Sam Bankman-Fried (Photographer: Jeenah Moon/Bloomberg)
The epic rise and sudden implosion of FTX—a top cryptocurrency exchange until this weekend—looks like an old-fashioned Bernie Madoff Ponzi scheme. It's alleged that the now-former CEO, Sam Bankman-Fried, along with others, engaged in reckless trading activities, in an effort to stave off an imminent demise.
Through the firm’s affiliated hedge fund, Alameda Research, Bankman-Fried and other employees at the Bahamas-based headquarters were accused of tapping into their customers' funds and digital assets. Without authorization, in a failed effort to keep the company afloat, he secretly transferred $10 billion of clients’ assets that were used to trade FTX’s way out of impending doom.
This conduct, at regulated financial institutions, is forbidden and results in serious civil and criminal repercussions. Since FTX is based outside of the United States, and there are open-ended questions about whether or not cryptos are securities, there will be intense scrutiny of the activities that took place.
The crypto sector is still young and unsettled. This is a cautionary tale for people currently working in or looking to pivot into the space. The industry is largely unregulated, and in light of what happened at FTX, you must be very careful. If you move to a crypto firm, you have to worry about your personal legal liabilities, which is a frightening prospect. Moving on from a company marred by scandal, you will be wearing a scarlet letter on your chest when interviewing for a new job. These serious issues must be considered if you want to work in this space.
How Did This Happen?
Bankman-Fried’s exchange is known, in part, for its own token, FTT. A rival crypto CEO, Changpeng Zhao (known as CZ), who runs Binance, said on Twitter that he would sell his holdings in FTT, as he didn’t feel comfortable. There was an overture by CZ to invest or take over FTX, but he quickly changed his mind after conducting due diligence. CZ’s backing away worried investors. This was the crypto equivalent of a run on the back. Customers wanted their assets out of the platform, and people who held FTT and other digital assets in other firms rushed to sell their holdings—afraid they’d lose some or all of their money.
Regulators Are Investigating
The U.S. Department of Justice, the Commodity Futures Trading Commission and the Securities and Exchange Commission (SEC), which have had a hands-off approach under SEC chair Gary Gensler, are now looking closely into the crypto exchange to determine if any criminal activity occurred, and why the customer assets were used without their knowledge.
There are also unresolved questions over how a 27-year-old person with little experience built an empire within three years, has enough money to place their name on stadiums, got Tom Brady and other high-profile celebrities to tout their company, purchased other crypto businesses and donated millions to politicians.
FTX and related entities, including Alameda Research, filed for Chapter 11 bankruptcy petition in the U.S. Bankruptcy Court for the District of Delaware on Friday. Bankman-Fried, in a statement, announced that he would be stepping down as CEO of the company. Since FTX invested in and has ownership stakes in a number of crypto-related companies, such as Voyager Digital, Celsius Network and crypto hedge fund Three Arrows Capital, there will be a need to investigate these and other entities. As many of these firms are not subjected to U.S. regulations, there are a lot of concerns about whether investors could get their money back.
From Being Compared To Warren Buffet And JPMorgan To Bankruptcy
Bankman-Fried was heralded as the next Warren Buffet and JPMorgan, as he rescued several crypto platforms that experienced difficulties. His fortune was valued at around $16.8 billion prior to last week. Now, he’s most likely broke in one of “one of history’s greatest-ever destructions of wealth.”
If the unauthorized trading wasn’t bad enough, FTX legal and finance teams found out that Bankman-Fried had a "back door" in the firm’s accounting system. This enabled the beleaguered CEO to change the financial records without employees or auditors finding out the real state of affairs. It was reported that the remaining assets were siphoned out of the exchange by hackers.
As these events unfolded, on Thursday, the wunderkind tweeted: “I f—ked up, and should have done better.”
The SEC Needs To Act Swiftly Before More People Get Hurt
Gensler, the head of the SEC, needs to immediately investigate FTX, as well as all the crypto-related platforms. He needs to put in place rules and regulations. For instance, since crypto trading can be volatile with severe losses, should only accredited investors be allowed to buy, sell and trade these digital assets? Alternatively, prospective investors need to take a course or complete assessments to show that they understand the risks associated with these investments and trading vehicles.
We’ve all seen the “pumps” for projects with the posters claiming the enormous amounts of money that could be realized. Regulated firms have strict rules of what people can say or write about the performance of securities or financial instruments. This is not the case in the crypto sector.
The SEC will need to substantially increase its budget and aggressively hire additional staff to scrutinize this sector. If it doesn’t, there will be more of these blowups, and unsuspecting participants will lose their nest eggs.
The unfortunate events will be good news for lawyers, compliance officers, accountants, auditors and regulators, who will all be in high demand.
