My understanding is that there are two major claims against FTX:[1]
Providing a âbackdoorâ 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 donât trust you to pay it all back. And FTXâs official policies said that they would do this, but they didnât.
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, itâs just the lying about it that is fraudulent.
My understanding of SBFâs defense here:
The backdoor was created because FTXâs 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, ARâs net position was positive, itâs just that many of the assets werenât 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/âops sucked, Alameda thought that some of this money was theirs, not FTX customersâ, 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 wasnât 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, FTXâs general counsel testified that FTXâs 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 FTXâs 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 âread the terms of serviceâ, there would be no fraud. [Edit: this is disputed, see here.]
A final point: SBFâs defense relied almost entirely on âgood faithâ, i.e. claims that FTXâs risk management systems were so terrible that he wasnât 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 FTXâs poor risk management should reflect negatively on them, even if it doesnât 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/âgood person respectively, and not actually engaging with the concrete details of what happened. So Iâm trying to summarize what seems to me to be the most relevant part, but I expect Iâm 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-â21, when:
FTX lost $1B when a trader took advantage of a software bug using a token called MobileCoin. The loss wouldâve wiped out all the revenue FTX had ever made. SBF told employees to count the loss as Alamedaâs. 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). âWe donât really have the money for this,â Ellison testified that she told SBF.
Then even before SBFâs spending spree really got going, Ellison warned him that Alamedaâs 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. Alamadaâs 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.
Thanks! Do you understand how that article is claiming that the borrowing occurred? I think maybe it is referring to the âbackdoorâ I listed, but it isnât very clear.
Iâd 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 âUSAO/âSDNY chose not to argue Xâ with âUSAO/âSDNY didnât think SBF committed fraud due to X.â
Iâm not so sure about:
Again, my understanding is that FTXâs 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 âread the terms of serviceâ, there would be no fraud.
âFTXâs terms of service did not prohibit itâ != FTX was allowed to do it.
With respect to the Governmentâs theory that the defendant and his co-conspirators misappropriated FTXâs customersâ funds, the defendant suggests that to establish misappropriation, the Government must establish a âviolation of the terms of a contract,â here the FTX Terms of Service. Dkt. No. 321 at 3. That is incorrect: misappropriation occurs when a party breaches a âfiduciary duty or similar relationship of trust and confidence,â which includes not just a âtrustee and trust beneficiary,â but also several other relationships such as when a beneficiary âentrust[s] the fiduciary with custody over property.â United States v. Chestman, 947 F.2d 551, 569 (2d Cir. 1991).
[ . . . .]
Indeed, the Second Circuit recently reversed a district courtâs granting of a Rule 29 motion in a wire fraud case where the defendants had argued that their misappropriation of funds received pursuant to a contract was not criminal if they had fulfilled the literal terms of their âcontractual bargain.â United States v. Jabar, 19 F.4th 66, 79 (2d Cir. 2021). The Second Circuit held that the district court should not have overturned the juryâs verdict, which took into account the overall pattern of the âdefendantsâ fraudulent acts with respect to the rest of the bargain.â Id.
SBF et al. would have needed to run FTX in a way that didnât create a âfiduciary duty or similar relationship of trust and confidenceâ and then breach it. Thatâs a lot harder to pull off than merely declining to comment about Alameda-related matters.
thanks! I couldnât 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 lawâeven foreign lawâis the presiding judgeâs domain. (âThe terms and any dispute shall be governed by, and construed in accordance with, English law.â) The lawyer had been planning to argue that, âFTX 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.â (see here.)
8.2.6 All Digital Assets are held in your Account on the following basis:
(A) Title to your Digital Assets shall at all times remain with you and shall not transfer to FTX Trading. As the owner of Digital Assets in your Account, you shall bear all risk of loss of such Digital Assets. FTX Trading shall have no liability for fluctuations in the fiat currency value of Digital Assets held in your Account.
(B) None of the Digital Assets in your Account are the property of, or shall or may be loaned to, FTX Trading; FTX Trading does not represent or treat Digital Assets in Userâs Accounts as belonging to FTX Trading.
