Sam Bankman-Fried’s Alameda quietly used FTX client money without sounding alarm bells, sources say

The quantitative trading company founded by Sam Bankman-Fried has been able to quietly use client funds from his FTX exchange in a way that has flown under the radar of investors, employees and auditors in the process, according to a source.

The source says that the way they did it was using billions of FTX users without their knowledge.

Alameda Research, the fund started by Bankman-Fried, has borrowed billions in client money from its founder’s exchange, FTX, according to a source familiar with the company’s operations, who asked not to be named because the details were confidential.

According to the source, the cryptocurrency exchange has significantly reduced the amount that FTX needs to keep on hand if someone wants to cash out. Regulators require their trading platforms to hold enough funds to match what customers deposit. They need the same support, if not more, in the event a user borrows money to make a transaction. According to the source, FTX didn’t have nearly enough.

Its largest client, according to one source, was the Alameda hedge fund. The fund was partially able to cover up this activity because the assets it was trading in did not touch its balance sheet. Instead of keeping any money, the source said, she was borrowing billions from FTX users, and then trading them.

None of this was disclosed to clients, CNBC is aware. In general, mixing and trading client funds with counterparties without explicit consent is, according to US securities law, illegal. It also violates FTX’s Terms of Service. Sam Bankman-Fried declined to comment on allegations of misappropriation of client funds, but said the recent bankruptcy filing was the result of issues with a leveraged trading position.

“The margin deal has taken a big hit,” Bankman-Fred told CNBC.

In conducting some of these leveraged trades, the quant fund has been using a cryptocurrency created by the exchange called FTT as collateral. In a lending agreement, collateral is usually the borrower’s pledge to secure repayment. It’s often dollars, or something else of value – like real estate. In this case, a source said that Alameda was borrowing from FTX, and using the exchange’s internal cryptocurrency, FTT token, to back these loans. The price of FTT tokens fell by 75% in one day, making the collateral insufficient to cover the trade.

Last week, FTX achieved has crashed From cryptocurrency strength of $32 billion to bankruptcy. The blurred lines between FTX and Alameda Research have led to a massive liquidity crisis for both companies. Bankman-Fried is stepping down as CEO of FTX and saying that Alameda Research will be shutting down. The company has since said Remove trading and withdrawalTransfer digital assets offline after a file Suspect $477 million hack.

When asked about the blurring of lines between his company in August, Bankman-Fried denied any conflict of interest and said FTX was a “neutral part of the market infrastructure.”

“I’ve done a lot of work over the past few years trying to eliminate conflicts of interest there,” the 30-year-old Bankman-Fred told CNBC in an interview. “I no longer run Alameda. I don’t work for it, and neither does FTX. We have a separate business team – we don’t want to be given preferential treatment. We want the best we can, to treat everyone fairly.”

Part of the problem, according to the same source, was the FTX network of complex leverage and margin trading. that it “instant margin“The trading feature allows users to borrow from other clients on the platform. For example, if a client deposits one bitcoin, they can lend it to another user and make a return on it.

But every time an asset is borrowed, FTX subtracts the borrowed assets from what they need to keep in their portfolios to match customer deposits, says one of the sources. In the typical case, exchange wallets need to match what customers deposit. But due to this practice, the assets were not individually backed and the company was understating the amount owed to the clients.

Alameda Trading Company was also able to take advantage of this spot margin feature. One source says Alameda has been able to borrow customer money, essentially for free.

The source explained that Alameda can publish the FTT tokens it holds as collateral and borrow customer funds. Even if FTX generates more FTT tokens, it will not cause the coin to depreciate because these coins never made it to the open market. As a result, these tokens retained their market value, allowing Alameda to borrow against them – receiving free money for trading with them.

FTX managed to maintain this pattern as long as it kept the price of the FTT and there was no flow of customer withdrawals on the exchange. The source said that in the week before the bankruptcy filing, FTX did not have enough assets to match customer withdrawals.

The source said that external auditors may have missed this discrepancy because client assets are an off-balance sheet item and, therefore, will not be reported in FTX’s financial statements.

It all collapsed last week.

CoinDesk mentioned The majority of Alameda’s balance sheet consists of FTT tokens, which has shaken consumer and investor confidence. Changpeng Zhao (CZ), CEO of one of its biggest competitors, Binance, has publicly threatened to sell FTT tokens on the open market, leading to the collapse of the FTT price.

This chain of events triggered a rush on the exchange, with clients withdrawing nearly $5 billion before FTX paused withdrawals. Sources say when customers went to withdraw their funds, FTX did not have the funds.