The story of how one of the world's largest crypto exchanges collapsed
What are FTX and Alameda Research?
FTX Trading Ltd. was launched in May 2019 by Sam Bankman-Fried, Gary Wang, and Nishad Singh. It operated as a global cryptocurrency exchange and virtual currency fund until Nov. 11, 2022, when it filed for bankruptcy.
In 2019, FTX began issuing its own cryptocurrency-derived digital asset, the FTT token, which was used as a form of currency on the FTX platform to make trades. Customers who used FTT tokens on the exchange to pay for their trades received discounts on the transaction fees. This offered customers an incentive to use FTT tokens as opposed to directly trading cryptocurrencies (e.g., Bitcoin, Ethereum, etc.).
By July 2021, FTX had over one million active users and emerged as the world’s third-largest virtual trading platform. The crypto platform successfully raised more than $1.8 billion from investors as capital. According to the U.S. Securities and Exchange Commission (SEC), Bankman-Fried portrayed FTX to the public and its investors as a “mature company that managed funds and risk in a conservative, rigorous manner.” However, the company was fraught with deficiencies, including weak or non-existent internal controls and business records.
Prior to launching FTX, Bankman-Fried and Wang founded Alameda Research LLC in October 2017. Alameda operated as a crypto hedge fund that bought and sold various cryptocurrencies on FTX’s exchange.
Bankman-Fried was the majority owner and CEO of FTX. He was also the majority owner of Alameda and its CEO until late 2021, when Caroline Ellison and Sam Trabucco became co-CEOs, and before Ellison became sole CEO in mid-2022.
What led FTX and Alameda to file for Chapter 11 bankruptcy?
The events and allegations outlined below are suspected to have ultimately led to FTX and Alameda filing for bankruptcy on Nov. 11, 2022.
According to the SEC, FTX granted Alameda special privileges, including the ability to access an unlimited line of credit. Over the years, Alameda drew down on this line of credit and borrowed billions from third-party crypto lending firms.
In May 2022, the price of digital assets fell. Alameda’s lenders demanded repayment on billions of dollars of loans. According to the SEC, Alameda was unable to fulfill its debt obligations, so Bankman-Fried instructed Alameda to further draw on the line of credit from FTX to repay its third-party lenders.
Alameda was now in a position where it owed FTX billions of dollars with no immediate capacity to repay its debt. Nevertheless, the SEC stated that Bankman-Fried continued to draw down on the line of credit to increase his investments and provide loans to himself and his associates.
On Nov. 2, 2022, crypto news website CoinDesk reported that most of these loans were backed by the billions in FTT tokens held by Alameda, which constituted the majority of Alameda’s assets. According to the SEC, Alameda and FTX collectively held the majority of the issued FTT tokens and only a small portion were in circulation. The SEC stated that Bankman-Fried “misrepresented the risk profile of investing in FTX” for reasons including:
- FTX valued the FTT tokens held by Alameda at prices greater than their market value.
- Alameda pledged the overvalued FTT tokens as collateral against the funds it borrowed from FTX (i.e., the line of credit).
- Bankman-Fried failed to disclose to investors FTX’s exposure to Alameda (i.e., the collateral was largely illiquid).
If the value of the FTT tokens fell, Alameda's collateral would also be worth less. As a result, FTX would be confronted with a solvency crisis if it could not recoup its loans from Alameda to cover impending customer withdrawals. This posed a risk to both FTX platform users and FTX investors.
This is precisely what happened in the days that followed the revelation by CoinDesk.
Crypto asset trading platform Binance announced shortly after the release of the Coindesk article that it would liquidate its more than US$500 million investment in FTT tokens. After Binance’s announcement, other FTX customers began to make withdrawals. Around the same time, the value of the FTT token fell from $22 to under $5.
Unable to cover all the customer withdrawals, FTX and Alameda filed for bankruptcy on Nov. 11, 2022.
The fall of Bankman-Fried and his associates
The bankruptcy filings and the ultimate collapse of one of the largest crypto platforms triggered the Department of Justice, the SEC, and the Commodity Futures Trading Commission (CFTC) to launch an investigation.
In mid-December 2022, Bankman-Fried was arrested and charged with two counts of security fraud, two counts of violating the anti-fraud provisions of the Commodity Exchange Act, as well as eight criminal charges. According to the SEC, Bankman-Fried allegedly diverted billions of dollars of FTX customer funds to Alameda for his personal benefit. Bankman-Fried “used Alameda as his personal piggy bank to buy luxury condominiums, support political campaigns, and make private investments, among other uses,” the SEC stated.
