Where did FTX’s money go? Crypto investigators offer new clues

TThe collapse of cryptocurrency exchange FTX seemed to materialize out of nowhere: in the space of a week in November, FTX transformed from one of the most respected and trusted parts of the cryptocurrency industry to a bankruptcy disgrace that lost more than $8 billion of his clients’ money, according to authorities.

Large chunks of cash have gone to pay off risky bets made by Alameda Research, the hedge fund started by FTX founder Sam Bankman-Fried. But mounting evidence suggests that the collapse of controversial stablecoin TerraUSD, which some critics have likened to a Ponzi scheme, months earlier may have started a knock-on financial crisis that sent FTX and Alameda tumbling.

The links between the collapse of the highly speculative TerraUSD and FTX, a much more mainstream player in the cryptocurrency market, could help explain how FTX losses have been mounting so rapidly and why it will be extremely difficult for FTX customers to get their money back.

Crypto investigators including Niklas Polk, who is part of a team at blockchain analytics firm Nansen, they have been on the trail of the missing billions of FTX by monitoring the transactions recorded on the blockchain. Polk recently co-authored a report containing evidence that after the TerraUSD crash, hundreds of millions of dollars in cryptocurrencies were transferred from FTX to major crypto lenders.

While much of the press coverage has focused on Bankman-Fried’s political donations and Bahamian real estate empire, those expenses seem to pale in comparison to Alameda’s debts after Terra’s collapse. Whether specific customer deposits can be directly linked to Alameda’s debt repayments remains to be determined.

Where did the money go?

FTX, founded in 2019, has enabled consumer investors to buy cryptocurrency and withdraw deposits, similar to how traditional financial institutions work. Alameda was created two years before FTX and was founded by Bankman-Fried as a quantum trading firm that made big bets on various parts of the crypto ecosystem.

Perhaps the biggest question left over from FTX’s bankruptcy is “where did the money go?” And the first part of that response the regulators say they already know. The Commodity Futures Trading Commission (CFTC) claims in a complaint filed last week that most of the lost customer deposits were used to cover risky bets and debts for Alameda Research.

FTX and Alameda were supposed to operate separately from each other, but Nansen found a wealth of blockchain evidence that the companies have been intertwined since FTX’s inception, with funds flowing freely between them. Alameda Research used FTX’s funds as an unlimited line of credit, the CFTC claims. Alameda was the only account on the platform allowed to have a negative balance, according to the CFTC.

Bankman-Fried says the mingling of funds between Alameda and FTX was unintentional but the result of his and others’ misreading of “confusing internal labeling,” he told Reuters.

In a cryptocurrency bull market, billions of dollars circulated freely among market participants, allowing Alameda’s use of FTX funds to go largely unnoticed and unquestioned. But in May 2022, the TerraUSD stablecoin crashed, causing a domino effect that wiped out over $400 billion of value in the crypto ecosystem. A stablecoin is so named because it is supposed to stick to the value of the US dollar. Stablecoins are a crucial part of the cryptocurrency ecosystem – when functioning properly, they offer traders the ability to park their volatile cryptocurrencies in a more stable currency.

While some stablecoins are fully backed by dollars held in an account, TerraUSD was algorithmic, meaning it relied on code, market activity, and sheer conviction to maintain its peg to the dollar. The stablecoin’s peg has also been theoretically underpinned by its algorithmic link to another currency, Luna, but many experts have questioned the stability of such a system.

Read more: What can we learn from the fall of the Earth

Several major industry players, including Three Arrows Capital and Voyager Digital, have filed for bankruptcy following the crash of TerraUSD and Luna. The ensuing chaos forced many cryptocurrency lenders to withdraw their loans. Alameda was one of the companies forced to pay, the CFTC says. The agency claims that Alameda did not have the money to service its debts and that in May or early June, at Bankman-Fried’s direction, Alameda directly withdrew several billion additional dollars of FTX users’ funds to pay off his debts. (Bankman-Fried has repeatedly denied that it “knowingly” transferred FTX users’ funds to Alameda.)

Subsequently, FTX’s internal books showed that Alameda owed $8 billion to FTX. But to hide this hole, FTX executives isolated it in a folder called “our Korean friend’s account,” according to the CFTC. (This may be a reference to Do Kwon, the embattled Korean co-founder of TerraUSD and Luna.) Because of this change, the debt no longer appeared on FTX’s records, the agency claims.

An accident, then a flurry of transfers

For the past two months, Polk and other Nansen analysts have been tracking money flows from FTX to Alameda. They published their findings in an extensive report on Nov. 17, which showcases the many frenzied trades FTX made following the TerraUSD crash. Notably, FTX transferred hundreds of millions of dollars worth of cryptocurrencies first to Alameda and then to the trading company Genesis, which had been a major lender to many cryptocurrency companies.

Polk says these transactions suggest FTX users’ funds may have been used to pay off a huge debt to Genesis. It is not yet possible to know for sure whether this has happened, in part because any decisions made internally by FTX or Genesis, including why certain transfers were made, are outside the blockchain and represent a “black hole” for crypto investigators.

“We can tell there is money flowing from Alameda to Genesis in that time frame, which they got from FTX. But there’s no telling whether it was their money or user funds,” says Polk. “And because the Genesis is centralized, we can’t say for sure whether it was used to repay which loans. But since it was a lender , we can at least assume that it was used for that purpose.

In a further twist, the New York Times reported earlier this month that federal prosecutors are investigating whether Bankman-Fried manipulated the markets in TerraUSD and Luna. (Bankman-Fried told al Times was unaware of and did not intend any market manipulation.) The Times quotes an anonymous source who claims that it was Bankman-Fried’s cryptocurrency trading firm that shorted Luna, or placed a giant bet on its fall, thus causing TerraUSD and Luna to crash and trigger a series of knock-on effects which led to the demise of FTX.

This link also has yet to be proven. “We investigated the Earth/Moon incident here, but found no ties to Alameda on-chain, but instead came to the conclusion that (at least on-chain) there wasn’t a single evil perpetrator to be found,” Polk wrote. in a post. he emails TIME. “But that could have just happened off-chain.”

An FTX representative did not respond to a request for comment.

Back payments

FTX, under new management, and federal agencies are now working to recover FTX funds that may be returned to customers. FTX says it has recovered $1 billion in assets, a fraction of the missing $8 billion or more. About $3.1 billion is owed to the company’s 50 major creditors, according to a bankruptcy filing by FTX last month. (It’s unclear whether that $3.1 billion is part of the $8 billion or separate.) Newly appointed CEO John Ray III says FTX may owe more than a million people and companies money.

But it now seems likely that much of the money FTX routed to Alameda is no longer in the hands of the latter company, especially if it was used to pay off debts incurred following the collapse of Earth-Moon.

Timothy Howard, a partner at law firm Freshfields and a former federal prosecutor in the United States Attorney for the Southern District of New York, says recovering money from third parties to return it to clients is possible but tricky. “The Department of Justice is committed to providing reparations to fraud victims. If the assets go to a third party and are the proceeds of a crime, they are potentially confiscable,” he says. “But third parties can bring an innocent defense of the owner – if they were not involved in the crime or had no knowledge or reason to know they were receiving the proceeds of a crime – to challenge the forfeiture.”

In a congressional hearing last week, Ray said Alameda spent a large portion of the money it received from FTX users, making it much more difficult to get the money back. “At the end of the day, we’re not going to be able to recoup all of our losses here,” Ray said. “Money was spent that we will never get back.”

—Reported by Nik Popli

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