The overnight implosion of 30-year-old Sam-Bankman-Fried's crypto empire on November 11 sent shock waves through the cryptocurrency industry.
Ongoing investigations by regulators are still trying to piece together the root causes of this debacle.
But what has emerged so far is that there was a conflict of interest between Bankman-Fried's two flagship companies: the FTX cryptocurrency exchange and Alameda Research, a hedge fund that is also a trading platform. Roughly speaking, retail investors were on FTX and institutional investors and professional traders were on both FTX and Alameda.
The two companies were supposed to be independent. But in fact it appeared that they were very closely intertwined.
'I Didn't Knowingly Comingle'
As a crypto exchange, FTX executed orders for clients, taking their cash and buying cryptocurrencies on their behalf. FTX acted as a custodian, holding the clients’ crypto.
FTX then used its clients’ crypto assets, through its sister company’s Alameda Research trading arm, to generate cash through borrowing or market-making. The cash FTX borrowed was used to bail out other crypto institutions in summer 2022.
At the same time, FTX was using the cryptocurrency it was issuing, FTT, as collateral on its balance sheet. This was a significant exposure, due to the concentration risk and the volatility of FTT.
The insolvency of FTX stemmed from a liquidity shortfall when clients attempted to withdraw funds from the platform. The shortfall appears to have been prompted by FTX’s founder reportedly transferring $10 billion of customer funds from FTX to Alameda Research.
In his first interview, on November 30, since his empire went bankrupt, Bankman-Fried admitted that FTX client funds were in Alameda accounts.
Was there a comingling of funds? Were FTX customer funds comingled with Alameda's? He was asked by journalist Andrew Ross Sorkin at the New York Times Dealbook Summit via Zoom.
"I didn't knowingly comingle," he replied.
He said that, back in 2019, FTX had no bank accounts globally. So some customers who wanted to transfer funds to FTX, were wiring money to Alameda which then issued a credit on their behalf on FTX. Basically, customers deposited funds on FTX via Alameda accounts.
"I think that was a substantial sum," Bankman-Fried said.
'I Was Nervous'
When did the comingling of funds begin? Ross Sorkin asked.
"Looking through this now, I think that position size for Alameda got substantially larger in 2022," Bankman-Fried responded. He said that the two companies had been reducing their relationship: Pre-pandemic, Alameda was the primary liquidity provider on FTX, and in 2022 it was one of the smallest liquidity providers.
But "I failed to pay nearly enough attention, and that's how we ended up here,” he concluded.
Bankman-Fried, who obviously wasn't comfortable answering the question despite his contrite tone, then tried to explain that he didn't run Alameda and therefore didn't have access to all the data. The problem is that he was the majority shareholder of the hedge fund.
"Look, I wasn't running Alameda; I didn't know exactly what was going on. I didn't know the size of their position," the former trader claimed. He said he should have appointed someone to oversee the relationship between FTX and Alameda.
"I was nervous because of the conflict of interest, of being too involved," the former billionaire said, while acknowledging that he did live with one or two of Alameda's employees for a while.
"Obviously that's a pretty big mistake... that I wasn't more aware."
He said FTX and Alameda were tied together more closely than he understood it to be.
