How to commit fraud wearing T shirts and shorts: A Case Study of FTX (Part 2 of 2)

In Part 1, we covered how Futures Exchanges are supposed to work, and how they earn their keep in an inherently risky proposition.

In Part 2, we will show exactly how Sam Bankman Fried used his own exchange (FTX) to defraud billions of dollars in investor and customer funds.

You may wanna sit down for this one.

We managed billions in dollars of customer funds, but we didnt need to use anything more than elementary mathematics #realtalk

Here is how to commit fraud at a futures exchange

Start your own futures exchange and advertise it as safe, with standard risk-management measures in place.

Conduct your own trades on the exchange using your own money.

Without disclosing it to anyone, exempt yourself from the risk-management measures that are in place for other traders.

If your bets are successful and your account grows, withdraw the money and use it for personal gain, such as purchasing luxury items or making political contributions.

If your bets are unsuccessful and your account shrinks or becomes negative, do not put more money in or close out your bets. Instead, allow the negative balance to accrue and ignore it.

If you engage in speculation on volatile assets, you will experience both wins and losses. However, if you consistently withdraw money after victories and do not reinvest after defeats, you will end up with a large amount of cash to spend and a severely negative account on your exchange.

Even if you win a billion dollars, spend it, and then lose it without replacing it, ultimately nothing has changed (everyone’s bets are even), but you have effectively transferred $1 billion from the exchange and its customers to yourself.

This constitutes fraud for three reasons. Firstly, you claimed to have excellent risk management, but in reality, your risk management was poor. Risk management is the entire purpose of a futures exchange; people entrust their money to you because they expect it to be safe, but you deceived them.

Secondly, it is fraudulent because it predictably shifts money from your customers to yourself. If prices rise, you take money out; if they fall, you do not put it back in. In the long term, prices will fluctuate, allowing you to extract funds from the exchange. Once you have taken enough, there will not be enough left for the other customers. You deceived your customers and then took their money for yourself.

Third, this could be considered fraud because you may be tempted to speed up the process. For example, if your account increases in value, you could withdraw money, and if it decreases again, you could ignore it. In this case, you would seek out assets that fluctuate rapidly in value. You might find a small, hard-to-sell token called CorgiCoin and bet on it, artificially inflating its price to withdraw a large amount of money, and then leaving as its value plummets.

Alternatively, you could create your own token, sell a small amount to establish a market price, keep 97% of it for yourself, and manipulate the market to maintain the price. Then, you could approach your own exchange and ask to borrow money using the token as collateral. The exchange, because you own and operate it and have exempted yourself from any risk management, would likely agree without considering the questionable value of the token.

Eventually, this scheme will fail. Your balance on the exchange will become extremely negative, and customers will try to withdraw their money. However, you will not have enough to give them because you have transferred too much to yourself and spent it.

Customers will notice and try to withdraw their money all at once, leading to a “run on the bank” and the bankruptcy of the exchange. However, you could excuse this by saying that operating a futures exchange, a highly leveraged financial institution, is difficult and mistakes were made in risk management and credit extension.

You could claim that liquidating some customers and extending less credit to them would have been difficult decisions, and even traditional futures exchanges sometimes fail. In this way, stealing money from customers could be seen as simply making mistakes in the complex business of providing leverage to certain customers, even if those customers are yourself.

Mistakes happen, after all.

Right?

What’s the scoop now with SBF?

On 12th December, Sam Bankman-Fried, the founder of Bahamas-based cryptocurrency futures exchange FTX and affiliated trading firm Alameda Research, was arrested on US charges of fraud. The US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have also filed civil fraud cases against him.

FTX offered trading in a wide range of digital assets, such as Bitcoin, Ether, and Tether, primarily as a derivatives exchange. The company advertised and claimed to have a sophisticated risk-management system. However, the SEC alleges that Bankman-Fried engaged in fraudulent practices and misrepresented the effectiveness of the risk-management system.

Alameda was a trading firm co-founded and majority-owned by Bankman-Fried that was exempt from certain risks and had special privileges on the FTX trading platform. These privileges allowed Alameda to borrow and withdraw digital assets from FTX without limits and use them for its own purposes without disclosing these advantages to investors.

Alameda used the borrowed funds to pay off its own lenders and to provide loans to Bankman-Fried and other FTX executives, as well as to make additional venture investments. The collateral for these loans was largely made up of illiquid, FTX-affiliated tokens owned by Alameda. These actions have resulted in charges being brought against Bankman-Fried by the SEC and CFTC.

He is currently fighting extradition to the United States, where it is presumed that he will be in jail for a very long time if convicted.

Our Top 3 Lessons learnt:

1. When it sounds too good to be true, it is.

2. Think hard before trusting 30 year olds with billions of dollars (We know of a number of Singaporean equivalents that made rediculous claims)

3. Venture Capital Funds really don’t know WTF they are doing, and they are just as vulnerable as any man on the street (Looking at you Sequoia, Temasek, and Softbank)

When in doubt, always listen to the old timers – they have weathered all types of storms and can call BS in an instant.

How yall crypto bros doing?

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