Former FTX users say the failed cryptocurrency exchange was a “Ponzi scheme”. Here’s how they work and what we know about how Sam Bankman-Fried operated

Until recently, Sam Bankman-Fried, or SBF, was the golden boy of cryptocurrencies, known for turning his cryptocurrency exchange, FTX, into a $32 billion giant in just two years.

But the disheveled, left-wing 30-year-old player was living a lie. SBF, who claimed to be a minimalist philanthropist, had used client funds to prop up his failing crypto empire and finance his lavish lifestyle.

Between the revelations and the broader downsizing of the cryptocurrency industry, FTX and its investment network, which included the business of SBF, Alameda Research, as well as over 200 other cryptocurrency companies, dramatically unraveled.

Meanwhile, SBF, the former “white knight” of cryptocurrencies that was once worth $26.5 billion, says it’s down to its last $100,000.

Former FTX customers, academicsand also the crypto loyal claimed that Bankman-Fried’s now-defunct cryptocurrency exchange was an outright “Ponzi scheme,” which has led to a deluge of civil lawsuits against him and his company. There are no rulings on the cases yet.

Despite the allegations and admissions of errors by SBF, the lawyers contacted by Fortune he said it’s too soon to declare FTX a true “Ponzi scheme,” even though they say prosecutors could eventually.

“I don’t know if this is a Ponzi scheme, and it will probably be some time before we know,” said Thomas P. Vartanian, executive director of the nonprofit Financial Technology and Cybersecurity Center.

Vartanian, who has represented parties in 30 of the 50 largest financial institution crashes in US history, noted that it could take years for prosecutors to dig into the complex, interconnected and mismanaged accounting of FTX and its subsidiaries.

“They will follow the money and they will follow it down to the penny. And they will understand if we are dealing with malpractice, civil fraud, criminal fraud and if it is a Ponzi scheme, a pyramid scheme or whatever it is,” he said. “But those are facts that I don’t think anyone will have for some time, until all the money has followed.”

However, Vartanian noted that the documents released so far since FTX’s bankruptcy are “pretty devastating.”

“So to me, so far, this looks like corporate misconduct,” he said. “And whether it turns into fraud and lawbreaking or a Ponzi scheme is another matter.”

But Carlos Martinez, a bankruptcy specialist at the law firm Scura, Wigfield, Heyer, Stevens & Cammarota, took it a step further.

“I think the lawyer’s response would be ‘we await the investigation’,” he said. “But I think it’s quite clear and dry. The writing is on the wall that this was or at least, if it wasn’t supposed to be a Ponzi scheme, it definitely worked like a Ponzi scheme.

How Ponzi schemes work

A Ponzi scheme is a scam that lures investors with promises of high returns with little or no risk. The problem is that Ponzis create those supposed returns using money from new investors, not profitable investments.

The name comes from Charles Ponzi, an Italian con artist who swindled US investors in the 1920s with a clever story and the promise of high returns.

The SEC has warned about the dangers of Ponzi schemes and their prevalence in crypto circles. And some crypto critics, like Nouriel Roubini, a professor emeritus at New York University’s Stern School of Business and CEO of Roubini Macro Associates, even argue that the entire crypto ecosystem is the “mother of all Ponzi schemes.”

FTX shared many similarities with previous Ponzi schemes. Sheila Bair, who was president of the Federal Deposit Insurance Corporation (FDIC) from 2006 to 2011, told CNN earlier this month that SBF’s ability to captivate regulators and investors was “very similar to Bernie Madoff in some sense”.

For more than 20 years, Madoff ran the largest Ponzi scheme in history before his arrest in 2008, stealing $65 billion from as many as 37,000 people. While final accounting has yet to be completed, FTX has $50 billion in debt to more than 100,000 creditors, bringing SBF’s business closer to Madoff’s numbers.

But did SBF run a Ponzi scheme? Or was it corporate fraud like the one that led to the collapse of Enron, the Houston-based energy company whose bankruptcy and subsequent accounting scandal rocked markets?

If you ask former Treasury Secretary Larry Summers, Enron is a better analogy to FTX than an actual Ponzi scheme.

“I would compare it to Enron,” Summers told Bloomberg earlier this month. “Not just financial blunder but, from reports, hints of fraud. Stadium names very early in a company’s history. Vast explosion of wealth that no one quite understands where it comes from.

What we know about how FTX operated

Whether FTX was a Ponzi scheme could be up for debate, but SBF may also have engaged in what prosecutors could determine to be “misappropriation of funds”, “fraud” or even “an outright Ponzi scheme,” he said Martinez Fortune.

For example, SBF used at least $4 billion of FTX client funds to support its trading firm, Alameda Research, as cryptocurrency prices fell earlier this year, according to CoinDesk. SBF denies that it has implemented a “back door” in FTX systems to do this, saying it’s “definitely fake” and that it doesn’t even know how to code.

A media representative for SBF did not respond to requests for comment Fortune.

But al New York Times Dealbook Summit on Wednesday, SBF expressed surprise at the collapse of FTX, saying, “I have never tried to commit fraud. I was excited about the prospects for FTX a month ago. I saw it as a thriving and growing business. I was shocked by what happened this month. And rebuilding it, there are things I wish I could have done differently.”

But the former crypto billionaire admitted that a “very poorly labeled accounting thing” allowed Alameda to be “substantially more in debt” than he anticipated.

FTX is also facing a spate of lawsuits over its advertising, just as Bernie Madoff’s marketing arm did in 2009 following his arrest.

FTX has hired celebrities including NFL star Tom Brady for expensive Super Bowl commercials. And in a 2018 presentation to investors (pictured below), he offered clients what he described as “high returns with no risk” and loans with “no downside.”

SBF and its team at FTX weren’t shy about spending either. The company lost $300 million on properties in the Bahamas for senior executives, ran up a $55,000 bill at Jimmy Buffet’s MargaritaVille Bar, and chartered private planes to fly Amazon packages to executives.

During his prime, Madoff and his colleagues also lived a life of luxury, purchasing multimillion-dollar mansions and luxury jewelry, clothes and watches, some of which were auctioned off to pay off his investors after his arrest.

Finally, before its fall, the major international FTX exchange held $9 billion in unsecured liabilities with just $900 million in assets, according to the Financial Times. Usually, total liabilities and total assets should match on a balance sheet, and the disparity shows that FTX was in a deep chasm before its collapse.

While SBF insisted that it simply misjudged the amount of liabilities on the books, FTX’s new CEO, John Ray III, who also handled Enron’s collapse, called FTX’s operations “a complete failure of controls.” corporate” with a “complete absence of financial information trustees.”

“From compromised systems integrity and faulty regulatory oversight overseas, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented,” he said.

Whether SBF was operating a Ponzi scheme through FTX will not be determined until after prosecutors finish their investigations and a jury decides on any criminal cases they bring. But Vartanian argued that Congress needs to pass tougher regulations on the cryptocurrency industry as soon as possible.

“I think Congress needs to write new rules to clarify that the cryptocurrency business is taking and using other people’s money, and that means it’s a trustee,” he said. “He’s a keeper, and should be treated as such under the law.”

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