FTX: Kids Round-tripping in Crypto-land

By Christine Duhaime | December 1st, 2022

Another crypto company bit the dust early this week, and with it, up to US$10 billion in customer money evaporated. BlockFi was a digital currency exchange, deposit-taking institution, and lender. BlockFi also issued and sold securities. It was not government-registered to provide any of those financial services in Canada. In early 2022, it settled a case with the SEC for misrepresentations made to investors.

SBF

Like many others in crypto before it, it promised to “protect your assets” if consumers used its services. On Monday, it filed for bankruptcy protection. According to the bankruptcy filings, consumer assets were put at risk and not protected.

In the past few months, a slew of crypto companies – Terra-Luna, Three Arrows Capital, Celsius, Voyager Digital, FTX and now BlockFi – have gone kaput, and with them, billions upon billions of dollars of customer money are gone. 

Voyager Digital is in a different category than the others because it is a Canadian public company, and one of its directors was a lawyer in British Columbia. It is being sued in the US for being an alleged Ponzi scheme.

The combined losses of those six crypto companies are of unprecedented proportions. This isn’t a Bernie Madoff sized evaporation of customer money held in trust – it’s many Madoffs. Before it blew up, CME Group CEO Terry Duffy said FTX was a pump and dump scheme, eg., like a capital markets fraud scheme.

Some of the founders of the six defunct crypto companies fled to extradition-friendly countries, where they are now professing their innocence in the court of Twitter.

It seems obvious that many crypto guys are not good at running companies but they seem exceptionally good at the art of deception. 

Crypto dudes fool everyone

These crypto dudes fooled executives at the Ontario and Quebec pension funds, they fooled lawyers, they fooled banks, they fooled experienced venture capitalists, they fooled journalists, they fooled members of parliament in several countries, and they fooled regulators. 

Canadian Kevin O’Leary talks about how he was fooled too, and talks about being targeted with hate on social media (and by the media) for his ties to FTX (here).(Footnote 1)

We got a taste of early deception in 2017, when a Canadian crypto dude settled with the SEC (see here) for lying in a pitch deck, on phone calls and in emails to banks, lawyers and investors about advisors, claiming untruthfully that several prominent people were advisors of his crypto company. Not only were they not advisors, but they had no knowledge that their likeness, bio and name were being used without consent to raise money, until reporters called them. 

In crypto culture, some of these guys don’t just fib about advisors, high investment returns or the protection of customer assets – the US government warns that some are impersonating people (see here) as part of their business model.

Where were regulators?

The effects of the six crypto debacles, including British Columbia based Voyager Digital, are rippling across the globe, leaving many wondering how such vast schemes went on for so long without regulators stopping them, despite numerous red flags and warnings.

It’s not like there are no laws to protect the public from this. In Canada and the US, numerous laws, including securities, consumer protection, competition, banking, fraud, financial crime, and lending laws all have a role to play. 

Round-tripping

One of the things emerging from these six crypto debacles is the extent to which crypto is a clubby, secretive world of guys who all know each other, and do transactions between each other. Not only that, if one looks at all of them together, it appears that some of them may have allegedly fronted for each other’s balance sheets or engaged in round-tripping. 

Round-tripping is a type of activity where money (or crypto) is moved in a circuit. It’s a type of financial magic trick that creates the illusion of having funds (or of solvency, assets, or revenues). Round-tripping is unknown to most professionals except in the world of public auditing. We wrote about round-tripping in the capital markets here and here.

With multi-party round-tripping for credit, a number of companies send money to each other, one by one. When credit is obtained by party one, the money is sent to party two. When credit is obtained by party two, the money is sent to party three. Around and around, it goes. The result is that the amount of credit extended by victim banks or other parties balloons, filled with hot air. 

Financial magic

Like all magic tricks, the illusion only lasts so long. The balloon must burst. 

A user on Twitter questioned the money movements of BlockFi and FTX, which we’ve paraphrased:

“BlockFi gave hundreds of millions of dollars to FTX; FTX gave it to its Alameda branch; Alameda gave it to Emergent, a shell company owed by SBF, FTX’s founder; Emergent used the money to buy shares of Robinhood; the Robinhood shares were used as collateral for a loan from BlockFi to FTX; FTX then used that money to bail out BlockFi.”

Changpeng Zhao, the CEO of the world’s largest crypto exchange, Binance, also tweeted about the money movements. We’ve paraphrased what he wrote like this:

“Voyager Digital gave hundreds of millions to Three Arrows Capital; FTX-Alameda gave $100 million to Three Arrows Capital; FTX-Alameda gave $110 million to Voyager; FTX-Alameda then borrowed $377 million from Voyager; Three Arrows Capital went bust; Voyager went bust.”

And then FTX went bust. And then BlockFi went bust.

A circus

But its circuitous, right? 

It was a kind of a merry-go-round of the same money spinning between many of these kaput crypto companies. Unfortunately, there were no adults in sight to turn off the circus lights at midnight and send the kids home. 

1: In that interview, O’Leary pitches using Canadian digital currency exchanges, which he alleges are “safe” if they are public companies – we know that isn’t the case because of the Voyager Digital case – it was a Canadian public company that was a digital currency exchange. FTX operated in several provinces in Canada, as well, as a digital currency exchange and it was not “safe”.

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