FTX and Alameda Research: A Case of Misused Customer Funds

FTX's Secret Software Changes

In 2020, FTX made significant software changes under the direction of its chief engineer, allowing Alameda Research to bypass automatic asset liquidation. This change was designed to protect Alameda, a hedge fund owned by FTX's founder, Sam Bankman-Fried, from losing borrowed money. The alteration enabled Alameda to borrow funds from FTX without the typical collateral constraints, essentially granting it an unlimited line of credit.

SEC Charges and Fraud Allegations

The U.S. Securities and Exchange Commission (SEC) has charged Bankman-Fried with fraud, highlighting this software tweak as a key factor. The SEC alleges that FTX lent billions to Alameda using customer deposits instead of its own reserves. These actions were undisclosed to investors, customers, and most employees, leading to severe legal consequences.

Misuse of Customer Funds

FTX's internal documents and staff insights reveal that Bankman-Fried diverted customer funds for unauthorized purposes, including venture investments, luxury purchases, and political donations. The company's financial mismanagement went unnoticed until its abrupt collapse in November, following a rush of customer withdrawals amidst financial health concerns.

Collapse and Aftermath

As the crypto market declined in May 2022, Alameda faced repayment demands from lenders. Without sufficient funds, it relied on its credit line with FTX, exacerbating financial instability. When customers attempted to withdraw funds in November, many discovered their money was gone, leading to FTX's bankruptcy and Bankman-Fried's resignation.

Impact of the Misconduct

The exemptive changes in FTX's code allowed Alameda to operate with significant advantages, unseen by regulators and investors. This misconduct has led to multiple criminal and civil charges against Bankman-Fried, signaling a dramatic fall from grace for the former billionaire and casting a shadow over the crypto industry.