FTX Crash: Secret Software Change Allows Sam Bankman-Fried’s Crypto Exchange to Use Client Funds

In mid-2020, FTX’s chief engineer made a secret change to the crypto exchange’s software.

He edited the code to exempt Alameda Research, a hedge fund owned by FTX founder Sam Bankman-Friedfrom a feature on the trading platform that will automatically sell off Alameda’s assets if it loses too much borrowed money.

In a note explaining the change, engineer Nishad Singh emphasized that FTX should never sell Alameda positions. “Be very careful not to get liquidated,” Singh wrote in the platform’s code comments, which shows that he helped the author. Reuters reviewed the code base, which has not been reported before.

The waiver allows Alameda to continue borrowing money from FTX regardless of the value of the collateral securing those loans. That tweak in the code caught U .’s attentionSecurities and Exchange Commission WILL accused Bankman-Fried of fraud on Tuesday. The SEC said the adjustment means Alameda has “nearly unlimited lines of credit”. Furthermore, the billions of dollars that FTX has secretly lent to Alameda over the next two years did not come from its own reserves, but the deposits of other FTX customers, the SEC said.

The SEC and a spokesperson for Bankman-Fried declined to comment for this story. Singh did not respond to several requests for comment.

The regulator, calling the exchange a “home of tokens,” accused Bankman-Fried of concealing FTX’s transfer of client funds to Alameda for undisclosed venture investments. buy luxury real estate and make political donations. U.S. prosecutors and the Commodity Futures Trading Commission also filed separate criminal and civil charges, respectively.

The complaints — along with previously unreported FTX documents seen by Reuters and three people familiar with the crypto exchange — provide new insights into how Bankman-Fried got its hands on client funds. customers and spend billions of dollars more than FTX earns without the knowledge of their investors, customers, and others. most staff.

Police in the Bahamas, where FTX is headquartered, arrested Bankman-Fried on Monday night, leaving the 30-year-old former billionaire heavily disgraced. His company collapsed in November after users rushed to withdraw their deposits and investors evaded his request for more funding. FTX declared bankruptcy on November 11, and Bankman-Fried stepped down as chief executive officer.

Bankman-Fried apologized to the customer, but said that he personally does not think he should bear any criminal responsibility.

The SEC complaint states that the automatic liquidation waiver written into the FTX token allows Alameda to continuously increase the credit line until it “grows into the tens of billions of dollars and becomes practically limitless.” It’s one of two ways Bankman-Fried transfers customer funds to Alameda.

The other mechanism is one whereby FTX customers deposit over $8 billion (approximately Rs 64,940 crore) in traditional currency into a bank account secretly controlled by Alameda. The lawsuit says these deposits were reflected in an internal account on FTX not affiliated with Alameda, which concealed its liability.

Safe, tested and conservative

When Bankman-Fried grew FTX into one of the largest exchanges in the world electronic money exchange, consumer protection is a central tenet of his cryptocurrency regulation in the United States. Bankman-Fried has highlighted this topic in numerous statements to customers, investors, regulators and lawmakers. He explained that FTX’s automated liquidation software protects everyone.

In his congressional testimony on May 12, he called FTX’s software “secure, tested, and conservative.”

“By quickly releasing the riskiest, least collateralized positions, the risk instrument prevents the accumulation of credit risk that can extend beyond the platform, leading to a spread”.

He didn’t tell lawmakers about changing the software to exempt Alameda. Indeed, he told investors that Alameda received no incentives from FTX, the SEC complaint said.

Bankman-Fried directed subordinates to update the software in mid-2020 to allow Alameda to maintain a negative balance on its accounts, the SEC complaint said. No other customer accounts at Alameda are authorized to do so, the complaint adds. This will allow Alameda to continue borrowing more FTX funds without providing additional collateral.

In software tweaks made in August 2020, Alameda was designated a “Primary Market Maker” or “PMM,” according to a Reuters review of its codebase. Market makers are dealers who allow an asset to be traded by being willing to buy and sell it.

To account for the change, Singh, the chief engineer, inserted a comment into the code: “Alameda will be liquidated, blocked.” He included a warning “don’t liquidate PMM.”

Only Singh, Bankman-Fried and a few other top FTX and Alameda executives knew about the exemption in the code, according to three former executives briefed on the matter. A digital dashboard used by employees to track FTX customers’ assets and liabilities was programmed to not take into account Alameda’s withdrawals from customers, according to two people and portal screenshots. previously reported by Reuters.

The SEC complaint says Bankman-Fried’s card house “began to collapse” in May 2022.

When the value of crypto tokens plummeted that month, some of Alameda’s lenders demanded repayment. Because Alameda did not have the funds to meet these requests, Bankman-Fried directed Alameda to tap its “line of credit” with FTX to obtain billions of dollars in funding, the complaint said.

Finally, when FTX customers rushed to withdraw their funds this November, panicking over media reports about the company’s financial health, many discovered that their funds had been lost. no longer there.

© Thomson Reuters 2022

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