Nishad Singh, the former director of engineering at FTX, pleaded guilty to U.S. criminal charges on Feb. 28, 2023.
On Nov. 2, 2023, Bankman-Fried was found guilty of two counts of fraud and five counts of conspiracy in the Manhattan federal court, and could face decades in prison.
Bankman-Fried’s associates, Ellison and Wang, also faced civil and criminal charges and pled guilty to fraud in late December 2022. According to the SEC, Ellison misappropriated FTX customer funds for Alameda’s trading activity and Wang created FTX’s software code that allowed Alameda to divert FTX customer funds. Both Ellison and Wang cooperated in the SEC’s investigation and testified against Bankman-Fried during his trial.
How were FTX customer assets allegedly diverted to Alameda without detection?
It is alleged that, with the help of Ellison and Wang, Bankman-Fried placed billions of dollars of FTX customer funds into Alameda for his personal benefit and then obscured these related party transactions by commingling the assets and liabilities of related parties and non-arm’s length parties in the companies’ financial statements.
According to the SEC, “From its [FTX] inception…assets and liabilities of all forms were generally treated as interchangeable, and there were insufficient distinctions between the assignment of debts and credits to Alameda, FTX, and executives, including Bankman-Fried, Wang, and Singh.”
In short, the allegations against FTX posit that the diversion of customer assets to Alameda occurred due to failures to segregate those assets physically and for record-keeping purposes:
1. Physical custody of customer deposits (cash)
FTX customers were directed to deposit their fiat currency into bank accounts controlled by Alameda. The funds were not deposited into separate or segregated accounts. According to the SEC, Alameda was able to use FTX customer funds for his own benefit.
2. FTX and Alameda didn’t properly account for the “borrowing”
The funds used by Alameda were not properly recorded in its accounting records so as to facilitate necessary accounting for the use of customer funds and the inter-company loans. Hence, customer funds were neither physically nor notionally segregated, and related party transactions were obscured.
What were the red flags?
Besides failing to segregate or properly account for customer deposits and related party transactions, other significant red flags identified by the SEC and in the Chapter 11 Petitions include:
- Bankman-Fried allegedly made all business decisions for FTX and Alameda, without board oversight or effective internal controls.
- Bankman-Fried had complete access to Alameda’s systems and records.
- Employees’ roles and responsibilities were often unclear, with Alameda and FTX sometimes sharing employees and office space.
- Bankman-Fried allegedly used an unsecured group email account to access confidential private keys for crypto wallets.
- FTX did not maintain a reconciliation of its customer assets on the blockchain, which is a shared database that stores information and is commonly used as a digital ledger to keep track of cryptocurrency transactions.
- Bankman-Fried allegedly used social media and non-secure communication applications for his business dealings that auto-deleted communications and he encouraged employees to do the same.
- Related party transactions are susceptible to acts of self-dealing, when individuals act in their own best interests rather than in the interests of the entity they serve. According to the SEC, Bankman-Fried and his associates allegedly worked together to obscure related party transactions to prevent detection by auditors and to allow Bankman-Fried and affiliates to benefit from the undisclosed use of FTX customer assets.
An effective control structure is one of the most important steps an organization can take to prevent employee fraud. These include establishing effective corporate governance, administering transparent and consistent accounting practices with authorization policies that cannot be overridden by a single person, and monitoring transactions between related parties to ensure compliance and deter inappropriate behaviour.
Address fraud at the core
FTX is a cautionary tale about keeping a close eye on an organization’s fundamental priorities such as regulatory oversight, transparent accounting, and basic internal control policies and practices.
At BDO, we have decades of combined experience in fraud prevention and fraud investigation. Our team members hold a variety of professional designations and degrees including Chartered Professional Accountant, Certified Fraud Examiner, Chartered Business Valuator, and Master of Forensic Accounting. We also employ data analysts and cybersecurity professionals as part of our team to help collect and preserve an organization’s data.
Our dedicated fraud team is here to help you prevent and detect fraud in your organization.
We caution the reader that the investigation into Bankman-Fried and his associates is ongoing, and the content of this article is based on information made publicly available as of Nov. 23, 2023.