Now that SBF has been actually convicted I think it might be good to have a simple explanation here of what he and rest of the EA-affiliated FTX leadership did.
[Edit: Hopefully I haven’t accidentally given the impression that I don’t think FTX did anything wrong (this question seems to have been downvoted). I absolutely believe they did wrong and committed fraud. I’m just not sure what it is that they did]
This is one of those times where Google has proved surprisingly useless. I see that he’s been convicted of several counts of fraud, but the only explanation I’ve managed to piece together is this:
Alameda held a load of FTT and borrowed from customer deposits held by FTX. People tried to withdraw their deposits after it came out that Alameda held so much FTT, but FTX couldn’t pay out because Alameda couldn’t give back the customer funds it had borrowed.
I get the impression that Alameda sneakily holding loads of FTT was very bad, but not illegal, is this right? I guess this is bad because the value of FTT is linked to the value of Alameda and vice-versa so it looks like their assets give them more security if something goes wrong than they actually do, although I only just figured that out.
As for Alameda borrowing customer deposits—I don’t understand any of this. What were the rules around lending out customer deposits? What made the lending out to Alameda fraudulent? This seems like THE key thing that FTX did wrong and I just can’t find a basic explanation of what the crime was.
Would greatly appreciate any clarification!
[Edit 2: could someone who is downvoting briefly mention why they are doing so? I’m a little confused as to why this got such bad reception]
In addition to the other answers, I’d like to mention something that while comparatively minor in impact, is IMO strongest in “there’s no plausible innocent explanation for this”, which helps to paint a picture of what FTX internal culture must have been like: FTX published on their website how much they had in their insurance fund. This fund was supposed to protect customers from losses e.g. arising from other unrelated customers being unable to pay back their margin loans. The number they published was a complete fabrication, in no way informed by the actual size of the insurance fund (which was typically smaller): it was calculated based on daily trading volume and a random number generator.
There was a bunch of news coverage about this at the time, here is the first result I found on Google.
@Jason left an answer here, referring to this sentencing memo:
(The last sentence in the response refers to this post.)
Note that the linked document was written by the prosecution, and is therefore presumably a biased summary of the evidence.[1] The defense equivalent (presumably with the opposite bias) can be found here.
Jason comments on this here to argue that it probably isn’t that biased.
I want to quickly address a couple of points of disagreement I have with Jason’s take. (Please don’t take this to mean that I accept the rest—there’s a lot I disagree with—I just don’t have time to respond to it all right now.)
This is misleading. The complete line from Ellison is, “I understood that he was telling me to use FTX customer funds to repay our loans,” then she proceeds to explain how she inferred this.
At no point in the trial does she say that he explicitly instructed her to touch customer fiat deposits.
The defense doesn’t seem to think so. “Caroline testified to you that what happened was, Alameda ‘would have to take the money from our line of credit to pay the lenders.’ And that’s at transcript page 763. And I asked her, Well, if that’s true, if the lenders were being repaid off the line of credit, wouldn’t the amount of the line of credit go up? She said, Yes, it would. And I said, How much did it go up by? Oh, 5 to 10 billion. But when you look at the actual data that was pulled by Dr. Pimbley——and that’s Defendant’s Exhibit 617——you see that in fact the line of credit did not go up during the period when the loans were being repaid. In fact, it went down for much of the period.”
Note that I am quoting the source I identified and summarized, which in turn quotes the trial transcript at page 675. As I noted, the prosecution’s statement here is a summary written for the trial judge who heard all the testimony—whether the memo’s use of that quotation was fair in that summary depends on all of Ellison’s testimony at trial. In particular, the prosecution’s memo was not meant to stand alone as proof beyond a reasonable doubt of SBF’s guilt of the charges. That had already been established by the jury’s verdict. I don’t think “read the trial transcripts” was a helpful answer to Michael’s original question which led me to post the comment.
For those of us who are not inclined to spend days reading over the transcripts, I would note that the jury convicted SBF on all counts with only four hours’ deliberation, the experienced district court appears to have bought ~0 of the defense’s positions at sentencing, and the media coverage does not suggest many (if any) of the journalists and legal analysts who carefully followed the trial bought SBF’s protestations of innocence either.
