The FTX Crypto Victim Card Can Be Hard to Play

The crypto industry has suffered many booms and busts in its brief lifespan, but nothing like this. Sam Bankman-Fried, currently sitting in a Bahamian jail, has been accused by the US securities regulator of orchestrating a years-long fraud that diverted billions in customer funds from opaque and offshore exchange FTX to a now-bankrupt trading empire.

The outrage among FTX’s roughly 1 million creditors is understandable, as is the skittishness of investors yanking money from other crypto platforms like Binance. Bankman-Fried has tried to present himself as a naive 30-year-old who got out over his skis, but each day brings new reports of elaborate internal tools used to support the profits of trading firm Alameda.

Less understandable, however, is the narrative of victimhood emerging from crypto-friendly firms that did business with FTX as an apparently trusted counterparty.

That includes entities that themselves went under months ago, such as crypto hedge fund Three Arrows Capital — whose co-founder recently claimed FTX colluded to bring it down — and crypto lender Voyager Digital, which said it was “shocked, disgruntled and dismayed” by FTX’s collapse. (Voyager had in September agreed to be bought out of bankruptcy by FTX.)

Meanwhile, Silvergate Capital Corp., which provided banking services to FTX and Alameda, is now in the sights of three US senators who want information on fund transfers between the two entities. Silvergate says it was a “victim” and will cooperate fully.

The causality of some of these claims is a little ironic, considering the likes of Three Arrows Capital and Voyager first went under as a result of a market-wide loss of confidence in crypto following the collapse of stablecoin Terra — and they explicitly said so at the time. Huge swaths of the crypto market were imploding well before FTX’s ultimately empty promises of a bailout.

The bigger issue is these are sophisticated financial institutions whose job it is to manage counterparty risk. Even without knowing the gory details of Bankman-Fried’s alleged deception, it was clear that FTX was an offshore exchange in the Bahamas, whose revenue mostly came from trading instruments that are illegal in the US, in an industry where exchanges take on conflicting roles such as broker and lender and issue tokens with minimal oversight.

There was too much greed and not enough fear. Three Arrows Capital co-founder Kyle Davies has argued that his fund was skeptical of FTX initially but ended up using it partly because of the implicit seal of approval that came from venture capital investors such as Sequoia. Yet it’s more likely that these big crypto exchanges became impossible to ignore because of their booming size and success pulling in huge piles of customer cash with high-risk products. And for Silvergate, FTX helped grow digital-currency customer deposits to $14 billion from $1.2 billion in about a year.

In an era when supposed “hedge” funds were pouring money into web3 gaming and DeFi rather than actual hedges, was it really a “black swan” event that FTX turned out to be a “fraudulent bucket shop” trading against its clients, as Davies recently told hedge-funder Hugh Hendry on a podcast? For an industry that’s younger than the iPhone, where a young billionaire could explain his business in terms remarkably close to a Ponzi scheme, maybe not. As Hendry deadpanned in response: “Well, such is life. ”

If the victim card needs to be questioned, it’s not because it would shield Bankman-Fried from the full force of fraud charges, but because it is legally self-serving for those playing it. 3AC is undergoing its own liquidation procedure, and its co-founders are clearly eyeing a chance at redemption. The liquidators’ legal team recently noted that Davies and his fellow co-founder only started blaming FTX after the exchange’s collapse, while cautioning that the co-founders hadn’t been cooperative in meeting creditor claims.

The chances of crypto markets ever progressing beyond speculative booms and busts will be slim to non-existent without more humility, transparency and a stronger anti-fraud mindset from both regulators and participants. This in turn requires a reckoning for all institutions in the sector that today are pitching FTX as an unpredictable one-off in an otherwise healthy market. We are a long way off.