Alleged FTX scams relied on cryptocurrency

Sam Bankman escorted Fried out of the Magistrate’s Court building after his arrest in the Bahamas

Not crypto crimes, just alleged crimes committed with cryptocurrency.

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 centered on general financial crimes, and the government agencies involved did not take advantage of the opportunity to focus on the heated debate about how crypto assets should be regulated.

This has led to some celebrations. “They’re not really crypto crimes — and that’s a huge relief for the broader crypto industry,” reads the summary provided by The Information. But don’t make it crooked. Outside the courtroom, it is clear that the alleged Bankman-Fried fraud could not have taken place without the encryption technology and the hype surrounding it.

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Consider the alleged fraud: Our best picture so far is that FTX, a cryptocurrency exchange, took money from customers to buy or bet on a variety of crypto assets, while Alameda Research, Bankman-Fried’s hedge fund, also made bets. on the stock exchange. Money sent by clients to FTX ended up in Alameda and was used to pay for failed hedge fund bets, as well as a variety of personal and charitable expenses by Bankman-Fried and his inner circle. When enough customers asked for their money back, FTX declared bankruptcy.

Crypto Component 1: The hype about the financial future that you can’t miss

Every trick is a story. Why do suckers share their money? What prompted people to donate $8 billion to FTX over the two and a half years of its existence?

Similar schemes in traditional finance, such as commodities broker MF Global, which used $1.6 billion of client money to pay off a lost bet in 2011, or Bernie Madoff’s multi-contract Ponzi scheme, which robbed its victims of perhaps $19 billion before its collapse in 2008, have not He succeeds in making a lot of money so quickly. FTX built on the cryptocurrency bubble and the perception that people are getting rich fast – an idea it drove through its massive advertising campaign.

Of course, any asset class can be subject to bubble dynamics, from land in Florida to particularly attractive tulip bulbs. But there is usually some basic physical, or at least cash flow, behind the crazy over-the-top auction. The stock meme mania in recent years has probably steamed up a lot of money, but no matter how overvalued Gamestop’s stock is, the company still generated over $1 billion in revenue last quarter.

The economic value behind FTX is much less clear.

Encryption Component 2: The ability to create assets out of thin air

The balance sheet used by Bankman-Fried in its recent vain attempts to raise money showed that the bulk of the company’s “assets” were crypto tokens either Created by or based on FTX.

This included the most famous FTT, a token issued by FTX that was effectively tied to the value of the exchange. But it also included Serum, MAPS, and Solana—other coins whose value depended at best on the perception of risk of the venture capital style, and on the fact that a relatively small number of coins were tradable.

FTX clients may not have realized how much their deposits on the exchange were backed by these tokens. In fact, the public revelation that Alameda had a huge position in FTT led to the token sale and run that crashed the exchange.

But the people running FTX and Alameda, if you believe their public story about their actions reflects mismanagement rather than outright theft, they believe the currencies they helped create were sufficient collateral for US dollar liabilities. Cynical or not, in the absence of their belief in symbology, this fraud could have stopped sooner than it did.

If FTX is not a cryptocurrency, then what is?

Some true cryptocurrency believers argue that the existence of FTX as a centralized exchange was the real problem here, and decentralized on-chain transactions would not have led to similar dynamics. But they need to account for the fact that the value of their crypto investment is highly dependent on the investor access provided by centralized exchanges such as Coinbase, Binance or FTX. Cryptocurrencies as we know it seems to require exchanges and stablecoins pegged to the dollar to simply function.

Another argument is that if crypto assets are properly regulated, this kind of thing won’t happen. This may be true, but it is also not clear what is “appropriate” regulation – or that much of the cryptocurrency’s “value” as a speculative asset or regulatory arbitrage tool may be taken away by the types of disclosures and capital requirements that apply to traditional securities or goods.

The only thing to watch is what kind of recovery is available to the victims of this alleged scam. MF Global’s customers are made fully integrated, with losses being borne by the company’s owners and counterparties. For the Madoff fraud, two different funds distributed more than $17 billion to victims and other creditors by way of recovering cash from scheme beneficiaries.

FTX will likely follow through with similar efforts, but will anything be left in the rubble until they return to investors?

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