When Did the FTX Fraud Start?

As the dust is settling on the whole FTX affair it is instructive to take a look back to see what lessons might be learned for those working and doing business in the crypto arena. Bankman-Fried is going to prison and it appears that due to the rally of Bitcoin and other cryptocurrencies that FTX investors and customers are getting a fair share of their money back. The story line that we have generally believed is that FTX was an amazingly successful business run by a well-intentioned and very bright guy. The story line continues that FTX and its Alameda subsidiary got caught in a financial squeeze when crypto winter took prices down. Thus, the story goes, they neglected to tell folks that they were in trouble and engaged in various shenanigans like moving money from one business to another and accounting it as new assets. A more thorough review of the evidence, especially from Bankman-Fried’s trial, shows that fraud appears to have been part of the business plan almost from day one. Any who thinks that these sorts of issues are now gone from the crypto world needs to think twice before blindly risking their money.

The Original Sin of FTX

Bloomberg Crypto published a useful article reviewing the whole FTX mess. They assert that Bankman-Fried got 25 years in prison instead of a lighter prison sentence because questionable business practices and dishonest accounting of assets date back to the beginning of the company. Highlights include an “allow negative” code that allowed Alameda to borrow without limit from customer assets held by FTX and a “customer insurance fund” meant to reassure investors that FTX had assets to cover all risks. The numbers in the “insurance fund” were created by a random number generator!

When Did the FTX Fraud Start?

FTX Was Perpetually Short of Cash, Looking for Money, and Hiding the Fact

In retrospect, FTX and its Alameda subsidiary were not all that profitable and often incurred losses even before crypto winter. What Bankman-Fried was really good at was hyping his operation and convincing wealthy people to invest with or become customers of FTX. From the get-go the strategy was to hide losses and provide the investing public with a picture of success. This brings to mind the WorldCom scandal back in 2002 when the second largest long distance telephone carrier in the USA had been driving up its stock price and driving competitors out of business. An internal audit discovered $3.8 billion in fraudulent balance sheet entries. The company went bankrupt and those at fault went to jail. Company CEO Bernard Ebbers got a 25-year prison sentence (same as Bankman-Fried), was released due to ill health after 14 years and died the next year. The glaring difference between these cases is that FTX did not have a process for internal audits of audits by an honest outside accounting firm. The SEC issued a warning in 2023 to be careful of alternatives to financial statement audits by crypto exchanges.

Distortion of Crypto Market by FTX

The focus on the FTX mess has largely been that of investor and customer losses combined with shading dealing by Bankman-Fried, et. al. What has been missed is how this sort of thing distorts markets and whole business sectors. Looking back at the WorldCom debacle, competitors of WorldCom went out of business and folks at the likes of AT&T, the biggest long distance carrier, were constantly scratching their heads trying to figure out how WorldCom was doing so well. In the case of FTX it was a matter of easy money, multiplying wealth, and getting rich (or richer) quickly. Folks at Alameda traded new crypto tokens trying to cash in on the boom and bust so common in this niche. They referred to these tokens as “shit coins.”

Making Sense of Why and How to Invest in Crypto

At the height of the crypto frenzy prior to crypto winter it appeared to many that crypto, and especially Bitcoin, would only go up in value against traditional currencies and traditional investments. People with more money than common sense threw wads of the stuff at folks like Bankman-Fried in hopes of multiplying their wealth. Folks who could not afford to lose money did so when they followed the advice of celebrities hyping cryptocurrencies. Bitcoin and the rest of the crypto world did not dry up and blow away with crypto winter. Rather, it has recovered, the issue for investors going forward is making sense of why and how to invest in crypto. The lessons we all ought to have learned from FTX and the rest are not to listen to our favorite celebrity for investment advice and remember that when something looks too good to be true, like FTX, it is commonly too good to be true!

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