Sam Bankman-Fried's Crypto Recession: The downfall of FTX and Alameda Research

Tuesday - December 5 2023, 06:24 UTC - 11 months ago

Sam Bankman-Fried founded FTX and Alameda Research, two companies that had significant overlap with each other. Ultimately, their operations led to massive losses for investors and customers. Bankman-Fried was convicted of seven counts of fraud and money laundering, and FTX launched its own custodian service, Fulcrum. This shows the need for strict regulations and oversight in the crypto industry.

A million years ago, back in 2019, Sam Bankman-Fried founded FTX, a company that ran one of the largest cryptocurrency exchanges. FTX was where many crypto investors traded and held their cryptocurrency, similar to the New York Stock Exchange for stocks. Bankman-Fried also founded Alameda Research, a hedge fund that invested in cryptocurrencies and crypto companies. In the traditional financial sector, these two companies would be entirely separate firms, or at least have firewalls in place to avoid conflicts of interest. But in early November 2022, news outlets reported that a significant proportion of Alameda’s assets were a type of cryptocurrency released by FTX itself.

A few days later, news broke that FTX had allegedly been loaning customer assets to Alameda for risky trades without customers’ consent and also issuing its own FTX cryptocurrency for Alameda to use as collateral. As a result, criminal and regulatory investigators began scrutinizing FTX for potentially violating securities law.

These two pieces of news basically led to a bank run on FTX, and soon afterward, FTX, Alameda Research and 130 other affiliated companies founded by Bankman-Fried filed for bankruptcy. This left huge numbers of investors who bought cryptocurrencies through the exchange with no good way to get their money back.

Within a month, Bankman-Fried was arrested and charged with wire fraud, wire fraud conspiracy, securities fraud, securities fraud conspiracy and money laundering by the Southern District of New York. In February 2023, additional criminal charges related to political donations were announced, followed by another indictment in March related to bribery. Bankman-Fried’s first trial began on Oct. 3, 2023, and largely focused on the "essentially unlimited" access to capital Alameda had on the exchange through a secret line of credit. The trial ended on Nov. 3, with Bankman-Fried convicted of seven counts of fraud and money laundering. He is expected to appeal.

In traditional markets, corporations generally limit the risk they expose themselves to by maintaining liquidity and solvency. Liquidity is the ability of a firm to sell assets quickly without those assets losing much value. Solvency is the idea that a company’s assets are worth more than what that company owes to debtors and customers. But the crypto world has generally operated with much less caution than the traditional financial sector, and FTX is no exception. About two-thirds of the money that FTX owed to the people who held cryptocurrency on its exchange – roughly $11.3 billion of $16 billion owed – was backed by illiquid coins created by FTX. FTX was taking its customers’ money, giving it to Alameda to make risky investments and then creating its own currency, known as FTT, as a replacement – cryptocurrency that it was unable to sell at a high enough price when it needed to. In addition, nearly 40% of Alameda’s assets were in FTX’s own cryptocurrency – and remember, both companies were founded by the same person. This all came to a head when investors decided to sell their coins on the echange. Pressure from investors trying to sell off their coins caused FTX’s liquidity pool to drain too quickly. At the same time, FTX had to buy back its own cryptocurrency, the FTT, on the open market to maintain its solvency – resulting in huge losses.

The collapse of FTX and Alameda Research demonstrated that the oversight in the crypto-world is faltering. In the traditional financial sector, these two companies would never have been run by the same person due to the conflict of interest. The US court system mandated that the remaining funds be held in a frozen trust pending a full investigation into the matter. In response to the opening of the criminal trial and lost customer funds, FTX launched its own independent custodian service, Fulcrum, to provide users with the ability to hold and store their digital assets in a secure and regulated environment. It remains to be seen if this is enough to avoid significant losses from similar investments in the future.

The story of Sam Bankman-Fried and his companies serves as a reminder of the importance of oversight in the crypto industry. The financial markets are a much more regulated beast than the world of cryptocurrencies. FTX handled more than $80 billion of trading volume in 2020, and Bankman-Fried was convicted of 7 counts of fraud and money laundering. Each FTT token was worth $13 at the time of FTX's bankruptcy. This incident and many more like it demonstrate the power of the regulators and the importance of investors to do due diligence on companies and individuals they are investing with. Ultimately, the outcome of these events left many individuals with extreme financial loss, reminding us that financial regulations are essential in providing financial protection of investors.