Sam Bankman-Frieds Alameda was quietly using FTX client funds without ringing alarm bells, sources say

Sam Bankman-Frieds Alameda was quietly using FTX client funds without ringing alarm bells, sources say

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The quant trading firm, founded by Sam Bankman-Fried, was able to use client funds from its exchange FTX in ways that flew under the radar of investors, employees and auditors, according to a source.

They did this by using billions of FTX users without their knowledge, the source says.

Alameda Research, the fund founded by Bankman-Fried, has borrowed billions of client funds from its founder’s exchange, FTX, according to a source familiar with the company’s operations, who asked not to be named because the details were confidential.

According to the source, the crypto exchange drastically underestimated the amount FTX needed to have on hand if someone wanted to withdraw funds. Trading platforms are required by their regulators to hold enough funds to match customer deposits. They require the same cushion, if not more, in the event a user borrows funds to make a trade. According to the source, FTX didn’t have nearly enough on hand.

The biggest customer, according to a source, was the hedge fund Alameda. The fund was able to partially cover up this activity because the assets it traded never touched its own balance sheet. Instead of holding money, it borrowed billions from FTX users and then traded them, the source said.

As far as CNBC is aware, none of this has been shared with customers. In general, mixing client funds with counterparties and trading them without express consent is illegal under US securities laws. It also violates FTX’s Terms of Service. Sam Bankman-Fried declined to comment on the allegations of misappropriation of client funds but said the recent bankruptcy filing was the result of problems with a leveraged trading position.

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“A margin position took a big hit,” Bankman-Fried told CNBC.

In some of these leveraged trades, the Quant Fund used a cryptocurrency created by the exchange called FTT as collateral. In a loan agreement, security is usually a promise by the borrower to secure repayment. It’s often dollars or something else of value – like real estate. In this case, a source said Alameda borrowed from FTX and used the exchange’s internal cryptocurrency, FTT token, to back those loans. The price of the FTT token fell by 75% in one day, leaving insufficient collateral to cover the trade.

Over the past week, FTX has plunged from a $32 billion cryptocurrency powerhouse into bankruptcy. The blurred lines between FTX and Alameda Research led to a massive liquidity crisis for both companies. Bankman-Fried resigned as CEO of FTX, saying Alameda Research would be shut down. The company has since said it is removing trading, withdrawals and moving digital assets offline following an alleged $477 million hack.

When asked about the blurring of lines between its companies in August, Bankman-Fried denied any conflict of interest, saying FTX is a “neutral piece of market infrastructure.”

“I’ve put a lot of work into eliminating conflicts of interest there over the last few years,” Bankman-Fried, 30, said in an interview with CNBC. “I no longer run Alameda. I don’t work for it, none of FTX does. We have segregated staff – we don’t want preferential treatment. We want to treat everyone fairly as best we can. “

margin trading

Part of the problem was the FTX network of complicated leverage and margin trading, according to the same source. The “Spot Margin” trading feature allowed users to borrow money from other clients on the platform. For example, if a customer has deposited a bitcoin, they can lend it to another user and earn a return on it.

But every time an asset was borrowed, FTX deducted the borrowed assets from what it had to keep in its wallets to match customer deposits, a source says. In a typical situation, an exchange’s wallets must match customer deposits. However, due to this practice, assets were not hedged one-to-one and the company underestimated the amount it owed customers.

The trading house Alameda was also able to take advantage of this spot margin feature. A source says Alameda has been able to borrow customer funds essentially for free.

The source explained that Alameda can pledge the FTT tokens it holds as collateral and lend client funds. Even if FTX created more FTT tokens, it would not decrease the value of the coin as these coins never made it to the open market. As a result, these tokens retained their market value, allowing Alameda to borrow – essentially getting free money to trade.

FTX was able to maintain this pattern as long as it kept the price of FTT and there was no flood of customer withdrawals on the exchange. In the week before filing for bankruptcy, FTX did not have enough assets to meet customer withdrawals, the source said.

External auditors likely overlooked this discrepancy as customer assets are an off-balance sheet item and therefore would not be reflected in FTX’s financial statements, the source said.

It all collapsed last week.

CoinDesk reported that the bulk of Alameda’s balance sheet consisted of FTT tokens, shaking consumer and investor confidence. Changpeng Zhao (CZ), the CEO of one of its biggest competitors, Binance, publicly threatened to sell its FTT tokens on the open market, causing FTT’s price to plummet.

This chain of events sparked a run on the exchange, with clients withdrawing around $5 billion before FTX paused withdrawals. When customers picked up their funds, FTX didn’t have the funds, sources say.

“No one saw this coming”

Former employees also told CNBC that the financial information they had access to about the company was inaccurate because of these accounting methods. CNBC reviewed a screenshot of FTX’s financials that a source said was taken last week. Although the company was bankrupt at the time, a former employee says the data incorrectly suggested that FTX would still have more than $1 billion left even if all customers took out their funds.

Three sources familiar with the company told CNBC that they were caught off guard by the company’s actions and that, to their knowledge, only a small cohort was aware that customer deposits were being misused. Employees said in some cases their life savings are tied to FTX.

“We’re just shocked and devastated,” said a current FTX employee. “I feel like I’m in a movie that’s happening in real time. Nobody saw this coming.”

As a result of the public backlash FTX has faced over this lack of funds, employees who say they are as devastated as customers are now facing financial hardship, harassment related to their stake in the company and clouded future job prospects.

“We couldn’t believe how we were scammed,” said a former employee.

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