Sam Bankman Fried

Who is Sam Bankman Fried?

Sam Bankman Fried (born March 6, 1992) was one of the richest and most powerful men in the crypto industry who’s fortunes have collapsed like a house of cards. Also also known by his initials SBF, is the founder and former CEO of FTX a crypto currency exchange which went on to become the third largest in USA, the largest one being Binance. With a meteoric rise he went on to create for himself a net worth in excess of $15 billion. Sam Bankman – Fried graduated from the Massachusetts Institute of technology( MIT ) with a physics degree in 2014.

After graduating he worked for a few years at a high frequency trading firm called Jane street. This firm is a quantitative trading firm and liquidity provider with a unique focus on technology and collaborative problem solving. Here he specialized in trading Exchange Trated Funds (ETFs). In 2017 he quit his job at Jane Street to start his own trading firm called Alameda Research, a hedge fund.

Sam Bankman – Fried, is an ardent advocate of the philanthropic philosophy of ‘Effective Altruism‘ in league with Elon Musk and Mark Zukerberg. Effective altruism posits that making money by (almost) any means necessary is ok as long as you are doing it for a humanitarian cause. Many experts believe that it is this philosophy that could have excused or encouraged behaviors that led to FTX’s downfall which could be worse than Theranos and Madoff scandals. Moreover the contagion effect it is going to spill off would further worsen the situation.

The rise of Sam Bankman Fried

Arbitraging

Around the time when SBF quit Jane Street Bitcoin was becoming a big thing. SBF started trading Bitcoin and he noticed that there were significant price discrepancies in different exchanges around the world. Specifically he saw that there were differences of as much as 10% between the price of Bitcoin on US exchanges as compared to Japanese exchanges. He could buy Bitcoin for $10,000 in the US, transfer them over to the Japanese Exchange and sell them for $11,000 each making a 10% almost risk free profit overnight. By doing these Arbitrage trades he was able to make $20 million in just a few weeks, a significant amount to start with. The price discrepancies eventually disappeared as more traders started doing the exact same thing that Alameda was doing. But these quick profits were enough to convince SBF that crypto had a huge potential.

FTX Launch

So in 2019 he launched FTX, a crypto exchange based out of Hong Kong. Their main selling point was that FTX was created by traders and for traders. They differentiated themselves by offering a huge number of crypto derivatives and leverage Tokens ( FTTs ) that experienced traders could use to take high risk high reward bets. On their platform, a trader could buy three times leveraged Bitcoin tokens meant to amplify their daily returns of Bitcoin by three.

They also had inverse tokens that one could buy to bet on the price of a coin going down. This isn’t too different from the three times leveraged ETFs one can buy on stock exchanges. But FTX was even more extreme on the leverage allowing users to take on as much as ten times leverage for some coins. 10 times leverage is only appealing to a small section of crypto traders. Thus SBF realized that if they want to grow FTX into a mainstream exchange, they need to attract mainstream users.

How mainstream users were trapped

The 8% lure

They had many ways of doing this firstly they launched an earned feature where users can earn 8% yield on both their crypto and USD holdings by depositing it within the app. They never really explained how they generated these yields. The idea was that this money could be lent to other users on the platform as margin loans. FTX would liquidate these margin loans before they defaulted so this was supposed to be almost risk free. However the high yields they offered were highly suspect.

When they first launched the service in 2021 the federal funds rate was close to 0%. If this was truly almost risk free they could have easily borrowed money from money market funds for two or three percent. Why would they be paying 8% to their depositors instead? Due to all this and more he was held by the mainstream financial media as a crypto messiah as he stepped in to bail out multiple smaller crypto companies over the past year. Under leadership of Sam Bankman – Fried, FTX was considered to be the safest company in the space with many even comparing him to the JP Morgan of the crypto industry.

Celebrity endorsements

FTX also paid millions of dollars to celebrities including NFL legend Tom Brady, NBA star Stephen Curry and super model Geselle Bundchen to endorse the platform in 2021. They shot a commercial that was in hindsight incredibly cringy where Tom Brady calls all of his friends convincing them to start using FTX . Anybody who took his advice Would end up in a world of hurt one year later. With so many celebrity endorsements and a legit looking app, hundreds of thousands of people assumed that the 8% yield was nearly risk free and many of them deposited their life savings into the seeming bubble. 8% looked extremely attractive in a zero interest rate environment.

Public image

Another factor which gave people trust in FTX, was Sam Bankman Freid’s impressive resume . He was an MIT graduate and former quantitative trader at Jane Street. People assumed that he was some sort of a genius. If you couldn’t understand how FTX generated these insane yields that just means you’re a boomer who doesn’t understand the magical abilities of crypto . And the fact that he signed the giving pledge to give away the majority of his net worth by the time he dies, further bolstered his public image that not only is he a genius he’s also a benevolent one .

