The Breakdown - BlockFi CEO and Former Colleague Continue the Crush of SBF's Defense

Episode Date: October 19, 2023

NLW covers the latest in the SBF trial, specifically looking at the testimony of former FTX Head of Engineering Nishad Singh and former BlockFi CEO Zach Prince. Today's Sponsor: Kraken Kraken: See what crypto can be - https://kraken.com/TheBreakdown Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Wednesday, October 18th, and today we are doing an SBF trial update. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, we are back to SBF trial coverage. And for those of you who are coming into this fresh, or who just need a little refresher on what

happened last week, the two biggest witnesses in the first full week of the trial were ex-FTX co-founder and CTO Gary Wong and Alameda Research CEO at the time of its failure, Caroline Ellison. Now, both of these folks were damning to Sam's case in different ways. Gary was bad for Sam because his testimony kind of showed the mechanics of implementing their fraud. He discussed when, at various points in the history of FTX, Alameda's very special and privileged relationship with FTX was built into the actual codebase. He also showed that it started extremely early, going all the way back to 2019. Now, Caroline's testimony was damning because it

showed just how much control Sam had over Alameda, even after nominally he had stepped down from the CEO role. Her testimony also made him look like just an utter asshole, but of course, being an asshole isn't illegal. However, the knowledge and control of Alameda is a different story. So after Caroline finished, the next big witness was Zach Prince of BlockFi. There were a few highlights. Prince said that he believed that Alameda research was solvent based on the balance sheets that he had seen. According to Prince's testimony, BlockFi began lending money to Alameda in late 2020 on what he recalled to be, quote, very robust loan agreements. The loans increased in size throughout 2021 after Prince held a conversation directly with Sam. By May 22, Alameda had loaned over a billion dollars from BlockFi, and those

loans formed a substantial portion of their outstanding loan book of between $5 and $10 billion. Now, the problems began after the collapse of the Terra Luna ecosystem. At that point, BlockFi called in Alameda's loans, which were of course in part due to losses that BlockFi had sustained from the collapse of Luna. Alameda repaid that money after which BlockFi made new loans to the firm worth $850 million. Those new loans were partially collateralized, but Prince's said that the collateral was stored on FTX. BlockFi also traded customer funds worth around $350 million on FTX, and so in total, Prince claimed that BlockFi lost, quote, a little over a billion dollars in the collapse of FTX. That loss was enough to force BlockFi into bankruptcy

just a few weeks after FTX went down. And while Prince said that at some point BlockFi might have still needed to fold, that without the losses associated with FTX, it was far from a foregone conclusion. Importantly, part of Prince's testimony was used to explain how crypto lenders worked. He noted that BlockFi customers explicitly agreed to their assets to be lent out, drawing a distinction to how FTX dealt with customer assets without their approval. Once again, SBF's defense struggled on cross-examination. At one stage, they spent multiple questions walking through BlockFi's due diligence process surrounding a particular set of loan documents.

They appeared to be trying to make the point that the loans evidenced to failure of risk management at BlockFi rather than fraud at Alameda. An exasperated prince had to remind the defense counsel that the loan documents related to a loan, which BlockFi's Risk Management Division had refused to make. Now, more than any other testimony that I've seen, it felt to me like when it came to Zach Prince, the reportage inside the room and what the vibe actually felt like, especially to those who were sitting in the jury box,

was really different than just reading about it in the transcripts. David Z. Morris, formerly of CoinDesk and now reporting on the trial for Protos, wrote, One thing about today was that it was clear they were actually effing up. Now, he expanded on that in a longer thread from Protos, quote, at the end of its second week of flailing, the Sam Bankman-Fried defense team took another battering today in court. Under questioning from prosecutors, former BlockFi CEO, Zach Prince, testified that his company would have been unlikely to lend to Alameda research if its balance sheets had accurately reflected its loans to FTX executives and illicit borrowing from FtX

customers. Prince told the jury, I think we wouldn't have worked with them because that's something that's not appropriate. Cross-examining Prince for Bankman-Fried's defense, Mark Cohen spent about 40 minutes attempting to chip away at that claim by walking, Prince through a credit evaluation document. The document showed how BlockFi's risk team evaluated Alameda's balance sheet, specifically examining the risk of using FTT as collateral, in response to Alameda's request for more lending in August of 2021. The defense tried to characterize Prince as having overridden his own risk team in evaluating the loans to Alameda. The real fault, Cohen seemed to imply, lay with anyone stupid enough to trust his client. But after nearly 40 minutes of examining

