FTX’s Alleged Regular Frauds Depended Entirely on Crypto

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Sam Bankman-Fried is escorted out of the Magistrates Court building following his arrest in the Bahamas

Not crypto crimes, just alleged crimes committed with crypto.

The arrest of FTX co-founder Sam Bankman-Fried on various fraud charges has been hailed in some quarters as a vindication of the cryptocurrency economy. After all, the allegations focused on generic financial crimes, and the government agencies involved failed to take the opportunity to focus on heated debates about how crypto assets should be regulated.

It led to a celebration. These aren’t really crypto crimes and that’s a big relief for the wider crypto industry, is the summary offered by The Information. But don’t twist it. Beyond the courtroom, it is clear that the alleged Bankman-Frieds fraud could not have been accomplished without crypto technology and the hype surrounding it.

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Consider the alleged fraud: the best picture we have so far is that FTX, the cryptocurrency exchange, took money from customers in exchange for buying or betting on a variety of crypto assets , while Alameda Research, the Bankman-Frieds hedge fund, also made bets on the exchange. The money that customers sent to FTX ended up in Alameda and was used to pay for failed hedge fund bets, as well as various personal and philanthropic expenses of Bankman-Fried and his entourage. When enough customers asked for their money, FTX declared bankruptcy.

Crypto Ingredient 1: The Financial Future Hype You Can’t Miss

Every con is a story. Why does the miller part with his money? What made people donate $8 billion to FTX over its two and a half year life?

Analogous schemes in traditional finance, like commodity broker MF Global, which used $1.6 billion in client funds to repay a lost bet in 2011, or Bernie Madoff’s decades-long Ponzi scheme, which robbed its victims of perhaps $19 billion before its 2008 collapse, failed to get away with that much money so quickly. FTX was dependent on the crypto bubble and the perception that people were getting rich quick, an idea it was driving with its own massive ad campaign.

The story continues

Of course, any asset class can be subject to bubble dynamics, from land in Florida to particularly attractive tulip bulbs. But usually there’s an underlying material object, or at least cash flow, behind the manic one-upmanship. The stock mania even in recent years is likely to vaporize a lot of money, but no matter how overvalued Gamestops shares are, the company still made over $1 billion in revenue last year. trimester.

The underlying economic value behind FTX is much less clear.

Crypto Ingredient 2: The Power of Creating Assets From Nothing

The balance sheet that Bankman-Fried used in its last failed fundraising attempts showed that the bulk of the company’s assets were crypto tokens created by or dependent on FTX.

This included the most famous FTT, a token issued by FTX that was effectively tied to the value of trades. But it also included Serum, MAPS, and Solanaother coins whose value depended at best on achieving venture capital-like risk and a relatively small number of coins being tradable.

FTX customers probably didn’t realize how much of their exchange deposits were backed by these tokens. Indeed, the public revelation that Alameda had a huge position in FTT led to a token fire sale and run that crashed the exchange.

But the people who operate FTX and Alameda, if you believe their public history of their actions reflecting mismanagement and not outright theft, thought the coins they helped create were sufficient collateral for bonds in U.S. dollars. Cynical or not, without their belief in tokenomics, this fraud would have stopped sooner than it did.

If FTX isn’t crypto, what is?

Some true crypto believers argue that the existence of FTX as a centralized exchange was the real problem here, and that truly decentralized on-chain transactions would not have led to similar dynamics. But they have to consider that the value of their crypto investments is hugely dependent on investor access provided by centralized exchanges like Coinbase, Binance, or FTX. Crypto as we know it seems to require dollar-pegged exchanges and stablecoins just to work.

Another argument is that if crypto assets were properly regulated, this sort of thing wouldn’t happen. That may be true, but it’s also unclear what proper regulation would be or that much of the value of cryptos as a speculative asset or regulatory arbitrage tool could be eliminated by the types disclosure and capital requirements that apply to traditional securities or commodities.

One thing to watch out for will be the type of recovery for victims of this alleged fraud. MF Globals customers were fully recovered, with owners and counterparties to the business bearing the losses. For the Madoff fraud, two different funds together distributed more than $17 billion to victims and other creditors by collecting money from scheme beneficiaries.

Similar efforts will likely follow at FTX, but will there be anything left in the rubble to return to investors?

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