It’s been an eventful few weeks since FTX’s November Chapter 11 Bankruptcy filing, and more and more details behind the Sam Bankman crypto empire are coming to light.
One of the main issues centers on what might appear to be the preferential treatment extended to Alameda Research in their dealings with FTX.
Alameda was routinely allowed to exceed FTX borrowing limits that other users of the exchange had to follow.
While admitting that Alameda Research did appear to enjoy a special relationship with FTX during a recent interview with the Financial Times, the founder and ex-CEO of FTX, Sam Bankman-Fried, seemed vague on the specifics of the relationship between the two companies.
Before the bankruptcy proceedings, FTX had made much of its corporate governance and rigid compliance processes. But, laudable as these may have been, it does look like Alameda found a way to slip between the cracks.
The high limits Alamdea enjoyed can be traced back to early 2019 when trading on the platform made up over 40% of all the turnover of FTX. Like other big exchanges, FTX operated on margin, lending traders money in exchange for an initial deposit. Traders would then be able to trade multiple of their deposited funds. This practice is known as Leverage, and while it can help to multiply profits, it does accelerate losses.
While margin trading is a common practice in the industry, it can lead to severe problems if the exposure gets too big. FTX’s exposure to Alameda was one of the critical drivers of the collapse. Alameda could not cover its liabilities towards FTX, estimated at close to $10bn, a crisis that led to the November bankruptcy of both companies.
FTX’s risk management procedures included an auto-liquidation process similar to most retail brokers. When client trades start to go negative, the risk management process automatically liquidates trades to protect the account and the broker from excessive losses. The client either deposits more funds (margin call), or the broker closes out trades to bring the account back within safe levels.
Alameda appears to have benefitted from an exemption to the FTX auto-liquidation protocol, according to John Ray III, the new CEO of FTX. He held few words back in his assessment of the way the exchange was being managed by Sam Bankman-Fried, pointing to a “secret exemption of Alameda from certain aspects of FTX.com’s auto-liquidation protocol.”