the loan letter, Prince informed Cohen that in fact the loan had not been made, with Prince, in fact, following the cautious recommendation of his risk team. Later loans were made to Alameda, but against much higher collateral requirements. This appeared to be an attempt to circumvent an earlier ruling by Judge Kaplan, that the defense could not argue that weak due diligence was to blame for the failure of investments or loans to FTX group companies. Cohen seemingly hoped to make a similar point about the use of FTT as collateral, but simply didn't have his facts straight. It would not be a stretch to describe the moment as humiliating for the defense. Maybe summing it up even more, actually, was another tweet from David Morris, where he said,

while it's in short-term memory, here's a gem from SBF's defense team today. Cohen shows Zach Prince a loan agreement between Alameda and BlockFi. Cohen says, this is Caroline Ellison's signature, yes. Prince says yes, but we actually negotiated it with Sam. Cohen says, we can remove this document, Your Honor. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours. Overly designed for some types of people, but not for others.

Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7, 365, and moves at the speed of real life. Not everyone believes it. We've got our fair share of detractors, but that's the way it always is when you're building something new. Cracken is a crypto company that has been through the highs and lows of the industry, facing forwards towards progress throughout. And now they're inviting us to see what crypto can be. Learn more at crackin.com slash the breakdown. Disclaimer, not investment advice.

Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, BVI, BVI, DBA, Crakin. Next up, on Monday, FTX's head of engineering Nashad Singh was called by the prosecution to give evidence against his former co-conspirator, SBF. Nishad is, of course, the third of three major collaborators alongside Gary Wong and Caroline Ellison, who are giving testimony under the terms of a plea agreement. Nishad's early testimony dealt with the expenditure and investments made by FtX.

He confirmed that Sam was closely involved in directing all big ticket spending by the firm. Alongside the widely publicized venture investments into Anthropic AI and Genesis Digital Assets, Nishad detailed a $200 million investment into a venture firm known as K-5. Nishad said that Sam had attended a dinner hosted by K-5, which featured high. high-profile guests, including Hillary Clinton, Kamala Harris' husband, Katie Perry, Orlando Bloom, Kate Hudson, Leonardo DiCaprio, Jeff Bezos, Kendall Jenner, and Chris Jenner. This was, of course, a party around the Super Bowl. After that K-5 dinner, Nashad claimed that Sam said, quote, he was very impressed with their level of connection to influential celebrities and entrepreneurs.

He thought it would be useful for FTX to leverage those connections, end quote. Sam later presented Nishad and FTX CTO, Gary Wong, with a spreadsheet that detailed hundreds of millions of dollars in bonuses and an additional billion dollars in venture funding that he wanted to pay to K-5 and its owners. Now, continuing along this line of questioning, after walking through a number of extravagant outlays, prosecutors asked Nashad about the infamous $30 million Bahamas penthouse, where key FTX executives had all lived together. Nishad talked about the group apartment shopping together and noted that they had considered much less expensive residences. He said that after the group inspected the penthouse, quote, Sam really liked this one.

Sam's a fan of views. Nishad explained that there had been a quote, substantial agreement about if we should go with it, in part because it was really expensive, in part because it's just super ostentatious. Nishad expressed his discomfort to Sam, who said, quote, he would pay $100 million for the drama just to be done with and go away. Nishad took this as a, quote, pretty clear sign that I should shut up and we should move forward with this. Now, separately, Nishad explained that Alameda accepted customer deposits from the very beginning even before the retail FTX exchange had launched. The earliest project was an over-the-counter trading desk. That system was configured for customer deposits to go to Alameda, which

Nishad believed were then forwarded to FtX. Regarding whether Alameda was allowed to use customer funds for its own purposes, Nishad said, I didn't have an affirmative understanding, but using it would break common sense expectations from customers. Nishad then discussed his understanding of the allowed negative feature, which allowed Alameda to run a negative balance on FtX and implicitly use customer funds.

