In late 2017, MIT alumnus Sam Bankman-Fried left the quantitative trading firm Jane Street to start his own cryptocurrency trading firm, Alameda Research. Founded prior to FTX, Alameda got its start by taking advantage of bitcoin price differentials between Japanese and U.S. exchanges, namely by buying bitcoin for a low price in the United States and selling for a premium in Japan.
At the time, Bankman-Fried estimated this trade netted about $20 million before the price spread narrowed as competitors took advantage of the same trade. Alameda’s initial strategy involved various trades similar to the Japan–U.S. bitcoin arbitrage.
After two years of running the quant fund, the 27-year-old entrepreneur embarked on the ambitious goal of starting a crypto trading exchange that would become FTX.
“At the time, it seemed extremely risky,” Nishad Singh, a childhood friend of Bankman-Fried who would later become the lead engineer of FTX, told Yahoo Finance.
In the early days, Alameda Research was the main liquidity provider for FTX, according to Bankman-Fried, accounting for half of the volume on the exchange. According to people familiar with the company, however, it was the other way around.
Jason Choi, an entrepreneur who met Bankman-Fried before FTX started, wrote in a Twitter thread that the impetus for founding FTX was to use client funds to capitalize Alameda Research. These claims were also bolstered by a recent Wall Street Journal report on commingling between the two firms.
However, Bankman-Fried said in a now-deleted tweet, “We don’t invest client assets.”
Alameda’s undercapitalization may have led to desperate measures, Choi suggested, pointing to a key announcement by Alameda Research last year. In a tweet, Alameda co-CEO Sam Trabucco announced that the fund had shifted away from quantitative strategies such as the Japan–U.S. arbitrage and instead had moved to a buy-and-hold approach. The firm was now “really long” on crypto assets.
One of these assets was Dogecoin. Trabucco’s justification for investing in the dog-based token was “all based on noticing how it goes up when Elon tweets.”
Choi speculated that this cavalier shift by Alameda was the result of thinning profits from their quant trades as “their edge eroded.” As a result, they “began to assume massive directional risks in crypto.”
Trabucco resigned from Alameda Research in August.
Terry Sawchuck, CEO and founder of wealth management firm Sawchuk Wealth, told The Epoch Times that Alameda was “at the core of why FTX had its catastrophic collapse.”
“It appears that Alameda ran into difficulty raising capital to increase leveraged bets, so, at some point, FTX began using its own issued token (FTT) as collateral to borrow money from many industry players and then gave it to Alameda to continue to finance their increasingly larger bets on crypto.”
An Unholy Alliance
Commingling client funds wasn’t the extent of the controversial relationship between Alameda and FTX.
According to a Wall Street Journal article, Alameda Research collected large amounts of tokens before FTX stated that it would be listing tokens between the start of 2021 and March 2022. In traditional markets, this practice is called “front running.”
Front running is both illegal and unethical when a trader is acting on inside information.
Owen Rapaport, cofounder of crypto compliance firm Argus, told Decrypt Media that the levels of front running by Alameda far exceed those of most prosecuted cases in the traditional finance world.
While there is some disagreement around whether these laws apply to crypto, the Boston-based law firm Newman and Shapiro believes that the practice is illegal under current law.
In addition to front running, former employees told Choi that FTX programming allowed for privileged access to Alameda, granting it faster trade executions than standard users. Other special privileges were granted to Alameda as well.
After FTX froze client withdrawals on Nov. 8, Bankman-Fried continued to siphon the exchange’s funds to Alameda, shown by the crypto transaction tracking website Etherscan. Soon after, Reuters released its report on Bankman-Fried’s “backdoor,” which was allegedly used to funnel $10 billion to his investment fund from FTX.
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” acting CEO John Ray and former Enron bankruptcy overseer said in a court filing on Nov. 17.
“From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”
Is Decentralization the Answer?
The collusion between Bankman-Fried’s investment fund and his crypto exchange has raised serious ethical concerns. Industry leaders and U.S. officials have united in calls for regulation while some crypto experts would prefer to see a shift toward decentralization.
In an opinion piece for CoinDesk, Amanda Cassatt, founder and CEO of Serotonin, a Web3 marketing agency, highlighted the relative stability of decentralized exchanges such as Uniswap and Balancer amid the FTX blowup. She believes that regulators don’t help the average person and instead provide privileges to those with more political access.
“What [Bankman-Fried] wanted from regulation wasn’t consumer protection, but rather to protect his incumbent position and entrench his competitive moat,” Cassatt said. “If there is a silver lining for the FTX fiasco, it is a reminder of the importance of decentralization.”
Taking a more middle-ground approach, Blockworks research analyst Matt Fiebach told The Epoch Times that while he sees self-custody and decentralized finance as “the main value propositions of the crypto space,” he thinks regulation has its place.
“Anybody who’s custodying assets on behalf of retail funds, institutions … there should be clear transparency in what they’re doing with those assets,” Fiebach said.
Some traditional investors say that decentralization isn’t the main point here.
“It’s an interesting dichotomy because without ‘centralized exchanges,’ crypto growth would likely have been minuscule by comparison,” Sawchuk said. “The issue is less with decentralization and more with lack of regulatory oversight.”
The wealth manager believes that stronger regulatory oversight is needed to clean up the crypto industry and that current regulators aren’t doing their job.
“The fact that this guy hasn’t been arrested yet raises some very serious red flags,” he said.