A few days ago I was thinking about writing a super-short explainer about the whole FTX affair, but then I got sick and never got around to it. But I'm better now! Plus Atrios linked today to an article that added, in the author's words, a "smoking bazooka" to the whole affair. So let's do it.
- In 2017 Sam Bankman-Fried (universally referred to as SBF) started up Alameda Research, a hedge fund with a focus on crypto. Alameda does what every hedge fund does: takes money from clients and then buys and sells stuff in order to make big profits for itself and its clients.
- In 2019 SBF founded FTX, a cyptocurrency derivatives exchange. Like all exchanges, it was basically a broker for investors who wanted to buy crypto products. One investor, for example, was Alameda Research. Unlike hedge funds, however, exchanges don't gamble with customer funds; they generally make money by charging set fees for every transaction they enable.
- In 2021 SBF moved both Alameda and FTX to the Bahamas and a few months later stepped down as CEO of Alameda, leaving it in the hands of Sam Trabucco and Caroline Ellison. However, executives from both companies shared a $30 million penthouse suite in Nassau, and SBF was apparently romantically involved with Ellison.
- Sometime around 2021—the date is vague—Alameda began borrowing huge amounts of money from FTX. This was client money that was held by FTX and was not supposed to be used for trading. Alameda's collateral for the loans was a crypto token invented by FTX but not really traded anywhere. It was notionally worth $10 billion but in reality was worth roughly nothing.
- At about the same time, Alameda loaned $4.1 billion to several FTX executives, including about $3 billion to SBF alone. This is the smoking bazooka.
- In addition, Alameda enjoyed special exemptions from FTX's usual trading rules. This allowed it to lose billions of dollars before fessing up to FTX—though it's likely everyone at FTX knew about this anyway but kept quiet because they didn't want to jeopardize the loans they were getting from Alameda.
- In November 2022 Alameda's eventual $10 billion in losses (loans to FTX executives + losses from bad trades) came to light. Since these were essentially losses of FTX client money, FTX clients naturally got worried about whether their money still existed. So they all started asking for withdrawals which FTX was unable to honor.
- On November 11 FTX and Alameda filed for bankruptcy.
There's plenty more background stuff, the juiciest of which involves SBF's involvement in "effective altruism" and his huge donations to Democratic politicians¹ and various worthy causes. There's also a vast amount of chaff and irrelevant detail that's being flung around—both deliberately and otherwise—to disguise what really happened. It was just mismanagement! SBF was in over his head! Look at his work combating parasitic worms in Niger!
But it ain't so. SBF's motives are a little opaque, but it was all just a fraud for at least the past couple of years. Why else do you think everyone from both FTX and Alameda continues to hide out in the Bahamas instead of coming home to answer the FBI's questions straightforwardly?
¹Although SBF says that actually he donated equally to both Democratic and Republican pols, but kept the Republican donations dark in order not to anger liberals.
What's really missing from most reporting is points 4 and 5 and probably 6.
Any other exchange is not loaning out client money (they may be, as a broker, loaning out client securities but that's another issue) .......
by the way, the other side of the story, in addition to obvious fraud, is FTX keeps being referred to as "an exchange" but really are acting more like a broker, and an unethical broker at that.
Its only about the crypto as a side issue. If Fidelity fraudulently lost the money in an account that is supposed to be just parked there awaiting trades it would have been the same story.
What I don't understand is why FTX as a broker had very much client money on hand. A broker needs some capital but mostly just puts buyers and sellers in contact. Possibly they had people offering money and couldn't turn it down?
There are two questions here:
- was it immoral/unethical?
- was it illegal?
The illegality hinges on EXACTLY what FTX claimed to be doing in their contracts with users; and it's unclear (to me anyway) what those contracts looked like. In the "normal" financial world I don't need to know or care about the nature of my contract with my bank or mutual fund provider or suchlike because that pesky Federal Government ensures those contracts legally match what "everyone expects".
But the crowd that created and made use of things like FTX were (and still are) VERY CLEAR that they don't need that "dead hand of paternalism controlling and constraining innovation". Which puts this in a rather different situation...
I have no problem with SBF eventually going to jail, but I'm not sure that will happen because (as I said) it's still unclear to me what laws were broken (criminal OR contractual). And I'm not sure it's a bad outcome if SBF walks away scot free except for some reputational loss!!!
The rest of us all have to suffer from the idiocies that emanate from the strong libertarian crowd and their religious claims as to how great everything (finance as just one small part) would be without a federal government and everything kept in check by mass eyeballs looking at contract details and publicizing bad actors; it's no bad thing if everyone burned by this gets some real-world experience as to exactly how that plays out in the real world...
It is a plausible hypothesis given known facts that actions like hidden usage of client funds from FTX by Almeda with hidden exceptions on limits will be within the remit of criminal fraud, and presumptivly provable.