Nishad explained that he had coded the first version of the feature at the direction of Sam and Gary Wong. He explained that because Alameda withdrew many assets that they didn't hold, those withdrawals were, quote, necessarily coming from other FtX customers. Repeating what we all know, Neshad said that this broke with customers' understanding of Alameda's status on the platform. He said, quote, I remember affirmative descriptions from Sam and others that Alameda didn't have special treatment, and this would constitute a form of special

treatment. Neshad also discussed the movement of Alameda's loans to an account where interest wouldn't be charged. He said that Sam was aware of the large amount owed by Alameda to FTX, but said that, quote, in theory, those balances are in banks. It's not something that they're borrowing in sort of the traditional sense. They're custodying it, so they shouldn't be charged interest. Let's move as a liability out of a location where it's being charged interest. Another part of the testimony had to do with the infamous FTX liquidation engine. During the height of its popularity, the FTCX liquidation engine was spoken about in glowing terms. It was said to be so well constructed that it allowed FTX to seamlessly offer margin

loans across multiple assets, which was a feature that was not present on rival exchanges. He said that, quote, even in instances in which a customer account ended up negative, and the insurance fund, which is a sort of bailout pool of cash, was empty, the expected option for resolving the negative balance would be a clawback, but there was nothing in the code that would do that. Instead, the account would remain negative, and Sam or Gary or others would sort of manually handle it however they saw fit. Essentially, Nashad gave evidence that this fabled liquidation engine didn't actually exist. Then the prosecution moved on to the final months at FtX. Nishad claims that he only found out about the massive hole in Alameda's balance sheet in

September once he was asked to help repair it. He said that Sam asked the senior executives to contribute their personal holdings of serum tokens to the balance sheet to, quote, make it appear that Alameda always had more collateral than it did. This manipulated balance sheet was intended to be given to the CFTC. Nishad said that he ultimately didn't contribute his own tokens because it, quote, felt wrong to attempt to trick a federal regulator. Nishad also recalled a conversation with Sam on the balcony of the penthouse, where Nishad asked what would be done about the hole in Alameda's balance sheet. He claimed that Sam said, quote, I'm not sure what there is to worry about. Net asset value is fantastic by almost any

measure. It was super positive even if you don't include FtX and FtX U.S. equity. Nishot burst that bubble by noting that Caroline Ellison and Gary Wong had pointed out that Alameda had borrowed $13 billion and was unable to repay. Sam simply responded, right, that. We're a little short on deliverable. Sam added that the issue had been, quote, taxing me some 5 to 10% of my productivity for this year. Nishad asked Sam, quote, what the hell the plan was? Sam responded with a variety of strategies, including selling off Alameda's illiquid assets, raising more money by selling FTCS equity and holding on until FTCS launch futures trading,

which he believed would happen, quote, any day now. Nishad asked Sam if he considered cutting expenses, which Sam said he was working on. Nishad said he was, quote, blindsided and horrified. I felt really betrayed that five years of blood, sweat and tears from me and so many employees driving towards something that I thought was a beautiful force for good had turned out to be so evil. I knew that customers were betrayed. So many customers had to put their trust in us. And you know, according to Sam's take, chances to rebuild this hole depended enormously on me continuing to try to make the company successful. And I knew that would require me betraying customers and employees. During September,

this was all coming out within Sam's inner circle, SBF planned a trip to the Middle East to attempt a long shot to rescue the company. Although the original plan was to put together a fundraising round for the company, Sam instead suggested doing a deal with Telegram. He said that they should buy $120 million worth of ton tokens, which had been the subject of an SEC enforcement action in 2020, but which were looking to relaunch. Alongside the investment, Sam had said that FTX engineers could build a payment network that utilized the token. Nishad said the plan, quote, made me extremely nervous, getting even longer random illiquid tokens was not something I was excited about, especially when the cost would come from customers. Nishad also discussed political donations that had been made in his name.

He said that FTX Digital Markets CEO Ryan Salem had access to his bank account for the purpose of making these donations. Nishad said that he was used to make donations, quote, for advantageous optics, that it was useful for my name to be associated with some donations, even if the end recipient understood they were really coming from someone else. Now, many people have pointed out that if the organizations or individual politicians accepting these donations knew they were coming from someone else, that would be extremely problematic for them. Finally, to close out the day, Nishad described work he had done to manipulate revenue data for FTCX. He said that at the end of 2021, he had, quote, made transfers from one of Sam's companies to another to FTX to make it appear as though

