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AGEFI Luxembourg

– Janvier 2022
Those are the words of John J. Ray III, a 40 years industry veteran – who also oversaw the aftermath of the Enron scandal – as he prepared to take up the role of new CEO of FTX in order to see what is left of the company through a grim set of proceedings. This assumption of duty was prompted as Sam Bankman-Fried (SBF) stepped down earlier this month, after ha- ving filed FTX for chapter 11, a mere few days following an estimated 32 billion dol- lars valuation of his former cryptocurrency derivatives exchange company.
Binance, another leading cryptocurrency exchange, attempted but quickly thought twice about launching a FTX rescue operation. All in all, the effect of this an- nouncement was of paramount proportion within the crypto world and the victims are – as expected — many. From customers, shareholders, hedge funds, venture capitalists and other business partners, nearly a mil- lion of stakeholders saw their cryptocurrency hold- ings literally vanish overnight. The ripples are in fact so wildly spread that one cannot help but somehow be reminded of the largest Ponzi scheme in history, once orchestrated by Bernie Madoff in 2008.
To some, however, this debacle was highly predictable and it was only a question of time before other cryp- tocurrency focus related companies followed the same fate as Luna and its stablecoin based terraUSD with their 40 billion dollars collapse, earlier this year.
Many voices have, once more, made themselves heard and the pleas for more control and regulation are now stronger than ever yet not unseen after similar “crypto-disasters”. Nevertheless, it seems as though things are somewhat different this time.

A stunning realization

The Mercedes-AMG Petronas Formula One team who had a FTX sponsorship as part the formula one championship, was amongst the first to be vocal about how flabbergasted they were by the current situation. “We considered FTX because they were one of the most credible and solid, financially sound partners that were out there…” said Toto Wolf, the team prin- cipal. Although Wolf further described himself as a true believer in cryptocurrency and blockchain, he firmly believes a tighter regulatory grip should be ap- plied to the industry: “And out of nowhere we can see that a crypto company can basically be on its knees and gone (in) one week. That shows how vulnerable the sector still is”.

“It’s unregulated and I believe it needs to find its way into regulations because there’s so many customers, investors and partners like us that have been left in utter disbelief at what has happened.

FTX’s involvement within the universe of sport does not stop there. Tom brady, Shaquille O’Neal, Stephan Curry, Naomi Osaka, the Major League Baseball, the Miami county – to name a few – all had business deal- ings of some sort with the platform. Furthermore, the San Francisco located NBA basketball team, the Golden State Warriors as well as the Miami Heat got impacted as well. The latter having had recently shaken hands with FTX on a 135 million dollars deal which entailed renaming the Heat basketball court in honor of the cryptocurrency exchange until 2040.

The island of Bahamas also had great plans to which FTX was central; they were once counting on big eco- nomic spinoffs and piggybacking on using the com- pany’s apparent success and notoriety to lure other crypto companies and have them relocate there. Today, they are left to pick up the piece.

“I am deeply sorry that we find ourselves in this cur- rent situation” wrote Galois Capital co-founder Kevin Zhou after admitting to investors that half his com- pany’s capital had been placed on FTX, in an official letter. Zhou is well known within the cryptocurrency spere as he was once credited with being one of the first to point out the first signs of what turned out to be Luna’s downfall. To this he added: “We will work tirelessly to maximize our chances of recovering stuck capital by any means”, knowing it could take years to recover even a fraction of the lost assets.

Indeed, a white-collar crime prosecution is far from straightforward even though there are exceptions – such as the Madoff scandal – where the prosecution was mostly fueled by the public opinion and the fact the US government wanted to limit the financial in- dustry discredit which arose from the fraud. Yet, in our current case, it will somewhat difficult for prose- cutors to establish jurisdiction and intent in order to make it “stick”.

The absence of regulatory safeguards is beyond belief

At first, the vast majority of the industry was in com- plete awe with FTX and it seems only yesterday that SBF was backed by the biggest names in finance, such as Garry Gensler (head of the SEC) – whom he had lunch with regularly – or posing with the head of the CFTC for a promotional photoshoot. SBF was indeed hard to miss as he appeared on the cover of numerous magazines while cozying up with the finance king makers and major deciders.

FTX also quickly got busy and became involved with politics. Indeed, the company acquired a townhouse on Capitol Hill where a myriad of cocktail parties took place. The objective of these get-togethers was none other than try and influence regulators and politicians through campaign donations as well as having law makers directly write to the SEC to dis- regard any preliminary fact finding elements per- taining to the Bahamas based exchange, with the help of their once newly hired head lobbyist, the for- mer CFTC head council.

It all looked like a well-oiled seduction machine and many wondered then how well would a company with no physical presence in the USA yet with a ma- jority its customers base from the latter nationality would fare, on a subject as regulatorily sensitive (or lack of thereof) as cryptos. Well, it went as bad as one could have guessed.

As John J. Ray III’s perusal into the company financials continues, a trove of incredible discoveries follows suit. As it turns out, none of FTX previous financial re- porting documentations are to be trusted. Indeed, Ray believes that the integrity of both the systems and the regulatory supervision have been compromised. Ad- ditionally, he notes that a small group of individuals which he suspects to be potentially corrupted and unfit to be managing the firm – had full control of the company.

More irregularities were also found regarding ques- tionable loans from FTX towards SBF’s many other companies, when they were to remain distinct from each other’s. SBF is also reported to have been roman- tically involved with the CEO of Alamenda, a com- pany he previously created and which was the recipient of a 10 billion dollars loan, directly from FTX.

The plot thickens as there is also the mention of mys- terious and unauthorized transfers from FTX’s own virtual wallets, a drainage totaling more than half a billion dollars shortly before midnight, on the same day of the Chapter 11 announcement. None of the company’s ex-officials seem to know what truly hap- pened there and appear to put the blame on a coordi- nated hacking operation.

The cherry on top of the cake is doubtlessly the fact that FTX was never truly audited and probably may have reported fictitious figures as it pertained to its fi- nancial health.

The plethora of these shocking revelations is still rais- ing eyebrows all around the globe and it is hard for some of the victims to understand how this scheme was permitted to continue.

Who is to blame then?

The big difference between FTX and Maddof’s Ponzi scheme is that Maddof had his offices on 3rd Avenue Manhattan, whereas FTX operates from a totally dif- ferent country. Through the course of the last few years, there had been some warnings emanating from some of the US regulators regarding the risks of in- vesting in such products, on such offshore platforms and without proper US supervision. Now that the party is over, you can be assured that a maximum of distance will be put between FTX’s former parties’ in- vitees and the now defunct company. The rhetoric of old will make its way back and will most likely be the bulk of their defense.

However, what we saw unfold could only occur be- cause of a lack of a dedicated cryptocurrency related regulatory framework, which – if it existed – would have successfully lured companies like FTX into reg- istering into the US. Things would have therefore been vastly different if these exchanges had to observe dis- tinct sets of regulatory standards, as for any other ac- tive financial institution. In addition, the need to draft dedicated consumer protection laws might in fact not at all be warranted. The damage done is such that the investment world has now freshly been reminded of the dangers. For how long ? Only time will tell.

We are clearly at the limit of the “free market” dogma, which advocates that less regulation is best for the market. It is also getting pricier and pricier for investors, venture capitalists to “invest” into what they believe to be the next breakthrough and which will help get rich overnight. Some investment discipline and the introduction of a poised and prag- matic approach when considering investments of this sort might also help reduce the financial impacts on victims.

By Willy Nicolas Annicette, Senior Manager Square Management.
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