The various Drama Llamas commenting in various places about why SBF is not already arrested of course is that the sheer messiness of crap record keeping make differentiation of fraud from mere incompetence harder.
"dead hand of paternalism controlling and constraining innovation" == accountability.
He learned one important lesson other scammers didn't - flatter journalists and others with big megaphones.
Even people I used to think occasionally try to be honest like Yglasias is writing apologia for this douchey crook.
This is disappointing news. I was looking forward to watching an FTX commercial during the Super Bowl.
If anyone would like to check out Alexandra Petri's humorous take on this:
https://www.washingtonpost.com/opinions/2022/11/25/ftx-cryptocurrency-explainer-satire/
If they could mint $10B in worthless tokens could the government mint $1T platinum coins to cover our debt? Just asking a question.
Yes. Difference being the US has a nuclear weapons arsenal and 325 million taxpayers and the biggest economy in world history!
Any fool can create money. The hard part is getting people to accept it. We accept USD because we need USD to pay our taxes and if we don't there are consequences.
No, the mere basis of taxes is not enough (as one can see in developing markets where legal tenders die despite being required for tax payment).
Rather USD has a proven utility.
Reasonably stable in exchange value
Reasonably accessible
Reasonably liquid
Reasonably managed for both liquidity and comparative exchange value
Also useful for paying taxes.
Long-term social trust.
While the Libertarian nutters, whose ideology is really an inverted Bolshevism, discount long-term social trust, in fact it's the bedrock of genuine markets and genuine market economics (versus bizarro world inverted Boslhevism they believe in)
Is it really fraud if the people doing it don't know it's a fraud but only think it might sort of be fraud?
Yes. The fraud portion of the list of charges is that FTX promised in writing that customers' funds wouldn't be loaned out. FTX then loaned out customers' funds. If the officers of FTX only thought it might, sort of be fraud, it is because they didn't read the contracts that their company had signed. That's not a defense against not having committed fraud.
indeed having hidden the Almeda derogations is a key signal there is not mere incompetence here.
The Financial Times Alphaville blog has some fun reading decomposing the ponzi scheme background for their "native" token as a mode of levering up through manipulated value (really Crypto has basically done not much more than replicate the scammy early 20th century penny stock industry, just a reminder of how we ended up with capital markets regulation...) and public comments by the very founder who in fact openly hinted at.
He really never kept his mouth shut...
Yes, but did they break any regulations? These are not regulated like banks or trading houses. They probably broke their terms of service, and may have committed fraud--though that might depend on the fine print in the terms of service...
There is no "may have committed fraud". The terms of service said your money is your money, does not belong to us, and we will never use it. Then they turned around and used it in shady "investments" in another one of their companies. The sad thing is if you are willing to rip people off with crypto there are plenty of good ways that are completely legal.
I like krugmans column today in The NY Times. What’s it all good for? Scamming.
“These (blockchain) protocols are, everyone tells me, extremely clever. I’ll take their word for it. The question I’ve never heard or seen satisfactorily answered, however, is, “What’s the point?” Why go to the trouble and expense of maintaining a ledger in many places, and basically carrying that ledger around every time a transaction takes place?”
https://www.nytimes.com/2022/12/01/opinion/blockchains-what-are-they-good-for.html
Interstellar commerce, of course. If you believe, as I do, that FTL is an oxymoron.
Lay off Effective Altruists:
http://www.mattball.org/2022/11/lay-off-effective-altruists.html
Fuck off, troll.
The only difference between FTX's digital currency and everybody else's digital currency is perception. None of them have any actual value although I suppose bitcoin has 'value' to the extent that it drives up electricity prices and the inputs to creating electricity. I've frequently said that collectively humans are no smarter than yeast but cyrpto has convinced me that the yeast are actually smarter; they don't waste a lot of resources accomplishing nothing.
There's an interesting human interest sidebar. This was the first time I'd read the name "Caroline Ellison". Immediately I wondered... could it be? But of course, she is no relation to Larry; that would have been just too perfect. But her actual story (https://en.wikipedia.org/wiki/Caroline_Ellison) is quite interesting: child of two Economics professors, National Merit Scholarship winner, math graduate from Stanford. Clearly a person of high intelligence and talent. And one who should be able to read and understand a contract.
Lack of understanding appears not to be the issue.
Sam Bankman-Fried is another product of our so-called meritocracy.
That's some awfully dry humor. Sure you're not British?
Yep, that's the crux of it. If he can't account for that money, they need to extradite him from the Bahamas and prosecute him for embezzlement.
Is it just me or does anyone else wish they could invent a “notional” (i.e., non-existent) “token” worth any ridiculous amount you can come up with and say it’s collateral for a loan?
GLENDOWER: I can call Spirits from the vasty Deep.
HOTSPUR: Why, so can I, or so can any man. But will they come when you do call for them?