FTX had higher revenues. Prior to this, FTX had recorded around $950 million in revenue for the year. Unsatisfied, Sam instructed Nishad to make these transactions to ensure that FTC had a billion in revenue for the year. The particular change was that Sam decided to charge his other company for staking serum tokens. Nishad said that he was instructed to backdate the transactions to make it appear that they had been charged throughout the year. Now, in addition to all these details, the other aspect of this testimony was sort of as a check on Sam's character. Sam had explained that he was friends with Sam's brother from high school, and that Nishad had initially felt intimidated by Sam, who he viewed as a, quote, formidable and brilliant person. Nishad said, I had a lot of

admiration and respect for him, but over time that eroded. Now, yesterday, Nishad faced cross-examination. And once again, it was not really that effective. A slate article on Monday characterized the cross-examination so far like this. The cross-examinations have rarely, if ever, directly rebutted the government's severe allegations, which encompass wire fraud, money laundering, and five conspiracy counts related to securities and commodities fraud, among others. More often, the attorneys repeat simple questions on matters the prosecution is already established, before building their way up to potential conclusions that never seemed to land. That characterization sort of held up here with Nishad.

Matthew Russell Lee at Inner City Press on Twitter, who I can't recommend highly enough for the play-by-play coverage, characterized the cross-examination as meandering. Now, that said, CoinDesk did write a piece yesterday called, For once, Bankman Freed's lawyer, lands a punch. The lead of that story is, Nishad Singh, a member of Sam Bankman-Freed's inner circle,

couldn't quite remember what he told prosecutors about his conversation with the fallen cryptocurrency mogul and other FTX executives, he said Tuesday, in response to questioning from SBF's lawyers. The former Bankman-Fried Confidants admission marked the first time since the trial began two weeks ago that the defense had seemingly managed to poke a hole in the case against their client, whose empire crumbled nearly a year ago. I think reflecting on what this testimony did for the prosecution, in many ways it was similar to Caroline Ellison.

In the same way, at one point Caroline finally broke down and really gave the impression of a person who had been racked by guilt with their knowledge of the things that they were doing, Nishad too sort of acted as a voice of consciousness, in that he clearly had guilt around what he was doing, even if he continued to do it. You basically have this situation where everyone around SBF, who knows about all these things that are going on, is getting increasingly uncomfortable with the brazenness of them, and yet is compelled or pressured by Sam to continue and just stop worrying about it. It really reinforces the idea that there was at the center of this story a central, dominant ringleader, which of course isn't really good for the defense.

Now, the next big question is whether SBF himself is going to go on the stand in his own defense. There are hints that he might. In a Sunday night filing, Sam's defense team reiterated their request for better access to Adderall for their client. The defense claimed that Sam has been receiving a single dose before leaving jail on the mornings of court appearances. They claim this dose wears off by the time the trial begins each day, meaning that Sam has been unable to, quote, concentrate at the level he ordinarily would, and that he would not be able to meaningfully participate in the presentation of the defense case. Their letter to the judge said that this lack of Adderall could play a critical role in determining, quote, the critical decision of whether Mr. Bankman-Fried will testify.

Many commentators have taken the position that the defense has been floundering so far. They've struggled to discredit witnesses or present a coherent case during cross-examination. In fact, their performance has been so bad that some are beginning to wonder if the plan is to set up an appeal on procedural grounds, alongside the practical issues with receiving adequate medication, in this letter the defense have flagged one of the grounds for an eventual appeal. The idea that throughout the process, Sam has been denied his right to, quote, meaningfully participate in his defense. Investor Adam Cochran certainly thinks that this is the gambit. He writes, P.S., they don't actually give an F about his meds.

They care about throwing out the trial. Vegan meals, lacking meds, weird medical hours. They'll probably try and claim some mental duress violating his right to compulsory process and self-defense. Does it work? Unlikely, but they want you to pity him. They want the jury to pity him. They want to throw every wrench they can into the gears of justice and grind it to a halt.

Now, others were speculating about whether Sam could actually resist the lore of testifying in his own defense. Delphi Digital General Counsel Gabriel Shapiro wrote, Imagine how epic it will be if SBF actually testifies. He could not even withstand cost examination by Coffeyzilla. Prosecutors will absolutely shred him on cross. Let's just hope he can be that stupid and narcissistic to give us one last show before he's put away for good. Of course, if Sam does make that last Hail Mary decision, you better believe we will be there to cover it. For now, that is going to do it for today's episode. I appreciate you guys listening as always.

Also, one more big thank you to today's sponsor, Cracken. Go to crackin.com slash The Breakdown and see what crypto can be. And until next time, be safe and take care of each other. Peace.