“Black box”: Sam Bankman-Fried’s trading company posed major risks to FTX

The collapse of Sam Bankman-Fried’s $32 billion cryptocurrency exchange captivated and stunned the crypto markets this week, but at the center of the crisis was a much lesser-known, but risky entity: Alameda Research.

Bankman-Fried’s digital asset trading shop opened in 2017, but within two years of its founding, it was trading around $600-$1 billion per day. Much of the funding was based on borrowing, often using other crypto tokens as collateral to make highly leveraged bets, according to industry participants.

The company, run by a small cadre of executives and ultimately controlled by Bankman-Fried, had close ties to FTX, a sprawling crypto trading venue that allowed customers to bet on the price of digital tokens like bitcoin using complex derivatives. Bankman-Fried founded FTX about a year and a half after Alameda. As of this week, Alameda owed the stock exchange $10 billion, according to people familiar with the matter.

“The tipping point is not FTX, it’s Alameda and the credit risk they took,” said Rosario Ingargiola, founder and CEO of Bosonic, a crypto settlement service.

Alameda ultimately sparked the conflagration that ultimately engulfed FTX.

A Nov. 2 report by crypto publication CoinDesk that claimed $5.8 billion of the $14.6 billion in assets on Alameda’s balance sheet were coins issued by FTX, known as FTT, raised deep concerns about the relationship between the two nominally separate entities. The report also said a large portion of Alameda’s FTT had been used as collateral for loans to an unknown party.

“This alone should raise alarms, but the bigger question is: who had accepted billions of dollars worth of financial transactions as collateral?” asked Clara Medalie, an analyst at Kaiko, a crypto market research provider.

The story deepened the market’s suspicions about Alameda’s health and whether it was sitting on big market losses during the spring crypto crisis. The balance sheet snapshot included the period when many major crypto names went bankrupt. The bankruptcy filing for one of them, Voyager Digital, revealed that Alameda owed the lender $376 million.

In a first sign of the liquidity problems facing Bankman-Fried’s empire, Alameda valued its FTT holdings at nearly 200 percent of FTT’s current market capitalization of $3.1 billion, according to the report.

Caroline Ellison, chief executive of Alameda, said Sunday that the balance sheet reflected only one of the company’s business units and that the company had more than $10 billion in assets that were not reflected in the numbers.

But the market was not convinced. Just over an hour later on Sunday, Changpeng Zhao, CEO of rival exchange Binance, said he would dump his FTT tokens, worth at least $580 million, in response to “latest revelations,” citing the example of luna, the cryptocurrency that collapsed overnight in May , which created a bout of severe market turbulence.

FTX customers also rushed for the exits. The stock market faced record withdrawals of about $5 billion on Sunday, and Bankman-Fried admitted this week that it had only $4 billion in readily marketable U.S. dollar assets to cover them. Bankman-Fried put the misjudgment of its clients’ leverage down to “poor internal labeling of bank-related accounts.”

On Monday, as FTX faced heavy withdrawals, Alameda sought to sell the most liquid assets on hand. A snapshot of Alameda’s balance sheet, seen by the Financial Times, showed it was looking to liquidate shares it held in retail brokerage Robinhood, crypto tokens, and ring in a loan for FTX’s EU arm. But only $1.8 billion was readily available despite its large debts to FTX.

On Tuesday, customers reported having difficulty withdrawing their money, which only added to the market’s fears. “FTX is neither a trading company nor a lender, so theoretically they should always have access to the equivalent of 100 percent of their client’s funds,” said Medalie at Kaiko.

Jean-Marie Mognetti, CEO of asset manager CoinShares, which has $30.3 million exposure to FTX, said Bankman-Fried’s trading venue is “not an exchange, it’s much broader.”

“Everything is integrated in this complicated way, creating this black box,” he added.

At the same time, holders of FTT tokens also sold heavily, which worsened Alameda’s position. On Tuesday, a record 309 million FTT were traded, equivalent to more than $1 billion, according to data from Kaiko, which traders attributed to FTX selling other assets in an attempt to defend its coin’s price.

But FTT’s price still fell by 80 percent on Monday and Tuesday. The loans secured against FTT were underwater, creating a vicious cycle that Bankman-Fried struggled to break.

Looking for a lifeline, he turned to his archrival — Zhao of Binance — who agreed to buy the exchange on Tuesday. FTX had “asked for our help,” Zhao wrote on Twitter, adding: “There is a significant liquidity crisis.”

But after less than 48 hours of due diligence, Binance walked away on Wednesday. Zhao cited concerns about FTX’s business practices and investigations by regulators.

With its best bet gone, Bankman-Fried scrambled for an alternative, asking investors for up to $8 billion to plug a hole in FTX’s balance sheet. He turned to crypto exchange OKX, stablecoin operator Tether and Justin Sun, founder of crypto token Tron, for a cash injection – but none materialized.

Investors who had been so ready to back him earlier in the year, such as Sequoia Capital and SoftBank, wrote the investments down to zero.

Bankman-Fried took to Twitter on Thursday to apologize for the crisis engulfing his crypto empire. “I’m sorry. That’s the biggest thing. I screwed up and should have done better,” he said, adding that Alameda would close. In a last ditch effort, he tried to reassure the market that FTX was solvent but not liquid and that the users of its US arm felt good”.

It was too late. Within 24 hours, FTX and Alameda had filed for bankruptcy, and Zhao predicted the effects would plunge the industry into a crisis similar to the crash of 2008. U.S. regulators are looking into FTX’s lending products and handling of customer funds, a person familiar with the matter said. For many, the reason was straightforward.

“It all boils down to a lack of transparency and conflicts of interest,” says Anish Puaar, head of European equity market structure at market maker Optiver. “You will never have a major exchange like the London Stock Exchange or Deutsche Börse so closely tied to a market maker.”