(C) You control the Digital Assets held in your Account. At any time, subject to outages, downtime, and other applicable policies (including the Terms), you may withdraw your Digital Assets by sending them to a different blockchain address controlled by you or a third party.
I think these rule out âFTX 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 interimâ:
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 couldnât withdraw customer funds during/âafter the collapse means FTX violated its own terms in (C).
(To be clear, this doesnât imply intent, which is required for fraud.)
I know this is a digression from the main question of intent but Iâm 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 âfrom June to November 2022, Alameda had taken between 8 and 12 billion, when there was at most 4 billion in the margin lending programâ while the defense said â80 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 customersâ assets.â
If you think SBF didnât know that AR was âborrowingâ client monies until after all such borrowing was done, weâre going to have to agree to disagree on that.
As to the other part: SBFâs 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 customersâsay, 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 donât see how the terms of service are even relevant to claims about fraud against investors/âlenders. Thatâs ~$3B on those counts alone.
If you think SBF didnât know that AR was âborrowingâ client monies until after all such borrowing was done, weâre going to have to agree to disagree on that.
No, I was suggesting that I agree with âthe three key witnesses for the prosecution that no one understood what had happened with the $8B in fiat deposits until it had already happenedââI wasnât talking about all borrowing.
I donât see how the terms of service are even relevant to claims about fraud against investors/âlenders. Thatâs ~$3B on those counts alone.
Maybe, but people have a tendency to lump these different figures together (as it looks like you just did wrt ARâs borrowing) and I donât think thatâs helpful when trying to figure out what exactly FTX did wrong. Why shouldnât we look at them one by one?
Besides, surely the weaker the case for fraud against customers, the more honest FTXâs self-representation would appear to be, and so the weaker the case for fraud against investors/âlenders?
Alameda research (AR) did a bunch of bad trades, and ended up owing FTX a lot of money....ARâs net position was positive, itâs just that many of the assets werenât kept on FTX itself and were illiquid
As far as the backdoor is concerned, it looks like the defense challenges this: âSBF had not been under the impression that Alameda did not need to secure its borrowing with on-exchange collateral: ââYou permitted Alameda to borrow without requiring that it post collateral to the exchange?â . . . SBF: âThat was not my understandingââ (Bloomberg). However, he did know of another customer who was not required to: âCan 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 Arrowsâ (BitMEX)....SBF testified that he had always been âaware of roughly the amount . . . that it was borrowingâ via its FTX credit line, which was âmillions in 2019 . . . and then by 2022, my understanding was that it was around $2 billion on average of borrowing through the info@ accountâ, clarifying that Alamedaâs balance on FTX was still âOverall positive, but negative in some assets.â Singh similarly testified that, prior to June 2022, he âthought Alameda had positive balances on FTX, that it was borrowing lots in some places but that overall they had more money than they didnât.â He emphasized the internal transparency of Alamedaâs borrowing via the margin lending program â in contrast to the popular narrative of a secret âbackdoorâ known only to an âinner circleâ, Singh reported that âAlamedaâs main accounts balance, is a front-and-center number in all of Alamedaâs trading systems. Itâs the sort of thing from my time at Alameda I couldnât imagine being missed or ignored by anyone thereâ.â (from here)
In June 2022, this bug was discovered, and FTX execs realized AR had been investing fiat which wasnât theirs
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 didnât yet understand why. The FT reported, âHowever, 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 Septemberâ. SBF claims that he didnât piece everything together until September/âOctober. Itâs 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 hadnât intended to, was illegal, or if theyâd even decided how to proceed before the run on FTX in early November.
My impression is that these valuations were wrong
I donât 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 âluckyâ investments that are now doing very well, but to my knowledge, no one has presented any evidence to support this as the sole explanation.
Again, my understanding is that FTXâs 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 âread the terms of serviceâ, there would be no fraud.
