OSINT Blog / Post

July 17, 2024

Could the Downfall of FTX and SBF Have Been Predicted?

Why is FTX in the News?

Earlier this month, the world's second-largest crypto exchange, FTX, filed for bankruptcy, and its billionaire owner, Sam Bankman-Fried (SBF), went from revered industry leader to reckless pariah. Now the target of investigations by the Securities and Exchange Commission and the Justice Department into how he handled the company's finances, SBF had created a house of cards, described by The Guardian as “the corporate equivalent of three children in a trench coat pretending to be a fully grown man.”

As an MIT graduate early on in his career, SBF joined the trading firm Jane Street Capital but quickly exited to experiment with Bitcoin. SBF attributed his career in banking and cryptocurrency to his belief in effective altruism, a belief founded on steps one can take to maximize positive impact on the world. Simply put, SBF’s public goal was to make as much money as possible to enable him to support as many noble causes as possible.

SBF initially worked alone, buying Bitcoin as cheaply as possible in Korea and selling it across other cryptocurrency exchanges in the US where it was trading for a higher value. His arbitrage work led to the establishment of Alameda Research, an investment firm founded in November 2017 by SBF and some college friends. By January 2018, just four months later, Alameda Research was making nearly $1M every day. In May 2019, SBF founded FTX, a cryptocurrency exchange that eventually grew to handle $10-$15B in transfers per day. By 2022, FTX was valued at $32B and SBF was a billionaire. 

So what went wrong and how did it all fall apart? CoinDesk published an article suggesting Alameda Research rested heavily on a digital coin actually invented by FTX, collateralizing an asset invented essentially out of thin air. Soon after, the Wall Street Journal accused Alameda Research of using FTX's customer deposits as loans for trading. This coverage sparked a run on FTX, with customers withdrawing billions of dollars from FTX. SBF tried and failed to secure a last-minute, strategic acquisition or funding round before filing for Chapter 11 bankruptcy. Today, there is a new CEO at the helm as FTX attempts to sort through its debts under court supervision.

What Were the Warning Signs?

The meteoric rise and fall of FTX and SBF begs the question: is there a way this could have all been predicted or avoided? With the right due diligence and tools, could OSINT have provided evidence to support the warning signs in FTX? Reviewing the coverage of FTX, there are several red flags that should have raised concerns to venture capitalists and other investors to prevent them from investing billions of dollars in SBF and his business.

On the surface, SBF appeared to have forged his way through a conventional path, attending a prestigious college and working at an elite investment firm, a background he could point to convey legitimacy. He also claimed to live the lifestyle of a tech entrepreneur, sleeping on a beanbag next to his desk in the office. He frequently spoke about all the good he was doing, pledging around a billion dollars to important political or legislative causes, donating significant sums to charity, and working with the Securities and Exchange Commission to draw up model legislation for regulating the cryptocurrency sector. 

As one dives deeper, however, while it is true that SBF graduated from MIT, he concentrated his studies in physics, a subject with no direct tie to economics, operations, or accounting. In addition, although SBF worked for Jane Street, a respected trading firm, his time there was a mere three years, followed up by a three-month stint at The Centre for Effective Altruism. Further setting off alarms, SBF lived and worked in a $40 million luxury penthouse in the Bahamas, a stark contrast to the public image he cultivated of a tech geek sleeping on a beanbag in headquarters to impress venture capitalists, institutional investors, and customers. One has to wonder, with the appropriate due diligence, should a physics graduate with only three years of trading in fiat currencies at the lowest rung of the ladder really be worth a gamble of billions of dollars in investment?

A CEO Multitasking Playing Video Games While Working

Looking at other publicly-available flags, SBF is rumored to have wowed investors on a video call whilst simultaneously playing video games. He even tweeted that he frequently played League of Legends during calls, evidenced in multiple recordings of interviews where he appears to be frequently clicking and his eyes dart around while speaking. SBF compared his gaming hobby to drinking and gambling, stating it was his way to switch off.

Until FTX hit the news this month, venture capital giant Sequoia Capital themselves had a blog post describing the unusual call with the young founder where in fact he played an intense League of Legends battle during a high-level video call with their investment team and decision-makers. Following this call, Sequoia Capital opted to invest over $100M in FTX, a sum they have now written off as a loss.

Needless to say, a CEO who is unable to provide his full focus during a top-tier investor meeting is perhaps not the right person to be managing billions of dollars. To drive that point home, if a CEO was drunk or unable to drag themselves away from a slot machine during an investment call, their judgment would likely be questioned. SBF’s inability to take a break from gaming during critical meetings for the company should have been a warning sign that prompted enhanced due diligence checks to determine the extent of the problem and identify other issues that might disrupt business operations.

