Commentary
The possibilities of intentional fraud and potential international conspiracy of a web of illicit money-laundering activities cannot be ignored.
But from the vantage point of this author—who was an employee of a cryptocurrency trading firm from 2018 to 2019–the downfall of FTX isn’t shocking at all.
The crypto industry isn’t regulated. And despite their fame and implied size of operations, most cryptocurrency firms are not robust, fully staffed operations befitting their notoriety.
Many of them are the improbable real-life manifestation of what you and a few of your college buddies once dreamed up in your dorm rooms at 2 a.m.
You want to rule the world of finance. You and your buddies are very smart. And you gather a couple years of experience working and you get bored.
Traditionally, it’s very hard to start a financial firm from scratch. You needed decades of experience on Wall Street. You needed a track record and a network of colleagues across industries for financial support. Finance, at its core, is a trust business. You needed, you know, real life and hard-won experience. And a beard and some gray hair can help too. Read the biographies of Stephen A. Schwarzmann for what it takes.
Gen Z might read all that and scoff.
Fortunately (or unfortunately) in the Wild West world of crypto, none of that old-fashioned experience is needed. You don’t need much to create “value” in crypto. And before long, you can generate millions in “magical” market cap.
And voila, you got your “fintech” / “Web3” / crypto firm.
You and your friends are smart and know how to trade stocks. Maybe even worked at a hedge fund (like the founders of FTX and Alameda Research did) for a couple of years to gain some basic street knowledge and intuition about the financial markets. You also know how to code trading algorithms and a slick-looking website.
But compliance, accounting, keeping good records, and setting up the proper internal controls befitting an international exchange? That’s boring.
If you’re a hard-charging, “move fast and break things” type of crypto entrepreneur, you don’t even think all of that is necessary. After all, Uber Technologies founder Travis Kalanick knew he was breaking local taxi laws by introducing ride-sharing, but he’d rather ask for forgiveness than for permission. And with enough users using its platform, Uber was able to force local governments to bend to their will.
And so if you’re operating in an unregulated market, you might even think you can get away with not having such bureaucracy.
There were very little controls at the crypto firm I worked at. Accounts and passwords were shared. Anyone who had it could log onto the exchanges we interacted with and transfer millions of dollars of crypto to their own accounts. Our offline crypto storage (cold wallets) were locked in a safe at night but during the day was piled up on a desk where anyone could pass by and take them. There was little oversight. Paper work and audit trail? Maybe some notes and scribbles that someone will eventually save down if they got around to it.
Was this all by some malevolent intent? No. We didn’t have the time to set up proper processes and controls. We also didn’t know what proper controls should look like. Crypto markets operated very differently from the stock market. And unlike traditional industries, there was no established incumbent company we could copy. And lastly, the market was largely unregulated so there was urgency to make it work. Meanwhile, the crypto industry was booming and it literally rained cash, so those “issues” could wait.
And FTX’s auditor Armanino LLP, who WSJ called a “crypto industry cheerleader,” once touted that it was the first accounting firm to have a subsidiary in the meta-verse.
All of this may sound outlandish. When I read newly appointed CEO John J. Ray III (who was also the CEO of Enron’s bankruptcy entity around 20 years ago) account upon arriving at FTX, these memories came rushing back.
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” Ray said after getting his bearings. “From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”
Ray must have never stepped foot in a crypto firm.
Of course, even Sam Bankman-Fried and his merry band of Gen Z executives should have known that client assets must be kept separate from firm assets. And backdoor channels that bypassed firm oversight present compliance issues. They may have known, but likely though the industry’s opacity and their outward success could mask those deficiencies for some time.
But the broader crypto industry crowned them and enabled them.
The crypto market, the supposed frontier of the “democratization of finance,” created an environment in which inexperienced and rebellious entrepreneurs can set up platforms and take billions of dollars of capital from retail investors without a whiff of regulatory or internal oversight.
American actor Matt Damon declared in a crypto.com commercial that “fortune favors the brave.” Without the proper oversight and guardrails, fortune is also fleeting.