Is it a lie if you yourself believe it? Regardless, I personally havenât yet come across any statements that seem to be claiming anything other than âFTX itself doesnât invest customer depositsâ or âAR is not front running other customers on FTX.â
Expanding on some of your points
SBF thought AR was following the risk management policy as published
Yes, as far as Iâm aware, no one testified that SBF told his team to create a âbackdoorâ or to âstop Alameda getting liquidated.â SBF and the people who created the âbackdoorâ only testified that SBF asked them to make sure Alameda wasnât 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 wasnât a coder himself, but he suggested something like âan alert or a delay,â so that engineers could check if the triggered liquidation was erroneous i.e. triggered as a result of Alamedaâs role as a backstop liquidity provider, or valid i.e. triggered as a result of Alamedaâs role as a customer. Gary and Nishad chose to implement SBFâs instruction by turning off auto-liquidation for Alamedaâs account.
consider that FTXâs poor risk management should reflect negatively on them, even if it doesnât qualify as criminal behavior on behalf of any individual
For what itâs 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.
Itâs the sort of thing from my time at Alameda I couldnât imagine being missed or ignored by anyone there
I donât understand how it can simultaneously be true that 1) ARâs balance was easily visible, 2) ARâs balance was very negative, and 3) people believed ARâs balance to be positive. Do you understand this?
This realization seems to have been spread over several months
Thanks, I have updated my comment to say âSometime in 2022â.
I donât think either the CFTC or the team handling the bankruptcy have offered any evidence that this was the case
Thanks, I have updated my comment to say âmy impression is that these valuations were not done rigorouslyâ â let me know if you think thatâs still incorrect.
I personally havenât yet come across any statements that seem to be claiming anything other than âFTX itself doesnât invest customer depositsâ
This is what happened though, isnât it? Customers deposited fiat into North Dimension, and through the fiat@ glitch, that fiat currency was invested in various things.
I donât understand how it can simultaneously be true that 1) ARâs balance was easily visible, 2) ARâs balance was very negative, and 3) people believed ARâs balance to be positive. Do you understand this?
I mean...I just think 2) is probably false. Nishad messed up in his testimony and some information that undermined the prosecutorsâ story slipped through. He also refers to FTX credit lines as nonwithdrawable, âQ. Iâm 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. Itâs a nonwithdrawable dollar amount thatâs granted to allow for easier trading without actually having to deposit as much money.â How is a credit line supposed to help them steal funds if the funds canât be withdrawn from the exchange?
Now if we assume Gary wasnât lying when he read out that ARâs main account on FTX was negative $2.7B in June 2022, I guess itâs still possible that when the prosecutor asked the question, they were pointing at the sub-account that was also helpfully named âinfo@alamedaresearchâ, or at the main accountâs balance in a particular coin. (It may not have even been deliberate on the governmentâs partâthereâs a point when one of the prosectors seems to not understand that thereâs a difference between ARâs net position on FTX and ARâs balances in different coins.)
âmy impression is that these valuations were not done rigorouslyâ â let me know if you think thatâs still incorrect
That seems fine to say. I think we just donât know either way, as the team handling the bankruptcy doesnât appear to have given anyone access to the original versions, so we just have SBFâs (and Garyâs?) memory of the rough figures and John Rayâs protestations that SBF is deluded.
Customers deposited fiat into North Dimension, and through the fiat@ glitch, that fiat currency was invested in various things.
Was invested by Alameda, not FTX. FTX customers invested each otherâs deposits all the time. And, if you believe the defense, FTX didnât 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 whoâs speaking (I think both âsidesâ are guilty of this), when the reality is somewhere in between.
You probably base âEven though this use of funds was unintentional and sounds extremely sketchy, FTXâs general counsel testified that FTXâs terms of service did not prohibit itâ on:
The government didnât want to focus you on that. Why? Again, the only witness who said he had read the terms of service was Can Sun, the general counsel who had helped to draft it. Even though he was very careful in what he told you, he admitted that nowhere do the terms of service contain language that prevents FTX from loaning customer fiat deposits to Alameda or anyone else.
Can Sun didnât 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 Alamedaâs borrowing. He didnât think that FTX or Alameda couldâve 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 peopleâs fund without their permission.
My understanding is that there are two major claims against FTX:[1]
Providing a âbackdoorâ 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 donât trust you to pay it all back. And FTXâs official policies said that they would do this, but they didnât.