Moreover, in my view what one would have to believe to find SBF innocent here is simply implausible—e.g., that he was that of the loop about multibillion dollar cash flows that he failed to grasp what should have been obvious from the conversations established by the testimony and documentary evidence, that he honestly believed ~all of the material public statements he made about how FTX operated and Alameda’s relationship to it, that he was so misinformed about how much non-customer money FTX had that he could direct Ellison to have Alameda “borrow” billions and billions of it without understanding that much of that was coming from customer funds, etc.
I think all that justifies a strong starting point that everyone else got it right, and it would take a lot of convincing analysis of ~ all of the prosecution’s evidence to move the needle on that.
+ the customer money FTX had that the customers explicitly consented to be loaned out, through margin lending or staking?
He might not have been well-informed about how much this was. It’s a number that changes by the minute. But maybe he would have a general idea, and enough to know that what he was asking for was more than customers would have consented to being loaned out.
And I think it was not fair because as far as I can tell, that quotation was the strongest piece of evidence the prosecution had that SBF directed Ellison to use customer funds in an improper way.
I agree. I don’t expect anyone to take my word for it on the basis of a couple of anonymous comments. But I’m trying to make a start on this forum because I am someone who is “inclined to spend days reading over the transcripts” and much else besides and given the conclusions I’ve come to, I’m not sure what else to do.
My understanding is that there are two major claims against FTX:[1]
Providing a “backdoor” to Alameda Research
When you trade derivatives, you can end up with a negative balance. This is not a weird crypto thing but is also true of trading on Fidelity or Vanguard or whatever: you short a stock, that stock goes up, now you owe the exchange money.
Alameda research (AR) did a bunch of bad trades, and ended up owing FTX a lot of money. Again, by itself this is not cause for concern. But if you e.g. owe Fidelity too much money then they are going to liquidate your account because they don’t trust you to pay it all back. And FTX’s official policies said that they would do this, but they didn’t.
Telling your investors that you will follow a certain risk management policy and then not actually following that policy is fraud. My understanding is that it would have been perfectly legal for FTX to not liquidate AR, it’s just the lying about it that is fraudulent.
My understanding of SBF’s defense here:
The backdoor was created because FTX’s code sucked and they were afraid of accidentally liquidating their backstop liquidity provider (AR), not because they actually wanted AR to follow different policies
And, in fact, AR’s net position was positive, it’s just that many of the assets weren’t kept on FTX itself and were illiquid
So, SBF thought AR was following the risk management policy as published
[The jury did not find this defense persuasive.]
Commingling bank accounts
Because FTX was unable to get a bank account, it sometimes told its customers to deposit funds in a bank account that was owned by Alameda
Because their code/ops sucked, Alameda thought that some of this money was theirs, not FTX customers’, and invested it
My impression is that both the prosecution and defense agree that until ~June 2022, this improper usage of funds was due to negligence, not malicious intent
Sometime in 2022, this bug was discovered, and FTX execs realized AR had been investing fiat which wasn’t theirs
Fortunately, the investments had done reasonably well, and AR had assets which could be converted back into the appropriate amount of fiat, if required[2]
Even though this use of funds was unintentional and sounds extremely sketchy, FTX’s general counsel testified that FTX’s terms of service did not prohibit it [though maybe it was implicitly prohibited, see this comment]
However, the prosecution pointed to statements that SBF made to the public which seemed to portray this type of action as prohibited, and the jury found this persuasive
Again, my understanding is that FTX’s actions here per se were not criminal, the crime came because they lied about what they were doing. If SBF had just not made public statements beyond “read the terms of service”, there would be no fraud. [Edit: this is disputed, see here.]
A final point: SBF’s defense relied almost entirely on “good faith”, i.e. claims that FTX’s risk management systems were so terrible that he wasn’t even aware that his behavior was fraudulent. And the prosecution even agrees with this defense at some points. Since your question was about what FTX did wrong, consider that FTX’s poor risk management should reflect negatively on them, even if it doesn’t qualify as criminal behavior on behalf of any individual.
This comes mostly from the closing arguments. Note that actually most of the arguments were the prosecution and defense trying to convince the jury that SBF is a bad/good person respectively, and not actually engaging with the concrete details of what happened. So I’m trying to summarize what seems to me to be the most relevant part, but I expect I’m getting things wrong, and would appreciate corrections.
At least under certain valuations of the assets. My impression is that these valuations were not done rigorously, but their accuracy is not that relevant to the criminal charges against SBF.
