Madhura Mahesh

TWTW#196, 31 December 2022, Vol. 4, No. 45

What happened?

On 11 November, Bahamas-based crypto exchange FTX filed for Chapter 11 bankruptcy in Delaware, US. This caused shockwaves through the crypto-market leading to a fall in crypto value. The US and Bahamas authorities opened investigations on the matter. 

On 12 December, former FTX CEO Sam Bankman-Fried was arrested by the Bahamian police after US officials filed criminal charges against him. He was charged by the US government with eight counts which include money laundering, misappropriation of consumer funds, intention to defraud FTX users and violation of US campaign finance rules. The US Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have filed similar charges separately.  

On 13 December, Bankman-Fried along with  FTX Chief Executive John J. Ray III were to testify in front of the House Committee on Financial Services on the collapse of FTX, finances of FTX and Almeda. As Bankman-Fried was arrested on 12 December, only Ray testified where he claimed that the FTX’s fall was “one of the worst business failures”. This was reportedly due to the lack of oversight and financial controls, lack of documentation and accountants and poor record keeping. He also accused the Bahamas government of collaborating with FTX to remove over USD 100 million to help Bahamian account holders amid its crash.   

On 13 December, the Bahamas Magistrate Court denied his request for bail and transferred him to the Fox Hill correctional prison until 08 February. The US authorities call the actions of FTX and its partners actions as one of the largest financial frauds in US history.  

On 22 December, Fried was extradited to the US where he was released on bail of USD 250 million bonds to his parent’s house in California. He is said to be presented in front of the US District Court in Manhattan on 03 January 2023. 

On 28 December, FTX customers filed a class action lawsuit against the exchange and the former executives including Bankman-Fried. The lawsuit claims that FTX’s holdings of digital assets belong to the customers and are seeking a declaration of the same. The lawsuit further asserts that: “customer class members should not have to stand in line along with secured or general unsecured creditors in these bankruptcy proceedings just to share in the diminished estate assets of the FTX Group and Alameda.” This comes as FTX is facing difficulties in liquidating its assets to pay customers and investors. 

What is the background?

First, the sudden withdrawal of funds by customers. Over the weekend before the bankruptcy filing, over USD six billion were withdrawn by customers in a span of 72 hours. From 05 November to 08 November, FTX customers suddenly withdrew huge amounts of funds which caused a liquidity crunch in the exchange. Seeing this sudden withdrawal of cash, Binance, another crypto exchange withdrew from a financial bailout agreement it had signed with FTX. The agreement was signed between the two to help cover FTX’s losses and keep the company afloat. On 10 November, the Bahamas government began the liquidation process of FTX assets in the Bahamas to protect customer funds in the country     

Second, FTX and Bankman-Fried illegal donations to Republicans’ and Democrats’ election campaigns. Bankman-Fried routinely donated to both the Republicans and Democrats’ election campaigns making him one of the largest donors. The Democratic National Committee and the campaign arms of the Senate and House Democrats have pegged the donation amount received from Bankman-Fried since 2020 to be around USD 1.16 million dollars. Investigations have revealed that Bankman-Fried has made illegal donations worth “tens of millions of dollars” to electoral campaigns of Republican candidates. Bankman-Fried himself acknowledged the “dark” donations explaining that any donations made to the Republicans would be criticised by the media and that he wanted to avoid a potential clash with the media.  These donations were largely made from the siphoned funds from FTX customers and Almeda LLC investors. 

Third, the volatile and unregulated cryptocurrency market. Cryptocurrency is largely unregulated as it is not recognised as a legal tender or even legalised in many economies. Due to this, the value of cryptocurrency is greatly affected by the smallest changes in international society. Mostly traded in US dollars, any factors affecting the value of dollars will also affect the value of cryptocurrencies. After FTX filed for bankruptcy, the value of the cryptocurrencies was on a decline with one Bitcoin trading for USD 15,586.94. The decrease in the value of Bitcoin also affected the value of other Bitcoins like Ether which traded for USD 1,081.56. 

Fourth, lack of regulations against crypto exchanges. FTX’s monetary fraud had largely flown under the radar due to the lack of regulations present against cryptocurrency exchanges. In the US the CFTC which largely regulates digital assets has taken action against a few crypto exchanges based both in the US and abroad but has largely failed in regulating exchanges due to the lack of clarity in the authority regulators have over these companies. Many crypto exchanges having lax rules internally, and many have taken advantage of to run illegal businesses fully based on crypto. 

About the author

Madhura Mahesh is a Research Intern at the National Institute of Advanced Studies.

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