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, itâs just the lying about it that is fraudulent.
My understanding of SBFâs defense here:
The backdoor was created because FTXâs 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, ARâs net position was positive, itâs just that many of the assets werenât 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/âops sucked, Alameda thought that some of this money was theirs, not FTX customersâ, 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 wasnât 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, FTXâs general counsel testified that FTXâs 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 FTXâs 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 âread the terms of serviceâ, there would be no fraud. [Edit: this is disputed, see here.]
A final point: SBFâs defense relied almost entirely on âgood faithâ, i.e. claims that FTXâs risk management systems were so terrible that he wasnât 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 FTXâs poor risk management should reflect negatively on them, even if it doesnât 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/âgood person respectively, and not actually engaging with the concrete details of what happened. So Iâm trying to summarize what seems to me to be the most relevant part, but I expect Iâm 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-â21, when:
FTX lost $1B when a trader took advantage of a software bug using a token called MobileCoin. The loss wouldâve wiped out all the revenue FTX had ever made. SBF told employees to count the loss as Alamedaâs. 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). âWe donât really have the money for this,â Ellison testified that she told SBF.
Then even before SBFâs spending spree really got going, Ellison warned him that Alamedaâs 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. Alamadaâs 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/âFYMhv#selection-1959.0-1962.0
If they can now pay back user due to the Anthropic investment, thatâs ex post luck.
Thanks! Do you understand how that article is claiming that the borrowing occurred? I think maybe it is referring to the âbackdoorâ I listed, but it isnât very clear.
Iâd 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 âUSAO/âSDNY chose not to argue Xâ with âUSAO/âSDNY didnât think SBF committed fraud due to X.â
Iâm not so sure about:
âFTXâs terms of service did not prohibit itâ != FTX was allowed to do it.
As the Government argued:
SBF et al. would have needed to run FTX in a way that didnât create a âfiduciary duty or similar relationship of trust and confidenceâ and then breach it. Thatâs a lot harder to pull off than merely declining to comment about Alameda-related matters.
thanks! I couldnât 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 lawâeven foreign lawâis the presiding judgeâs domain. (âThe terms and any dispute shall be governed by, and construed in accordance with, English law.â) The lawyer had been planning to argue that, âFTX 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.â (see here.)
From the May 13 2022 FTX Terms of Service:
I think these rule out âFTX 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 interimâ:
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 couldnât withdraw customer funds during/âafter the collapse means FTX violated its own terms in (C).
(To be clear, this doesnât imply intent, which is required for fraud.)
I know this is a digression from the main question of intent but Iâm 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 âfrom June to November 2022, Alameda had taken between 8 and 12 billion, when there was at most 4 billion in the margin lending programâ while the defense said â80 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 customersâ assets.â
I havenât looked into this, and based on your comment, you seem more informed than me on this issue.
If you think SBF didnât know that AR was âborrowingâ client monies until after all such borrowing was done, weâre going to have to agree to disagree on that.
As to the other part: SBFâs 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 customersâsay, 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 donât see how the terms of service are even relevant to claims about fraud against investors/âlenders. Thatâs ~$3B on those counts alone.
No, I was suggesting that I agree with âthe three key witnesses for the prosecution that no one understood what had happened with the $8B in fiat deposits until it had already happenedââI wasnât talking about all borrowing.
Maybe, but people have a tendency to lump these different figures together (as it looks like you just did wrt ARâs borrowing) and I donât think thatâs helpful when trying to figure out what exactly FTX did wrong. Why shouldnât we look at them one by one?
Besides, surely the weaker the case for fraud against customers, the more honest FTXâs self-representation would appear to be, and so the weaker the case for fraud against investors/âlenders?