According to the guy who wrote the 2nd book on FTX, it was a fraud from mid-’21, when:
FTX lost $1B when a trader took advantage of a software bug using a token called MobileCoin. The loss would’ve wiped out all the revenue FTX had ever made. SBF told employees to count the loss as Alameda’s. This concealment enabled FTX to raise ~$1B from VCs.
Even with that VC money, Alameda then borrowed more from FTX (especially for the Binance buyout). “We don’t really have the money for this,” Ellison testified that she told SBF.
Then even before SBF’s spending spree really got going, Ellison warned him that Alameda’s debts were risky. But SBF asked her to invest an additional $3B in VC, even though Alameda had already helped itself to ~$2B from FTX users and borrowed $9B from other lenders. Alamada’s biggest asset was crypto that FTX had either created himself or was pushing (FTT, etc.) and without those, FTX owed ~$3B more than it had. She testified telling SBF that if they made the investments, and the market crashed and lending firms asked for their money back, Alameda would go broke and FTX would fail. Which then happened.
archive.is/FYMhv#selection-1959.0-1962.0
If they can now pay back user due to the Anthropic investment, that’s ex post luck.
Thanks! Do you understand how that article is claiming that the borrowing occurred? I think maybe it is referring to the “backdoor” I listed, but it isn’t very clear.
I’d note that DOJ chose to present a relatively simple pathway to conviction for the jury. That was smart when you have to convince 12 semi-random U.S. citizens to vote for conviction. Advocating for more complex ways in which the conduct also violated the law merely would have allowed the defense to present smokescreens. Therefore, I would be careful not to equate “USAO/SDNY chose not to argue X” with “USAO/SDNY didn’t think SBF committed fraud due to X.”
I’m not so sure about:
“FTX’s terms of service did not prohibit it” != FTX was allowed to do it.
As the Government argued:
SBF et al. would have needed to run FTX in a way that didn’t create a “fiduciary duty or similar relationship of trust and confidence” and then breach it. That’s a lot harder to pull off than merely declining to comment about Alameda-related matters.
thanks! I couldn’t think of a succinct way to summarize your comment, so I just said [Edit: this is disputed, see here.]. Let me know if you have suggestions.
It sounds like whether AR borrowing fiat deposits was criminal depends on whether the terms of service prohibited it, allowed it, or failed to comment on the matter.
But am I right in thinking that this is all moot with respect to the question of fraud if you believe the three key witnesses for the prosecution that no one understood what had happened with the $8B in fiat deposits until it had already happened?
Interestingly, a UK lawyer was prevented from testifying for the defense because interpretation of the law—even foreign law—is the presiding judge’s domain. (“The terms and any dispute shall be governed by, and construed in accordance with, English law.”) The lawyer had been planning to argue that, “FTX therefore owed no obligations as trustee of any fiat currency, and its obligations were only those contractual obligations in the Terms. On the English law interpretation of the Terms, FTX was obliged to honour customer withdrawals (i.e. to repay the debt of fiat currency that it owed), but was not constrained to use fiat currency for any particular purpose in the interim.” (see here.)
From the May 13 2022 FTX Terms of Service:
I think these rule out “FTX was obliged to honour customer withdrawals (i.e. to repay the debt of fiat currency that it owed), but was not constrained to use fiat currency for any particular purpose in the interim”:
If Alameda borrowed customer deposits from customers (without customer consent, e.g. not via margin lending or staking or whatever), this would be through FTX. Either:
FTX treated the deposits as belonging to FTX Trading, either intentionally, which makes it theft, or unintentionally, and in either case violates (A). Or,
FTX intended to repay, so FTX was treating the deposits like loans to FTX, which makes them loans, violating (B), and then loaned them out to Alameda.
The fact that FTX customers couldn’t withdraw customer funds during/after the collapse means FTX violated its own terms in (C).
(To be clear, this doesn’t imply intent, which is required for fraud.)
I know this is a digression from the main question of intent but I’m still curious about it: Do we know how much money was actually in the margin lending program? How much of the fiat deposits were available for margin lending? Prosecutors said “from June to November 2022, Alameda had taken between 8 and 12 billion, when there was at most 4 billion in the margin lending program” while the defense said “80 percent of the assets on FTX were margined assets used in futures trading. 80 percent are in this margin trading where customers are always borrowing other customers’ assets.”
I haven’t looked into this, and based on your comment, you seem more informed than me on this issue.
If you think SBF didn’t know that AR was “borrowing” client monies until after all such borrowing was done, we’re going to have to agree to disagree on that.
