FTX used customer accounts to fund risky bets, creating its downfall

Crypto exchange FTX has loaned billions of dollars worth of client assets to fund venture bets from its trading subsidiary Alameda Research, kicking off a stock market implosionsaid an insider.

FTX CEO Sam Bankman-Fried said in investor meetings this week that Alameda owes FTX about $10 billion, people familiar with the matter said. FTX made loans to Alameda using money that customers had deposited into the exchange for trading purposes, a decision that Mr. Bankman-Fried described as bad judgment, one of the people said.

In general, FTX had $16 billion in client assets, the people said, so FTX has given more than half of its client funds to its Alameda subsidiary.

Alameda is taking out additional loans from other financial firms, according to people familiar with the matter. As of Monday, Alameda owed $1.5 billion in loans to non-FTX counterparties, according to one of these people and another person familiar with the matter.

A spokesman for FTX declined to comment.

FTX paused client withdrawals earlier this week after being hit with about $5 billion worth of withdrawal requests on Sunday, according to Thursday morning tweet by Mr. Bankman-Fried. The crisis forced FTX to scramble for an urgent investment.

FTX they made a deal to sell to its giant rival Binance on Tuesday, but Binance pulled out of the deal the next day, saying FTX’s problems were “beyond our control or ability to help.”

Failure of FTX to fulfill withdrawal requests shocked crypto investors and heavily tarnished the reputation of Mr. Bankman-Fried, who had embraced digital currency regulation and branded himself as a crypto entrepreneur driven by ethics and philanthropy.

“An exchange really shouldn’t have a problem getting its customers’ deposits,” said Francis Coppola, a UK-based economist. “He shouldn’t be doing anything with those assets. They literally have to be there for people to use.

As questions about FTX’s health brewed on Monday, Mr Bankman-Fried tweeted: “FTX has enough to cover all client assets. We do not invest client assets (not even treasuries).” He later deleted the tweet.

A warning seen in London on Thursday that FTX was unable to process withdrawals.


photo:

Leon Neal/Getty Images

On Thursday morning, Mr. Bankman-Fried said in a tweet that Alameda Research was ceasing trading.

In traditional markets the brokers must keep client funds segregated from other company assets and regulators can punish violations. In 2013, for example, the Commodity Futures Trading Commission fine broker MF Global $100 million for misappropriating client funds during its disorderly collapse two years earlier—a slump also fueled by risky bets gone wrong.

But MF Global’s clients were eventually bailed out after a years-long bankruptcy process. Since FTX operates in the Wild West of crypto, it is unclear if customers will ever get their money back.

The disclosure of the loans suggests that the root of FTX’s collapse lies in its relationship with Alameda, a firm known for aggressive trading strategies financed by borrowed money. Some crypto traders have expressed caution about the tie-up, worrying that it represents a conflict of interest for an exchange to be attached to a trading business.

Mr. Bankman-Fried founded and is the majority owner of both companies. He was Alameda’s CEO until last year, when he stepped down from the role to focus on FTX.

Alameda’s chief executive is Caroline Ellison, a Stanford graduate who, like Mr. Bankman-Fried, previously worked for the quantitative trading firm Jane Street Capital. Alameda is based in Hong Kong, where FTX was headquartered before moving to the Bahamas last year.

In theory, exchanges like FTX make money by allowing customers to trade cryptocurrencies and collecting transaction fees. Alameda pursued various trading strategies to cash in on a volatile, riskier business model.

Among the strategies Alameda engaged in after Mr Bankman-Fried founded the firm in 2017 was arbitrage – buying a coin in one place and selling it elsewhere for more. An early profitable trade involved buying bitcoin on US exchanges and selling it in Japan, where it commanded a premium over its US price.

Another business in Alameda is market making – offering to buy and sell assets on crypto exchanges throughout the day and collecting a spread between the buy and sell price.

In WSJ Tech Live, FTX’s Sam Bankman-Fried and Lightspeed Venture Partners’ Ravi Mhatre discuss how the crypto industry plans to stage a comeback.

More recently, Alameda has become one of the biggest players in “extractive agriculture,” or investing in tokens that pay interest-rate-like rewards, according to analysts who used public blockchain data to track the firm’s activities. One crypto wallet controlled by Alameda has generated over $550 million in trading profit since 2020, according to blockchain analytics firm Nansen.

Cultivating yield can be risky, as tokens often have an initial spike in price as investors pile in, seeking the rewards, then crash as they exit.

“It’s basically like collecting pennies before the steamroller,” said independent blockchain analyst Andrew Van Aken. “You use dollars or stablecoins to get these very speculative coins.”

— Peter Rudegeair and Caitlin Ostroff contributed to this article.

Write to Vicky Ge Huang at [email protected]Alexander Osipovich at [email protected] and Patricia Cousman c [email protected]

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