The Downfall

SBF will be held at MDC while awaiting trial on seven counts of fraud and money laundering, for which he faces up to 115 years in prison. The government charges that he embezzled and misappropriated billions of dollars in customer deposits at his then crypto exchange, FTX, and used those funds to bankroll speculative venture investments, buy real estate in the Bahamas, make over $100 million worth of political contributions, and, of course, enrich himself.

Among other things, the Department of Justice (DOJ) has compiled millions of pages worth of evidence to prove that:

• SBF commingled the funds of FTX customer deposits with Alameda Research, a hedge fund that he had founded but publicly insisted was a “completely separate entity”;

• Alameda’s balance sheet was padded with FTT, cryptocurrency tokens created by SBF, which were used as collateral to secure billions of dollars in loans;

• SBF and Alameda CEO Caroline Ellison deliberately inflated the value of FTT tokens in order to give the impression of a healthy balance sheet;

• SBF funneled over a hundred million dollars into illegal campaign contributions;

• Executives at FTX bribed a Chinese official to unfreeze trading assets there, and also made false statements to a US Bank; and

• Despite repeated statements and tweets while FTX was unraveling in November that the only thing that “matters right now is trying to do right by customers. That’s it,” and that “every penny of [raised funds] — and of the existing collateral — will go straight to users, unless or until we’ve done right by them. After that, investors — old and new — and employees who have fought for what’s right for their career, and who weren’t responsible for any of the fuck ups,” in reality, SBF and other executives prioritized certain creditors at the expense of FTX customers and for the personal benefit of SBF.

Among the government’s star witnesses is Ellison herself, then CEO of Alameda Research and also Bankman-Fried’s on-again, off-again girlfriend. Ellison has apparently turned over notes from meetings and personal notes and to-do lists, which include one list titled “Things Sam is Freaking Out About.” According to the DOJ, among the items on this list are: “Alameda’s trading hedges, bad press about the relationship between Alameda and FTX, and fundraising.” The DOJ also has in its hands a recording by an Alameda employee from a meeting during the hedge fund’s final days, where Ellison offered a “general overview of the situation”:

Starting last year, Alameda was kind of borrowing a bunch of money via open-term loans and used that to make various illiquid investments. . . . Then with crypto being down, the crash, the — like, credit crunch this year, most of Alameda’s loans got called. And in order to, like, meet those loan recalls, we ended up borrowing a bunch of funds on FTX which led to FTX having a shortfall in user funds.

I guess, like, then — yeah, what does this mean? I guess, mostly I wanna say, like, I’m sorry. This really sucks. It really sucks for all of you guys. I think it’s, like, really not fair to you guys. Like, I think you’ve been doing a great job. You’ve been working really hard. . . . I think my current default plan is that Alameda will likely wind down once we can, like, repay all of our creditors and sort of wind down a bunch of our, like, whatever remaining obligations we have. Yeah. Totally, like, definitely no pressure for anyone to stick around. . . . Even if you are sticking around or whatever, like, definitely feel free to take a break. Like, go sleep, like, whatever.

Which brings us back to how SBF went from playing video games at parents’ Palo Alto home while on bail to getting escorted by US marshals to Brooklyn’s Metropolitan Detention Center. Last week, a federal judge revoked Bankman-Fried’s bail after concluding that he had tried to interfere with witnesses, most recently by leaking the contents of his coconspirator and ex-girlfriend’s personal diaries to the New York Times in an effort to discredit or intimidate her. The judge concluded: “The documents are in part personal and intimate. They are personally oriented, not business oriented. There’s something that someone who has been in a relationship would be unlikely to share with anyone except to hurt and frighten the subject.”

What a stand-up guy.

It’s tempting to think that cryptocurrency’s scam economy is done for. After all, Bankman-Fried’s downfall is only the most prominent and precipitous nosedive to take place in the crypto world of late. Alex Mashinsky, the former CEO of crypto lender Celsius, is also awaiting trial. Meanwhile Do Kwon, the creator of the now-crashed “stablecoin” Terra (a crash that triggered a domino effect of crypto bankruptcies), faces eight counts of fraud and conspiracy (at least once he’s done serving time in Montenegro for using a forged passport).

Beyond this, the train of crypto bankruptcies keeps rolling, from crypto custodian Prime Trust to crypto lender Genesis Global Capital. And that’s to say nothing of the usual flow of scams, hacks, and multimillion-dollar thefts.

The SEC’s Warpath

Perhaps most important, US regulators (and some of their counterparts overseas) finally seem determined to put the kibosh on crypto trading. Earlier in the year, the Securities and Exchange Commission (SEC) filed charges against crypto exchange Kraken and crypto firm Paxos. By May, the SEC had doubled the size of its crypto enforcement unit.

