How the FTX scam was set up – The “tampered” software and the tactics of deception

In mid-2020, a change was made to FTX's software, whereby the hedge fund of its founder, Sam Bankman-Freed, could virtually borrow indefinitely from the cryptocurrency exchange.

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In mid-2020, the chief engineer of the major cryptocurrency exchange FTX, Nishad Singh, made a secret change to its software.

The “tweaked” software exempted the hegde fund, Alameda Research, owned by FTX founder Sam Bankman-Fried, from the general rule to automatically liquidate assets of companies borrowing from the exchange if the value of their pledges declined.

Thus, the hedge fund could borrow virtually unlimited amounts from FTX, i.e. from the money of the exchange’s clients.

The two misappropriation mechanisms

This was one mechanism for misappropriating the money that some 1 million investors had placed in FTX, who are now facing losses of billions of dollars.

The second mechanism involved the deposits of more than $8 billion made by FTX clients in dollars, which were secretly controlled by Alameda Research to be invested in other companies and real estate and for political donations.

May was the crucial month

The fraud began to take on major proportions last May, when Bankman-Freed’s “paper tower” began to shake, according to a lawsuit filed against him by the US Securities and Exchange Commission (SEC).

With cryptocurrency prices started taking a dive, several of Alameda’s creditors began demanding repayment. As the hedge fund did not have the capital to meet these demands it made use of its open line of credit with FTX to secure billions of dollars in funding thanks to a software change made in 2020.

Finally, when last month FTX clients rushed to withdraw their money after reports of a black hole on its balance sheet, many discovered that it had gone up in smoke.

The SEC’s charges

When Singh secretly changed FTX’s software, he wrote a memo to the platform’s administrators warning them never to liquidate Alameda’s assets. “Be very careful,” he said.

The code change caught the attention of the SEC, which yesterday filed heavy charges against Bankman-Fried for defrauding investors. The exemption from automatic liquidation, which was provided by the FTX code, allowed Alameda to continually increase its credit line “until it reached tens of billions of dollars and became virtually unlimited,” the regulator said.

photo of sam bankman fried
FTX’s former CEO, Sam Bankman-Fried is accused of defrauding investors

Bankman-Fried posed as an investor protector

Strikingly, Bankman-Freed consistently proclaimed that there needed to be a regulatory framework for crypto in the US to protect investors. He even argued that software for automatic liquidation would protect everyone.

In congressional testimony on May 12, he stressed that FTX’s software is “secure, proven and conservative.”

“By quickly reducing the riskiest and least collateralized positions, the mechanism prevents the creation of credit risk that would otherwise extend beyond the platform, leading to a domino effect,” Bankman-Fried said in his testimony.

Of course, he said nothing to MPs about the change that had been made to the software. Instead, he assured them that there was no favorable treatment of Almeda by FTX.

With information from Reuters

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