Role of media

Lastly, the mainstream financial media created his messianic image for his bailing out multiple smaller crypto companies over the past year. The media also went ahead comparing him to the JP Morgan of the crypto industry. SBF was so confident in his position that in June of this year he signed the ‘giving pledge‘ which billionaire signed to pledge the majority of their net worth to charitable causes by the time they die. Fortunately for SPF this giving pledge isn’t going to cost him a Penny because his net worth plummeted to zero over the course of just a few days.

It wasn’t just retail investors who were fooled, FTX raised billions of dollars from prestigious venture capital funds including Sequoia Capital which was an early investor in Google. Other important players having direct exposure in FTX are – Temask, Ontario Teachers’ Pension Fund. Also some crypto specific venture funds such as Paradigm and Multipoint Capital etc. There are also firms that have specifically traded on FTX and held their crypto currencies on their platforms are – Genesis, Coin Share, Galaxy, Wintermute, Crypto.com and Galois Capital. These funds are going to be stuck on the platform. They range from $10 Million to $100 Million. Given that the bankruptcy process is going to linger around for years, they might want to give up their claims on bankruptcy even at discounted price.

During the 2022 crypto crash, FTX stepped in to bail out multiple crypto lending firms including Voyager digital and Block File saving their customers deposits. This is when the media perception of SBF increased. He was viewed as the one financially responsible CEO in the crypto space helping to bail out the smaller players in this time of crisis. Some commentators even started comparing him to JP Morgan founder John Pierpont Morgan as he built his financial empire 100 years ago by bailing out and buying up distressed companies .

The downfall of Sam Bankman Fried

Binance role

The House of Cards showed its first signs of shaking on November 2nd, when Coindesk released an article about Alameda Research, a crypto trading firm also owned by SBF. As it turns out Alameda owned billions of dollars worth of FTX’s native FTT (token). Shortly after this news was published, Binance which is FTX’s largest competitor announced plans to dump its entire stake in FTT. This caused the price of FTT to tank. As of the time of writing this article it has fallen by almost 90% and looks to be on its way towards zero. Unsurprisingly the collapse of FTT’s price has caused Alameda to go bankrupt.

However it wasn’t just Alameda, FTX and FTX US have both also filed for bankruptcy on November 8th. FTX halted all crypto withdrawals leaving its 1,000,000 users unable to access their own crypto. Thousands if not tens of thousands of people all over the world deposited their life savings into FTX because they trusted SBF to keep their funds safe. Now it is unclear when or if they will ever see any of this money again. FTX US is also filing for bankruptcy and they have warned that they may halt withdrawals. In a few days there’s a good chance that this will already have happened by the time you’re reading this article.

Was it a gambling operation?

So how could this happen? While they’re all owned by Sam Bankman Fried, FTX, FTX US and Alameda research were supposedly separate entities. Why are FTX Depositors now holding the bag for Alameda’s trading losses. As it turns out SBF allegedly misappropriated FTX depositor money to fund what was essentially his massive gambling operation in Alameda. Both the US Securities and Exchange Commission (SEC) as well as the Department of Justice ( DOJ ) are reportedly investigating FTX for mishandling customer funds. While the SEC can only bring civil charges. The Department of Justice has the power to put people behind bars. This is potentially a big problem for SBF as he currently resides in the Bahamas which has an extradition treaty with the US.

The Bahamas angle

He moved FTX’s corporate headquarters to the Bahamas where he lived in a luxury compound along with nine members of his inner circle all of whom reportedly had romantic relationships with each other. One of the members of the inner circle was the 28 year old Harry Potter fan Caroline Ellison who SBF appointed as CEO of Alameda research. According to coindesk, SBF had a romantic relationship with Caroline. At least for a time none of this information by itself is incriminating.

But the fact that SBF plays League of Legends on the job and appoints his girlfriend to be CEO of Alameda research which had over $10 billion of assets certainly isn’t a good look from the corporate governance perspective and corporate governance is a big concern .

SBF is a founder of FTX, FTX US and Alameda research but he was ostensibly only the CEO of FTX and FTX US. He appointed his alleged romantic partner in Caroline Ellison to be CEO of Alameda research. Supposedly Alameda research was Independent of FTX .

The business model

Alameda’s business model was to make money trading crypto. FTX was supposed to make money by charging fees on customers crypto transactions. There’s no reason that these two companies should have any interaction but as it turns out they appear to have been joined by the hip. According to private documents obtained by Coindesk, Alameda had $14.6 Billion of assets as of June 30th. Its single largest holding was $3.66 billion of FTT tokens. It also had $2.16 billion of FTT collateral that means that 40% of its assets were related to FTX. FTT token offers users discounts on trading days when they use the exchange. The idea is that, as FTX’s user base grows more people will want to buy the coin and the value will increase.