This has come along with more oversight and attention to banks and accounting firms that work with crypto companies. Early this summer, the SEC filed its most significant charges yet, against Binance, the world’s largest crypto exchange, and Coinbase, the United States’ largest crypto exchange.

The SEC is on the warpath to define most cryptocurrency tokens, with the exception of Bitcoin, as securities (tightly regulated financial instruments). If they succeed, it will deem any exchanges or broker-dealers that buy and sell these crypto tokens illegal.

The die-hard Bitcoin “maximalists” argue that the regulatory war with crypto doesn’t matter anyway. Bitcoin isn’t the target of the SEC, and Bitcoiners have concluded that weeding out other coins and projects will only strengthen their OG project. Other crypto proponents have recently concluded that the worst is behind them and the technological force unleashed by Bitcoin will continue to grow, “as sure as we are the sun will rise tomorrow.” (Daniel Kuhn wrote this for CoinDesk a week after the cryptocurrency news site laid off almost half its editorial staff.) The article ends on a rousing: “Crypto isn’t just playing the long game; it’s playing a game that may not have an end. But like all things that go up, prices and sentiment will likely crash again.”

The reality is that whatever crypto’s anti-authority ethos, cryptocurrency as a currency can’t succeed without mainstream adoption, and as an investment, it will not deliver returns without big players buying in. If the SEC makes it impossible for both commercial and retail investors to trade in crypto, both of these schemes are undermined.

And as Bloomberg columnist Matt Levine has argued, going after some of the biggest players in the crypto industry gives us a window into how seriously the SEC takes this fight. “These cases,” he writes, “are high-risk cases for the SEC: Coinbase and Bitcoin are big well-funded companies with good lawyers and lobbyists, they have the resources and motivation to fight these cases to the end, and they do have decent legal arguments.”

It would have been nice if the SEC had gone after crypto before a procession of large crypto entities had paid off celebrities to sell their services as trustworthy (even heroic), pulled in millions of people to invest, then loaned off and lost their money, with nothing more than “oops, sorry” to show for it. But the reality, as Levine argues, is that the SEC, like all financial regulatory bodies, is also a political body. And it has long tended to go after financial threats and misdeeds after the fact, only once it is popular to do so.

What Next for the Scam Economy?

How the SEC lawsuits are resolved won’t be determined for some time. If the SEC wins and most crypto tokens are considered securities, it will deliver a major blow for the cryptocurrency industry in the United States. In either case, there’s still room for pro-crypto politicians to rewrite the rules within Congress and pave the way for some version of a regulated crypto industry. A lot depends on whether crypto’s waning popularity can recover, and — relatedly — how much money can still be made. This will determine who is left to fight for crypto.

In this regard, the scam economy has shown surprising resilience. Despite continued volatility, speculators sniff money. In fact, making money off of volatility is part of the financial sector’s bread and butter. As Bloomberg News recently noted: “One reason for the increased [trading] volume [of coins named in SEC lawsuits] could be that traders are attracted to the possibility of greater price volatility than in the broader market.”

The reality is that capitalism often rather likes scams, as long as a) they make money, and b) you don’t get caught. Alternatively, c) they make money, you do get caught, but the punishment is not too prohibitive or long-lasting. (Cue the death of the subprime mortgage industry after the Great Recession, only to be resurrected some years later with renamed “nonprime” mortgages.)

BlackRock, the world’s largest asset manager, filed an application to run a Bitcoin exchange-traded fund, while Charles Schwab, Fidelity, and Sequoia have gotten behind EDX, a new cryptocurrency platform that operates in a more regulatory-friendly way. One avenue, therefore, is for capitalists to find a more respectable version of crypto, one that allows them to “trade crypto while almost completely rejecting the crypto financial system.”

The other avenue is the traditional “keep pumping the bubble” tack, so that investors can ride the hype train for at least a little while longer until the next crash and burn causes more financial harm. A current popular approach: hitch the waning-hype-of-crypto train to the waxing-hype-of-AI train. Worldcoin, for instance, marries the two, and for that has managed to raise $125 million in venture capital and reach a $3 billion valuation.

The project was cofounded by another Sam: Sam Altman, CEO of OpenAI and the creator of ChatGPT. Altman is the new, rising wunderkind. Worldcoin’s mission is to thwart a future AI dystopia (also promoted by Altman?) by cataloging every human in the world and giving us each a unique “proof of personhood” identification, which we can use as the line between humans and machines gets blurry. Worldcoin will build this catalog by scanning every person’s eyeballs, and in exchange for our agreement to get our irises cataloged, they will pay us in their own cryptocurrency.

If you think this sounds like a questionable business model, you’re probably right. But one thing is certain: despite SBF’s welcome and all-too-rare comeuppance, Silicon Valley scams aren’t going anywhere, not soon enough anyway.