As to the other part: SBF’s conduct happened, in relevant part, in the Southern District of New York (and other conduct happened with a sufficient nexus to SDNY to establish venue there). US law, not English law, governs as to whether various representations targeted at the United States (or with a sufficient nexus to the US) create a relationship of trust that gives rise to the possibility of criminal misappropriation. Also, even if the ToS were a defense as to anyone who had signed it, the alleged false statements also reached many potential customers—say, everyone who watched the Super Bowl. The offense would be complete at that moment; no contract that FTX and a new customer might subsequently sign would change the illegality of those statements.
If SBF thinks Judge Kaplan misinterpreted US law, he can take that up with the United States Court of Appeals for the Second Circuit (and likely will). Interpretation of law being a question for the court is pretty well-established.
Also, I don’t see how the terms of service are even relevant to claims about fraud against investors/lenders. That’s ~$3B on those counts alone.
No, I was suggesting that I agree with “the three key witnesses for the prosecution that no one understood what had happened with the $8B in fiat deposits until it had already happened”—I wasn’t talking about all borrowing.
Maybe, but people have a tendency to lump these different figures together (as it looks like you just did wrt AR’s borrowing) and I don’t think that’s helpful when trying to figure out what exactly FTX did wrong. Why shouldn’t we look at them one by one?
Besides, surely the weaker the case for fraud against customers, the more honest FTX’s self-representation would appear to be, and so the weaker the case for fraud against investors/lenders?
I broadly agree with all of this.
A few points of (minor) potential disagreement
As far as the backdoor is concerned, it looks like the defense challenges this: “SBF had not been under the impression that Alameda did not need to secure its borrowing with on-exchange collateral: “‘You permitted Alameda to borrow without requiring that it post collateral to the exchange?’ . . . SBF: ‘That was not my understanding’” (Bloomberg). However, he did know of another customer who was not required to: “Can you name any customers that were allowed to pledge outside investments as collateral for withdrawing money on FTX apart from Alameda? . . . [SBF:] I believe that we did that with a firm called Crypto Lotus, and I believe that we considered that with Three Arrows” (BitMEX)....SBF testified that he had always been “aware of roughly the amount . . . that it was borrowing” via its FTX credit line, which was “millions in 2019 . . . and then by 2022, my understanding was that it was around $2 billion on average of borrowing through the info@ account”, clarifying that Alameda’s balance on FTX was still “Overall positive, but negative in some assets.” Singh similarly testified that, prior to June 2022, he “thought Alameda had positive balances on FTX, that it was borrowing lots in some places but that overall they had more money than they didn’t.” He emphasized the internal transparency of Alameda’s borrowing via the margin lending program — in contrast to the popular narrative of a secret “backdoor” known only to an “inner circle”, Singh reported that “Alameda’s main accounts balance, is a front-and-center number in all of Alameda’s trading systems. It’s the sort of thing from my time at Alameda I couldn’t imagine being missed or ignored by anyone there”.” (from here)
This realization seems to have been spread over several months. In June 2022, they realized AR owed FTX $8B more than they thought it had, but they didn’t yet understand why. The FT reported, “However, not all elements of the prosecution narrative line up neatly. Singh said he left the crucial June meeting still thinking things were OK and did not realise customer funds were being raided until September”. SBF claims that he didn’t piece everything together until September/October. It’s not clear even at that point if they thought of what they had done as illegal, or if they thought that continuing to work on raising liquidity for AR to rectify the mistake rather than announcing to the world that AR had accidentally invested $8B that they hadn’t intended to, was illegal, or if they’d even decided how to proceed before the run on FTX in early November.
I don’t think either the CFTC or the team handling the bankruptcy have offered any evidence that this was the case and SBF continues to maintain that AR had sufficient assets to meet its liability. The fact that customers are probably going to be made whole with much (I think billions?) to spare, is always attributed to SBF having made some “lucky” investments that are now doing very well, but to my knowledge, no one has presented any evidence to support this as the sole explanation.
Is it a lie if you yourself believe it? Regardless, I personally haven’t yet come across any statements that seem to be claiming anything other than “FTX itself doesn’t invest customer deposits” or “AR is not front running other customers on FTX.”
