Bankrupt Crypto Exchange FTX Under Investigation


FTX notice that it can't process customer withdrawals

What’s going on with FTX? The cryptocurrency exchange FTX has filed for bankruptcy amid revelations that it lent billions in customer assets to an affiliated trading firm called Alameda Research. Now its owner—a prominent Democratic donor and supporter of cryptocurrency regulation—is reportedly under criminal investigation.

Both FTX and Alameda Research were owned by Sam Bankman-Fried. Earlier this year, a Fortune magazine headline said he “has been called the next Warren Buffett.” But “now, Bankman-Fried looks, at best, like the original storyline for Michael Saylor of Microstrategy during the Dotcom bust. Or, more likely, like Elizabeth Holmes of Theranos infamy. Or, with increasing plausibility, like a less civic-minded Bernie Madoff,” writes Michael W. Green at Common Sense.

Bankman-Fried’s downfall is bad news for Democrats. He spent a reported $36 million on donations to Democrats this election season, making him “the second-largest donor to Democrats after George Soros,” according to the Financial Times.

What it means for cryptocurrency regulation is less clear. Bankman-Fried and FTX were major proponents of the proposed Digital Commodities Consumer Protection Act (DCCPA), which was introduced in the Senate in August and passed out of the Committee on Banking, Housing, and Urban Affairs in September. “The whole thing was being spearheaded by Sam and FTX, and their credibility has just been shredded,” Nic Carter, a general partner at Castle Island Ventures, told Fortune.

“While some hoped that legislation like the DCCPA would pass during the lame-duck session after Tuesday’s midterms, [Kristin Smith of the Blockchain Association] said that’s now unlikely, both because Bankman-Fried was a driving force and that policymakers may be more reluctant as they wait for the fallout,” Fortune reports.

But FTX’s implosion could ultimately serve as fodder for those who think cryptocurrency-related businesses need more oversight. “The recent events show the necessity of congressional action,” argued Rep. Patrick McHenry (R–N.C.), the top Republican on the House Financial Services Committee, in a statement. 

The downfall of FTX is at once simple and complicated.

The root cause seems to be simple: poor decisions—bordering on fraud—by Bankman-Fried. As a cryptocurrency exchange, FTX is supposed to hold people’s crypto assets and help them make trading transactions (a service for which it collects a fee). Instead, it lent billions of dollars in customer assets to Alameda Research, a scheme The Wall Street Journal described last week:

FTX Chief Executive Sam Bankman-Fried said in investor meetings this week that Alameda owes FTX about $10 billion, people familiar with the matter said. FTX extended loans to Alameda using money that customers had deposited on the exchange for trading purposes, a decision that Mr. Bankman-Fried described as a poor judgment call, one of the people said.

All in all, FTX had $16 billion in customer assets, the people said, so FTX lent more than half of its customer funds to its sister company Alameda….

FTX paused customer withdrawals earlier this week after it was hit with roughly $5 billion worth of withdrawal requests on Sunday, according to a Thursday morning tweet from Mr. Bankman-Fried. The crisis forced FTX to scramble for an emergency investment.

FTX made a deal to sell to its rival Binance, but Binance backed out, saying the company’s problems were “beyond our control or ability to help.”

Now the U.S. Department of Justice, the Securities and Exchange Commission, and the Manhattan U.S. attorney’s office are reportedly investigating.

Whether or how Bankman-Fried broke the law is more complicated. Lending out customer funds without their consent “is generally forbidden in the regulated securities and derivatives markets,” notes the Journal, but the same rule doesn’t apply when it comes to cryptocurrency. Still, the move may be considered fraud or embezzlement. From the Journal:

“What this will boil down to is, were there deliberate lies to convince depositors or investors to part with their assets?” said Samson Enzer, a former Manhattan federal prosecutor. “Were there statements made that were false, and the maker of those statements knew they were false and made with the intent to deceive the investor?”

Prosecutors also could home in, the lawyers said, on statements Mr. Bankman-Fried made on Twitter last week, when he said FTX was “fine” and customer assets were safe—comments he later deleted.

Jurisdiction in this case is also complicated. FTX is based in the Bahamas, and was previously based in Hong Kong, though it did serve U.S. customers and have a U.S. affiliate.

The details of FTX’s bankruptcy are also complicated. “FTX is what’s known in the industry as a ‘free fall’ bankruptcy,” reports Bloomberg:

More than 130 related companies sought court protection at the end of last week without filing any of the usual court motions or explanatory documents seen in a big US insolvency case. Two days later, the companies’ main court docket contains only a 23-page fill-in-the-blank petition. In nearly every other multi-billion dollar Chapter 11 case in recent years, lawyers quickly file a smattering of routine requests designed to stabilize operations.

In a statement, the company’s new chief executive officer—a man who helped oversee the unwinding of Enron Corp.—told customers that details about the bankruptcy would hit the court docket “over the coming days.”

ELECTION 2022

Democrats retain control of Senate. The victory of incumbent Sen. Catherine Cortez Masto in Nevada means Democrats will continue to control the U.S. Senate next year. Cortez Masto beat Republican Adam Laxalt in a very close race. That means Democrats now have 50 Senate seats and—with the vice president’s tie-breaking vote in play—a Senate majority, no matter what happens in Georgia, where Sen. Raphael Warnock (D–Ga.) and Republican challenger Herschel Walker are heading into a runoff vote.

Several elections for seats in the U.S. House of Representatives are still too close to call. “Republicans were closer to taking the House, having won 211 seats compared to Democrats’ 206, with 218 needed for a majority,” reports Reuters. “But the final outcome might not be known for days as officials continue counting ballots nearly a week after Americans went to the polls.”

FREE MINDS

RIP Sharon Presley and Martin Morse Wooster. Two libertarian luminaries, Sharon Presley and Martin Morse Wooster, passed away recently. Both were contributors to Reason.

Wooster died on November 12 after being struck by a car in a hit-and-run in Williamsburg, Virginia. He was a senior fellow at the Capital Research Center, a journalist, and the author of several books, including Angry Classrooms, Vacant Minds; The Great Philanthropists and the Problem of “Donor Intent”; and Great Philanthropic Mistakes. For a while he served as Reason‘s Washington editor. You can find his extensive Reason archive here.

Presley died on October 31 after a long struggle with various health issues. A longtime libertarian activist, she was the founder of Laissez Faire Books, the founder and executive director of the Association of Libertarian Feminists, and the author or editor of several books, including Exquisite Rebel: The Essays of Voltairine de Cleyre. You can find her Reason archive here.

FREE MARKETS

A preview of Scott Lincicome’s new book on how free markets can help American workers:

QUICK HITS

• “Every election denier who sought to become the top election official in a critical battleground state lost at the polls this year, as voters roundly rejected extreme partisans who promised to restrict voting and overhaul the electoral process,” reports The New York Times.

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