The FTX Crypto Debacle: Largest Fraud Since Madoff?

Abstract

In her letter to Treasury Secretary Janet Yellen dated September 15, 2022, U.S. Senator Elizabeth Warren requests “the Treasury Department’s (Treasury’s) comprehensive review of the risks and opportunities presented by the proliferation of the digital asset market, which ‘will highlight the economic danger of cryptocurrencies in several key areas, including the fraud risks they pose for investors.” Senator Warren warns, “It is crucial that Treasury “create the analytical basis for very strong oversight of this sector of finance because cryptocurrency poses grave risks to investors and to the economy as a whole.”

Just weeks later, during November 2022 reports emerge that “In less than a week, the cryptocurrency billionaire Sam Bankman-Fried went from industry leader to industry villain, lost most of his fortune, saw his $32 billion company plunge into bankruptcy and became the target of investigations by the Securities and Exchange Commission and the Justice Department.” The demise of FTX and its’ many related crypto entities created contagion and collateral damage for other participants and investors in the cryptocurrency community. The U.S. bankruptcy proceedings of many FTX related entities, scattered across many jurisdictions worldwide, will likely take years to sort out.

Shortly after the Chapter 11 filing, post-bankruptcy FTX new CEO John J. Ray III characterizes the collapse of FTX as the result of “the absolute of concentration of control in the hands of a very small group of grossly inexperienced and unsophisticated individuals who failed to implement virtually any of the systems or controls that are necessary for a company that is entrusted with other people’s money.”

In just a few years Bitcoin and other cryptocurrencies have had a major societal impact, proving to be unique payment systems challenge for law enforcement, policy makers, and financial regulatory authorities worldwide. Rapid introduction and diffusion of technological changes, such as Bitcoin’s crypto foundation the blockchain, thus far continue to exceed the ability of law and regulation to keep pace. The story of FTX and potential consequences for investors and the global financial system is the subject of this paper.

This paper proceeds in thirteen parts. First, is a discussion of the history and growth of crypto currencies. Second, crypto and national security risks is examined. Third, the failure of FTX is introduced. Fourth, bankruptcy. Fifth, the collateral damage thus far to the crypto ecosystem is described. Sixth, the FTX demise is examined in terms of threshold questions that may help to understand what has transpired and how productive policy may be crafted for the future. Seventh, the role of the SEC is explored. Eighth, the CFTC is discussed. Ninth, crypto and the federal Reserve is addressed. Tenth, features the role of Congressional inquiries. Eleventh, explores regulatory implications. Twelfth, focuses on the failure of corporate governance. Thirteenth discusses prosecution and litigation. And last, I conclude.

Keywords: Almeda Research, audit, Sam Bankman-Fried, BlockFi, Celsius, Coinbase, corporate governance, crypto, DARE, digital assets, ethics, EO 14067, Federal Commodities Trading Commission, FCTC, Federal Reserve System, FinCEN, FTX, Genesis, Gary Gensler, national security, SEC, terrorism finance,