Expanding on some of your points
Yes, as far as I’m aware, no one testified that SBF told his team to create a “backdoor” or to “stop Alameda getting liquidated.” SBF and the people who created the “backdoor” only testified that SBF asked them to make sure Alameda wasn’t erroneously liquidated (as it almost was once, which would have been disastrous not only for Alameda, but for FTX and FTX customers in general, because before FTX was successful enough to attract other backstop liquidity providers, it was very reliant on Alameda as a backstop liquidity provider.) SBF wasn’t a coder himself, but he suggested something like “an alert or a delay,” so that engineers could check if the triggered liquidation was erroneous i.e. triggered as a result of Alameda’s role as a backstop liquidity provider, or valid i.e. triggered as a result of Alameda’s role as a customer. Gary and Nishad chose to implement SBF’s instruction by turning off auto-liquidation for Alameda’s account.
For what it’s worth, SBF appears to have always taken responsibility and expressed great remorse for the mistakes he made regarding poor risk management, even if he does continue to deny criminal activity.
Thanks!
I don’t understand how it can simultaneously be true that 1) AR’s balance was easily visible, 2) AR’s balance was very negative, and 3) people believed AR’s balance to be positive. Do you understand this?
Thanks, I have updated my comment to say “Sometime in 2022”.
Thanks, I have updated my comment to say “my impression is that these valuations were not done rigorously” – let me know if you think that’s still incorrect.
This is what happened though, isn’t it? Customers deposited fiat into North Dimension, and through the fiat@ glitch, that fiat currency was invested in various things.
I mean...I just think 2) is probably false. Nishad messed up in his testimony and some information that undermined the prosecutors’ story slipped through. He also refers to FTX credit lines as nonwithdrawable, “Q. I’m going to ask you some more questions about line of credit in a bit, but just at a high level, what is a line of credit? A. It’s a nonwithdrawable dollar amount that’s granted to allow for easier trading without actually having to deposit as much money.” How is a credit line supposed to help them steal funds if the funds can’t be withdrawn from the exchange?
Now if we assume Gary wasn’t lying when he read out that AR’s main account on FTX was negative $2.7B in June 2022, I guess it’s still possible that when the prosecutor asked the question, they were pointing at the sub-account that was also helpfully named “info@alamedaresearch”, or at the main account’s balance in a particular coin. (It may not have even been deliberate on the government’s part—there’s a point when one of the prosectors seems to not understand that there’s a difference between AR’s net position on FTX and AR’s balances in different coins.)
That seems fine to say. I think we just don’t know either way, as the team handling the bankruptcy doesn’t appear to have given anyone access to the original versions, so we just have SBF’s (and Gary’s?) memory of the rough figures and John Ray’s protestations that SBF is deluded.
Was invested by Alameda, not FTX. FTX customers invested each other’s deposits all the time. And, if you believe the defense, FTX didn’t know what this customer was doing until it had already happened. I think FTX and Alameda are treated as effectively the same company or completely separate entities depending on the context and who’s speaking (I think both “sides” are guilty of this), when the reality is somewhere in between.
Great summary!
You probably base “Even though this use of funds was unintentional and sounds extremely sketchy, FTX’s general counsel testified that FTX’s terms of service did not prohibit it” on:
Can Sun didn’t think so. (Unless I misunderstand something.) He said that there was the margin lending program that did allow that but that had a few hundred million USD in it, so by far not enough to explain Alameda’s borrowing. He didn’t think that FTX or Alameda could’ve borrowed from capital outside the margin lending program because it was owned by the customers.
So I think what the defense lawyer is trying to do here is to say that the ToS did not explicitly prohibit such borrowing, but he omits that the borrowing is still implicitly prohibited just like it is generally prohibited to borrow other people’s fund without their permission.
Thanks! I updated the summary and included a link to this comment – let me know if you think it’s inaccurate.
Jason’s comment and my response here are relevant.
The FTX estate (which I understand includes Alameda) did a lot of things wrong, but regarding this:
FTX promised many times, in many different forums, that it had sophisticated risk controls that would automatically liquidate customer accounts when limits were breached. Then it turned out that this was true for most counterparties, but Alameda was a big multi-billion dollar exception.
I think there’s an argument that if FTX had kept its promises about risk controls, there wouldn’t have been a criminal conviction, though possibly that would have negatively affected the business in other ways.
I don’t have a link on hand but Matt Levine has some great articles explaining the collapse of FTX. Perhaps check out some of the stuff he wrote in November 2022 when the news was just breaking for background & then more recent stuff for a fuller picture. :)
I also initially misinterpreted the title so maybe consider renaming it something like “Can someone explain the FTX fraud?”