street, a highly-regarded proprietary trading firm. After three-and-a-half-years, he left and founded Alameda Research, a hedge fund which focused on cryptocurrency trading. He also persuaded Caroline Ellison, a colleague of his at Jane Street, to join him. Alameda Research was quite successful, making millions by taking advantage of arbitrage opportunities in Japanese and Korean crypto markets. However, Bankman-Fried eventually grew frustrated with the quality of the exchanges Alameda had to use for crypto trading. This frustration drove Bankman-Fried to design his own cryptocurrency exchange which he named FTX — a platform where users could trade, buy and sell a variety of cryptocurrencies, NFTs and other digital assets. FTX quickly attracted many users, and its valuation soared as revenue increased from $89 million in 2020 to $1.02 billion in 2021. This led investors to value FTX at $32 billion. 

Additionally, with the help of their aggressive marketing campaigns, FTX grew not only in valuation, but also in popularity — many might remember their hilarious Super Bowl commercial starring Larry David, or their ads featuring Tom Brady and Stephen Curry. In these advertisements, FTX was portrayed as a “safe way to get into crypto.” Bankman-Fried also carried a sterling reputation. His messy, unkempt appearance and stellar academic credentials created an aura of genius. He was also well-known for his philanthropic endeavors, and regularly expressed his desire to give away the majority of his wealth to charity. His willingness to bail out other struggling cryptocurrency companies earned him comparisons to JP Morgan. He was a frequent participant in congressional hearings on cryptocurrency regulation. He also gave large donations to both political parties. With a brilliant, philanthropically-oriented CEO at the helm, it seemed like all was well with FTX. However, one report published by crypto news site CoinDesk in early November changed everything.

There had long been speculation that Alameda Research was receiving special treatment from FTX — Bankman-Fried was the majority owner in both companies, and many executives of FTX and Alameda lived in the same penthouse apartment in the Bahamas. Nevertheless, both Bankman-Fried and Alameda Research CEO Caroline Ellison consistently maintained that they were separate entities. 

Then, about a month ago, CoinDesk reported that Alameda Research’s main asset was FTT, a cryptocurrency produced by FTX, which aroused suspicion amongst crypto investors. Upon hearing this, Binance, the world’s largest crypto exchange, announced that it was selling all of its FTT holdings — about 500 million dollars worth of FTT. This caused FTT’s value to plunge. Once word got out, panic ensued. Everyday users, sensing that something was terribly wrong with FTX, rushed to withdraw their money (like a regular bank, FTX allowed users to deposit their money in accounts). What followed was a classic bank run. Customers simultaneously rushed to withdraw their money. Withdrawals reached around 6 billion dollars over a three day span. Eventually, FTX did not have the necessary liquidity to give remaining customers their money back and suspended customer withdrawals. 

In response, Binance, FTX’s main competitor, agreed to bail out FTX before ultimately backing out, stating that FTX’s issues are “beyond our control or ability to help,” while also citing troubling rumors that FTX mishandled customer deposits. Finally, on November 11th, FTX filed for bankruptcy and Bankman-Fried resigned as CEO. 

In the aftermath of FTX’s bankruptcy, The Wall Street Journal reported that FTX had transferred around $10 billion worth of customer deposits to Alameda Research to fund its risky trades — a clear violation of FTX’s terms of service which explicitly stated that customer deposits would not be touched by FTX. In response to these allegations, Bankman-Fried publicly insisted that he never knowingly misused customer deposits, instead chalking up his blunders to “massive failures in oversight” and plain ignorance. Essentially, he asserted that he did not knowingly engage in any criminal activity. 

However, prosecutors clearly felt otherwise, and on December 12th, Bankman-Fried was arrested. His indictment highlighted four distinct areas of misconduct — defrauding FTX customers, defrauding FTX investors, defrauding Alameda Research lenders and violating campaign finance laws. To elaborate a bit more, prosecutors allege that from the start, Bankman-Fried stole money from FTX customers, which was used for a variety of purposes — some of the money, for example, was transferred to Alameda to fund its trades or pay off its loans. Some was used by Bankman-Fried to make large political donations and invest in real estate, among other things. 

Now, it appears that prosecutors have plenty of evidence against Bankman-Fried. On Dec. 21, both FTX cofounder Gary Wang and Alameda Research CEO Caroline Ellison pled guilty to several counts of fraud and are both cooperating with authorities. In a court hearing, Ellison admitted that she, along with Bankman-Fried and other FTX executives, engaged in a slew of fraudulent activity: from the very beginning, they diverted billions of dollars in customer deposits to Alameda Research, which were used to pay back Alameda’s creditors and fund its risky trades. Some of these funds were also lent out to Bankman-Fried and other FTX executives to buy real estate and donate to political campaigns. She also admitted that they tampered with balance sheets to mislead investors. She also testified that Alameda had special privileges on FTX which allowed it to take on far more risk than regular users. Essentially, everything about FTX and Alameda was one big scam. This admission of guilt runs in stark contrast to Bankman-Fried’s declaration that he never knowingly commingled funds. With the evidence against him mounting, experts say that Bankman-Fried’s legal situation is dire. 

In conclusion, there appears to be strong evidence that there was an extensive amount of fraudulent activity at FTX. This is a shocking and unfortunate situation for customers and investors who trusted FTX. In the coming months, there are hopes that new CEO John Ray will be able to locate customer funds and perhaps make them whole again. Only time will tell, but it is likely that the FTX scandal will go down in history as, in Damian Williams words, “one of the biggest financial frauds in American history.”