The Coindesk Trigger

As it turned out Binance the world’s largest crypto exchange and former investor in FTX was also a major holder of FTT token. Shortly after the Coindesk article was released by they dumped all of its FTT token citing recent relevation . This caused the price of FTT to tank and as of the time of writing this article is down by almost 90% and looks to be on its way towards 0. This caused massive losses for Alameda research and the trading firm went bankrupt a few days later. FTX halted withdrawals meaning the FTX customers, many of whom deposited their life savings with the company were not able to access their funds.

This was weird, why would the collapse of Alameda research have any impact on the FTX exchange? They were supposed to be two separate companies. Perhaps the more basic question is how did Alameda research have $14 billion of assets to begin with? According to a Wall Street Journal report Sam Bankman Fried siphoned off billions of dollars worth of customer assets from FTX and funneled them to Alameda research. They used these funds to build a massive positions in FTT token as well as other crypto currencies and this ended up being a massive disaster.

Fallout

On November 10th shortly after FTX halted withdrawals, SBF tweeted an explanation. He blamed poor internal labeling of FTX assets which led SBF to under estimate how much margin users were taking on. He thought that the exchange had 0 leverage when it actually had 1.7 leverage. After the Coindesk article was released people started pulling their money out of FTX.

Basically like a bang front he further said that FTX assets were greater than claimed to posits. However the assets were illiquid meaning that it would take time to sell them. Eventually they’ll be able to sell them and all the depositors will be paid in full. He also said that the liquidity crunch only affected FTX international. The US exchange FTX US was 100% liquid and all users could fully withdraw if they wanted to.

He contradicted everything he said the very next day when he announced that Alameda Research FTX and FTX US were all filing for bankruptcy. If they were truly solvent they could have just waited to slowly liquidate their assets. So what actually happened to the customer deposits at FTX and FTX US ?

When you buy stocks on a regulated stock brokerage such as Robin Hood or Charles Schwab for example there is almost zero risk of losing your stocks. If you buy a share of Microsoft the brokerage will go on to the NASDAQ and buy one share of Microsoft that has your name on it. Whenever the market is open you can sell your apple share because your broker owns it. Even if every single customer sold all their stocks at once the brokerage would be able to honor these withdrawals because they have in their custody every single share that their customers own.

The Modus Operandi

FTX clearly did not act in a similar manner they allegedly took their customer deposits and loaned them to Alameda Research. That would explain how Alameda Research managed to amass $14 Billion of assets. Alameda Research would use these funds to make risky bets in the crypto market. If the Bets worked out they’d be able to pay back their depositors and keep the rest as profit. If the bets went wrong, their customers would end up holding the bag. They apparently went all in on the FTT token and now that it’s crashed they have no way of making their customers whole, hence the withdrawal freeze.

Confusion at Binance

When the liquidity crunch first started Binance, the world’s largest crypto exchange offered to acquire FTX and protect user deposits. Remember that Binance triggered FTX and liquidity crunch when it dumped its entire FTX stake a few days earlier so it looked like a predatory move whereby buying hands dumps its FTT tokens thus allowing them to buy the rival exchange on the sheet. But it looks like Binance didn’t even know the extent of FTX problems after just one day of due diligence Binance abandoned the deal citing allegations of FTX mishandling. Customer Funds finances pull out all but confirms FTX is insolvent.

The Reality

If the assets were really greater than its liabilities, they would have been willing to pay something for it. With FTX headed towards collapse, the FTT tokens of Alameda Reseach are likely worthless. Remember that FTT allows users to get discounted Commission rates on FTX. With FTX now bankrupt FTT tokens will be about as valuable as a sears loyalty card. If the allegations about FTX misappropriating funds are true things are not looking good for depositors. Much of their money has been squandered by Alameda. It remains unclear how much of their money they’ll get back if they get anything at all.

So how did all this happen?

It was partly because SBF ran all of his companies from his compound in the Bahamas. There was almost no regulatory oversight nobody knew how FTX was making the 8% yield that offered to its customers and nobody knew what Alameda was doing. He took advantage of the fact that there is:

• no regulatory oversight
• no consumer protections
• no licensure
• no insurance
• no net capital
• no transparency
• no sunlight
• Thus we have no idea what’s going on inside of these entities

Sam Bankman Fried was able to fool the financial media, venture capitalists and celebrities into thinking that he could create money out of thin air. SBF is actually using Alameda which all of the allegations seem to be leading to as his personal Piggy Bank for whatever he wants to use it for. With the power of crypto everybody deserves the presumption of Innocence and SBF will have his day in court if it comes to that. But as it stands, now it looks like FTX was a multibillion dollar fraud where SBF misappropriated customer funds and attempts to enrich himself. Everybody is entitled to the presumption of innocence and SBF has not yet been criminally charged. But there is significant circumstantial evidence that FTX and Alameda were running a multi billion dollar scam.

See Also

Rahul Sir’s IAS Academy