Cryptographic implosion has similar traits to Operation Madoff

“Madoff: The Monster of Wall Street” is a four-part documentary streaming on Netflix. This couldn’t be more relevant given the spectacular implosion of Sam Bankman-Fried and his FTX cryptocurrency empire.

While not much is known about “SBF” and FTX, the similarities to Operation Madoff are striking.

Ponzi Characteristics: Madoff ran a pure Ponzi scheme. He took money from new investors and used it to pay off old investors. Unlike Charles Ponzi, Madoff did not promise investors 100% returns every 90 days. Madoff has promised a steady month-to-month increase of something like 10% a year. Since Madoff wasn’t actually doing anything with the money, investors could withdraw their fictitious profits every year for years and get paid entirely out of their own deposits.

If panicked investors hadn’t started cashing in en masse during the 2008 financial crisis, Madoff could have gone on and on.

SBF and FTX were in the cryptocurrency “industry”. This industry is a Ponzi scheme without Ponzi. Cryptocurrency is a computer creation with no tangible value beyond what a gullible buyer will pay. With no money from new investors, old investors have no way out. Unless you fool a few people all the time, Crypto is a tulip bulb craze with no tulips.

Gullible institutions: Much of Madoff’s money came from “feeder funds.” These are brokers who take money from investors and entrust the actual investment to people like Madoff. Any broker should have known that Madoff’s returns were too good to be true. The split-strike options strategy allegedly used by Madoff was neither new nor unknown. While it could prevent large losses, the strategy could not produce the positive returns reported by Madoff in every sharply falling market.

Institutional “victims” of FTX include Blackrock, Softbank, Tiger Global and Sequoia Capital. It’s no surprise to see Sequoia, duped by Valeant in 2017, or Softbank, which was a major investor in WeWork among other disasters. But couldn’t Blackrock, which manages $8.6 trillion, understand that a Crypto firm buying up other Crypto firms was a house of cards?

Regulatory failure: The Securities and Exchange Commission received numerous warnings about Madoff’s deal, including a demonstration that Madoff’s dummy trades amounted to more than 100% of options actually traded. The SEC didn’t even bother to pick up the phone and call the Depository Trust Company to verify that Madoff was trading something.

FTX operated in a regulatory vacuum. While SEC Chairman Gary Gensler says the Commission has the authority to regulate cryptocurrency exchanges, that is not the case.

Lax Internal Controls: Madoff was audited by a two-person accounting firm and did not hold assets with a third-party custodian.

At FTX, nobody seems to know exactly what happened to all the money.

Ultimately, Madoff’s $64 billion scheme consisted of $19 billion in deposits and $45 billion in fictitious “profits.” About $15 billion of the $19 billion was recovered by hoovering money from investors who withdrew more than they put in. FTX victims can count themselves lucky if they recover so much.

Jeffrey Scharf welcomes your comments. To contact him, write to [email protected]

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