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: âSBF had not been under the impression that Alameda did not need to secure its borrowing with on-exchange collateral: ââYou permitted Alameda to borrow without requiring that it post collateral to the exchange?â . . . SBF: âThat was not my understandingââ (Bloomberg). However, he did know of another customer who was not required to: âCan 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 Arrowsâ (BitMEX)....SBF testified that he had always been âaware of roughly the amount . . . that it was borrowingâ via its FTX credit line, which was âmillions in 2019 . . . and then by 2022, my understanding was that it was around $2 billion on average of borrowing through the info@ accountâ, clarifying that Alamedaâs balance on FTX was still âOverall positive, but negative in some assets.â Singh similarly testified that, prior to June 2022, he âthought Alameda had positive balances on FTX, that it was borrowing lots in some places but that overall they had more money than they didnât.â He emphasized the internal transparency of Alamedaâs borrowing via the margin lending program â in contrast to the popular narrative of a secret âbackdoorâ known only to an âinner circleâ, Singh reported that âAlamedaâs main accounts balance, is a front-and-center number in all of Alamedaâs trading systems. Itâs the sort of thing from my time at Alameda I couldnât imagine being missed or ignored by anyone thereâ.â (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 didnât yet understand why. The FT reported, âHowever, 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 Septemberâ. SBF claims that he didnât piece everything together until September/âOctober. Itâs 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 hadnât intended to, was illegal, or if theyâd even decided how to proceed before the run on FTX in early November.
I donât 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 âluckyâ 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 havenât yet come across any statements that seem to be claiming anything other than âFTX itself doesnât invest customer depositsâ or âAR is not front running other customers on FTX.â
Expanding on some of your points
Yes, as far as Iâm aware, no one testified that SBF told his team to create a âbackdoorâ or to âstop Alameda getting liquidated.â SBF and the people who created the âbackdoorâ only testified that SBF asked them to make sure Alameda wasnât 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 wasnât a coder himself, but he suggested something like âan alert or a delay,â so that engineers could check if the triggered liquidation was erroneous i.e. triggered as a result of Alamedaâs role as a backstop liquidity provider, or valid i.e. triggered as a result of Alamedaâs role as a customer. Gary and Nishad chose to implement SBFâs instruction by turning off auto-liquidation for Alamedaâs account.
For what itâs 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 donât understand how it can simultaneously be true that 1) ARâs balance was easily visible, 2) ARâs balance was very negative, and 3) people believed ARâs balance to be positive. Do you understand this?
Thanks, I have updated my comment to say âSometime in 2022â.
Thanks, I have updated my comment to say âmy impression is that these valuations were not done rigorouslyâ â let me know if you think thatâs still incorrect.
This is what happened though, isnât 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 prosecutorsâ story slipped through. He also refers to FTX credit lines as nonwithdrawable, âQ. Iâm 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. Itâs a nonwithdrawable dollar amount thatâs granted to allow for easier trading without actually having to deposit as much money.â How is a credit line supposed to help them steal funds if the funds canât be withdrawn from the exchange?
Now if we assume Gary wasnât lying when he read out that ARâs main account on FTX was negative $2.7B in June 2022, I guess itâs still possible that when the prosecutor asked the question, they were pointing at the sub-account that was also helpfully named âinfo@alamedaresearchâ, or at the main accountâs balance in a particular coin. (It may not have even been deliberate on the governmentâs partâthereâs a point when one of the prosectors seems to not understand that thereâs a difference between ARâs net position on FTX and ARâs balances in different coins.)
That seems fine to say. I think we just donât know either way, as the team handling the bankruptcy doesnât appear to have given anyone access to the original versions, so we just have SBFâs (and Garyâs?) memory of the rough figures and John Rayâs protestations that SBF is deluded.
Was invested by Alameda, not FTX. FTX customers invested each otherâs deposits all the time. And, if you believe the defense, FTX didnât 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 whoâs speaking (I think both âsidesâ are guilty of this), when the reality is somewhere in between.
Great summary!
You probably base âEven though this use of funds was unintentional and sounds extremely sketchy, FTXâs general counsel testified that FTXâs terms of service did not prohibit itâ on:
Can Sun didnât 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 Alamedaâs borrowing. He didnât think that FTX or Alameda couldâve 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 peopleâs fund without their permission.
Thanks! I updated the summary and included a link to this comment â let me know if you think itâs inaccurate.
Jasonâs comment and my response here are relevant.