So. Many. Warning. Signs.
And to all appearances, every one of them was missed.
FTX had a valuation of $32 billion, making it the third largest crypto exchange in the world. It had the backing of top-tier investment funds, including Sequoia Capital, BlackRock and SoftBank. As for its 30-year-old founder and CEO, Sam Bankman-Fried -- known within the crypto world as "SBF" -- he was lauded as the next Warren Buffett.
Now FTX is in bankruptcy court, and its finances are in shambles. The new Chief Executive, John Jay Ray III, says part of the problem was FTX management, which was under the control "of a very small group of inexperienced, unsophisticated and potentially compromised individuals.”
Another big mystery is how FTX managed to fool so many blue-chip investors. "Where was their due diligence?” asks Stephen Young, who helped start crypto exchange Coindirect before founding peer-to-peer lending platform NFTfi.
In hindsight, the implosion of FTX and its affiliated hedge fund, Alameda Research, isn't exactly shocking. For years, Alameda has promoted questionable claims that it could guarantee investment returns. The exchange's U.S. arm also created the impression that certain customer deposits were government insured, when that wasn't necessarily the case. Privately, some investors say they were also spooked by FTX’s support for newly created tokens that could be used as collateral to assume more leverage.
Ray, who oversaw the restructuring of Enron Corp. — the largest bankruptcy in U.S. history when it filed in 2001 — wrote in a court filing Nov. 17 that in his 40 years of corporate restructurings, “never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information."
How did FTX unravel so quickly?
The short answer is, it didn’t. According to U.K.-based economist Frances Coppola, FTX appears to have been trading while insolvent for months, if not years, prior to filing for bankruptcy. In Coppola's view, FTX's estimated hole of $6 billion to $10 billion finally caught up to it.
FTX and Alameda didn’t respond to requests seeking comment.
Guaranteed returns “with no downside”
Sam Bankman-Fried grew up in the cradle of Silicon Valley. The son of two Stanford University law school professors, SBF graduated from MIT with a degree in physics before taking a job with quantitative trading firm Jane Street in lower Manhattan, according to a profile posted on Sequoia Capital. (The profile has now been removed.)
SBF quickly cultivated a reputation for being a skilled and efficient trader, and for his staunch support of a movement called “effective altruism.” EA, as it’s known, believes in maximizing your earning power in order to have the financial wherewithal to do more good.
SBF struck out on his own after Jane Street, starting hedge fund Alameda Research in a walk-up apartment in Berkeley, Ca. To raise capital for its market-making activities, Alameda promised investors “high returns with no risk,” according to its early offering documents.
“For investments of $50m or more, we are willing to discuss higher rates of return,” according to the document, posted on Twitter in January 2019 by Three Arrows Capital Co-founder Su Zhu.
This offering document was also circulated across private Telegram groups for crypto professionals, according to Qiao Wang, a core contributor to Alliance DAO, a community for web3 founders. During his “Blockcrunch” podcast on Nov. 14th, web3 investor Jason Choi also recalls that Alameda guaranteed investment returns in its early marketing materials.
SBF Blames “Messy Accounting” For Commingled Funds
Over the next few years, SBF grew his crypto empire into a sprawling network of more than 130 companies. After a few years in Hong Kong, he moved FTX's headquarters to the Bahamas. SBF also backed projects like Serum, a decentralized exchange on the Solana blockchain. The fundraising, said Choi -- who passed on the opportunity to invest -- was “unlike any standard" venture deal.
Among other things, Choi said, the Serum project had clauses that gave investors who moved quickly a lower price than those who came in hours or days later: “This forced investors, basically, to abandon due diligence and invest on the spot, which I obviously was not comfortable with,” said Choi on his podcast, “and in hindsight, this should have been a massive red flag.”
Of course, investors, technically, aren't forced to invest in anything. But what's surprising in the high-risk crypto environment is how many investors who did invest appeared not to do their diligence on SBF and his companies.
As FTX grew, its finances became more complex - typical for any large-scale business. SBF has blamed “messy accounting” for commingling the assets of Alameda Research and FTX, saying in a text message chain with an Axios reporter in November that it was never his intention to lend out FTX customer funds. “It was more like, ‘FTX doesn't have a bank account, I guess people can wire to Alameda's to get money on FTX,’" SBF wrote in the text exchange, according to Axios.
Some of that money may have never reached FTX, according to SBF, because “we basically forgot about the stub account that corresponded to that."
TX is also running into problems over some of the promises it made to customers. In August, FTX’s U.S. arm, and its then-President Brett Harrison, was ordered by the Federal Deposit Insurance Corp. (FDIC) to stop making “false and misleading” claims that direct payroll deposits to the crypto exchange’s U.S. arm are protected by the government. Harrison left his post a month later, in September.
The FDIC order was issued a week after TruthDAO posted a story highlighting the errant claims of FTX and other crypto companies about FDIC deposit insurance for crypto investors.