In late 2017, MIT alumnus Sam Bankman-Fried left the quantitative trading firm Jane Street to start his own cryptocurrency trading firm, Alameda Research.
Founded prior to FTX, Alameda got its start by taking advantage of bitcoin price differentials between Japanese and U.S. exchanges, namely by buying bitcoin for a low price in the United States and selling for a premium in Japan.
At the time, Bankman-Fried estimated this trade netted around $20 million before the price spread narrowed as competitors took advantage of the same trade.
Alameda’s initial strategy involved various trades similar to the Japan-U.S. bitcoin arbitrage.
After two years of running the quant fund, the 27-year-old entrepreneur embarked on the ambitious goal of starting a crypto trading exchange that would become FTX.
“At the time it seemed extremely risky,” Nishad Singh, a childhood friend of Bankman-Fried who would later become the lead engineer of FTX, told Yahoo! Finance.
In the early days, Alameda Research was the main liquidity provider for FTX, according to Bankman-Fried, accounting for half of the volume on the exchange.
According to people familiar with the company, though, it was the other way around.
Jason Choi, an entrepreneur who met Bankman-Fried before FTX started, stated in a Twitter thread that the impetus for founding FTX was to use client funds to capitalize on Alameda Research.
These claims were also bolstered by a recent Wall Street Journal report on commingling between the two firms.
Despite this, Bankman-Fried said in a now-deleted tweet, “We don’t invest client assets.”
Alameda’s undercapitalization may have led to desperate measures, Choi suggested, pointing to a key announcement by Alameda Research last year.
In a tweet, Alameda co-CEO Sam Trabucco announced the fund had shifted away from quantitative strategies like the Japan-U.S. arbitrage and instead had moved to a buy-and-hold approach.
The firm was now “really long” crypto assets.
One of these assets was Dogecoin.
Trabucco’s justification for investing in the dog-based token was “all based on noticing how it goes up when Elon tweets.”
Choi speculated that this cavalier shift by Alameda was the result of thinning profits from their quant trades as “their edge eroded.”
As a result, they “began to assume massive directional risks in crypto.”
Trabucco resigned from Alameda Research in August of this year.
Terry Sawchuck, CEO and founder of wealth management firm Sawchuk Wealth, insists that Alameda was “at the core of why FTX had its catastrophic collapse.”
“It appears that Alameda ran into difficulty raising capital to increase leveraged bets, so at some point FTX began using its own issued token (FTT) as collateral to borrow money from many industry players, and then gave it to Alameda to continue to finance their increasingly larger bets on crypto,” he says.
Commingling client funds was not the extent of the controversial relationship between Alameda and FTX.
According to a Wall Street Journal article, Alameda Research collected large amounts of tokens before FTX said it would be listing tokens between the start of 2021 and March of this year.
In traditional markets, this practice is called “front running.”
Front-running is both illegal and unethical when a trader is acting on inside information.
Owen Rapaport, the co-founder of crypto compliance firm Argus, told Decrypt Media that the levels of front running by Alameda far exceed those of most prosecuted cases in the traditional finance world.
While there is some disagreement around whether these laws apply to crypto, Boston-based law firm Newman and Shapiro believes the practice is illegal under current law.
In addition to front running, former employees told Choi that FTX programming allowed for privileged access to Alameda, granting it faster trade executions than standard users. Other special privileges were granted to Alameda, as well.
After FTX froze client withdrawals on Nov. 8, Bankman-Fried continued to siphon the exchange’s funds to Alameda, shown by the crypto transaction tracking website Etherscan.
Soon after, Reuters released its report on Bankman-Fried’s “backdoor,” which was allegedly used to funnel $10 billion from FTX to his investment fund.
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” acting CEO John Ray and former Enron bankruptcy overseer said in a court filing on Thursday.
“From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”
The collusion between Bankman-Fried’s investment fund and his crypto exchange has raised serious ethical concerns.
Industry leaders and U.S. officials have united in calls for regulation while some crypto experts would prefer to see a shift toward decentralization.
In an opinion piece for CoinDesk, Amanda Cassatt, founder and CEO of Serotonin, a Web3 marketing agency, highlighted the relative stability of decentralized exchanges like Uniswap and Balancer amid the FTX blowup.
She believes regulators do not help the average person and instead provide privileges to those with more political access.
“What [Bankman-Fried] wanted from regulation wasn’t consumer protection, but rather to protect his incumbent position and entrench his competitive moat,” Cassatt explained.
“If there is a silver lining for the FTX fiasco, it is a reminder of the importance of decentralization.”
Some traditional investors say that decentralization is not the main point here.
“It’s an interesting dichotomy because without ‘centralized exchanges,’ crypto growth would likely have been minuscule by comparison,” Sawchuk said.
“The issue is less with decentralization and more with lack of regulatory oversight.”
The wealth manager believes stronger regulatory oversight is needed to clean up the crypto industry and that current regulators are not doing their job.
“The fact that this guy hasn’t been arrested yet raises some very serious red flags.”