An American CEO Operating Outside the US and its Oversight

In 2019, Bankman-Fried relocated Alameda from California to Hong Kong, a friendlier and less regulated destination for the crypto industry. For similar reasons, FTX was based in the Bahamas in 2021, along with its executive team, drawn by a regulatory setup that enabled risky trading options the United States government prohibited. The external venture capital firms who had invested in FTX had no seats on the board of FTX. Instead, SBF left all oversight to himself and a small cohort of colleagues, most of whom he shared a five-bedroom penthouse within a 600-acre oceanside resort. He lived in that apartment with nine others and claimed that his circle of close colleagues whom he relied on to run the business numbered about 15. FTX executives living in the apartment included Caroline Ellison, CEO of Alameda Research (and SBF’s purported on-again, off-again partner), Nishad Singh, FTX’s director of engineering, Gary Wang, the exchange’s chief technology officer; and Ramnik Arora, the head of product.

FTX’s offshore nature and the living situation of its executives meant that it could never have a truly clean operation, with objective, outside perspectives and appropriate checks and balances. SBF and his small leadership team of inexperienced US nationals instead managed the company in a foreign domicile without assistance or input from any of their experienced investors. On review, this suggests a clear attempt to avoid regulatory oversight.

When conducting due diligence into FTX, investors should have noticed a clear lack of experience in the leadership team, who had all left the same origin company to a small island with limited regulation. Due diligence would also have identified the company had a much smaller employee footprint than competitors like Coinbase and Binance, and many employees reported that it was usually difficult to actually reach SBF, who chose to primarily engage with the small coterie sharing his penthouse.

Inappropriate Use of Company Funds

Unfortunately, the story gets worse. The newly-appointed CEO of FTX, who also guided Enron through bankruptcy, recently revealed that corporate funds were used to purchase homes and other personal items for employees and advisors of FTX. Even more worrisome, there does not appear to exist any documentation that these transactions were conducted as loans. Ultimately, that may mean some or all of the purchased real estate is recorded solely in the personal name of the employees and advisors on the official records of the Bahamas, limiting recourse for securing repayment.

As of today, the source of the corporate funds is not officially or publicly known. Regardless, the situation begs the question, “why is a startup in its growth stage giving multimillion-dollar loans to employees and advisors, particularly those who are not at C-level?” Analyzing the social media channels of FTX employees could have highlighted individuals living beyond a standard lifestyle at their expected level, enabling investors to speculate that company funds may somehow have been used to purchase high-value assets such as houses and cars.

Clear Conflicts of Interest

SBF’s two companies, FTX and Alameda, were always closely linked, to the extent that there have been long-standing allegations of potential conflicts of interest between them. Recent interest from journalists has offered a leaked balance sheet from Alameda Research, which allegedly shows that a significant portion of Alameda’s assets were held in a “margin position”  in tokens created by FTX, effectively meaning Alameda had borrowed billions of dollars in funds from FTX.

Alameda was run by Caroline Ellison, who was working out of the same Bahamas penthouse as SBF and was often seen in the FTX office, obtaining a real-time view of FTX’s trading data. SBF also allegedly contributed to decision-making on big trades. It appears evidence then that both Ellison and SBF would openly exchange or action insights from both Alameda and FTX, demonstrating an alarming lack of distinction between the businesses. A final conflict of interest concern was that Alameda traded heavily on the FTX platform, meaning on some occasions Alameda likely profited when FTX’s other customers lost money. 

The leaked balance sheet and internal insights now known may not have been available to investors at certain points in this sequence of events. However, it was already an open secret that FTX and Alameda were tightly intertwined, despite potential lack of hard evidence. FTX had backing from major investment firms, including Blackrock and Softbank. One further wonders how their due diligence processes supported such an investment. While regulators had not made any obvious moves to investigate links between the companies, public data, such as LinkedIn company employee lists, social media posts, and business directories could have pointed investors toward obvious indicators of risk.

How Can Venture Capitalists Learn from the Mistakes of FTX?

In sum, FTX’s collapse can be chalked up to a number of factors—a young, naive CEO who was out of his depth, unethical business practices, lack of oversight, misuse of company funds, and conflicts of interest. But before the damage was done, there were ample warning signs that could have been brought together to boost skepticism or tip off potential investors about the business. 

That’s where open-source intelligence (OSINT) comes in. Introducing the right OSINT technology during the due diligence process guarantees that no publicly available information will go overlooked on a potential target investment. Through AI and behavior recognition, warning flags like excessive spending on luxuries or unusually close connections between separate entities can be instantly detected and flagged. Better yet, with solutions like Skopenow, venture capitalists and other large investors can automate this whole process. Skopenow scans the internet for data and information relevant to any person or business to provide higher assurance that the right investments are made while, at the same time, investments in “the next FTX” are avoided.

About Skopenow

Founded in 2016, Skopenow is the leader in threat intelligence and OSINT investigations. The company's SaaS platform automates the collection, analysis, and presentation of public open-source information on any person, business, or event. Skopenow is used by over 1,000 top enterprise and government agency customers across the United States, including 20% of the Fortune 500. To learn more about how Skopenow optimizes OSINT in any due diligence, investigation, or research workflow, request a demo and free trial today at www.skopenow.com/try.