The Breakdown - Gary Wang and the Alameda Grift History

Episode Date: October 10, 2023

Turns out the grift was there from the beginning. Former FTX cofounder and CTO Gary Wang testified last week and earlier today about the way in which Alameda was privileged and how early the lies began. Today's Sponsor: Kraken Kraken Pro is the one-stop destination for pro traders - https://k.xyz/TheBreakdownPod 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 Tuesday, October 10th, and today we are getting into Gary Wang's testimony at the SBF trial. It was not a pretty sight at the end of last week for Sam, and so we will be discussing all of that. 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 die deeper into the conversation. Come join us on the breakdown discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, guys, before we get into the Gary testimony, I want to address what is obviously the biggest event of the last few days and how I'm thinking about covering it on the show.

I saw a tweet this morning from Mr. Family Office and it said this. I was on an early morning portfolio review call with an investment bank today. I'm always struck by how cold and clinical these guys can be in the face of world events. Quote, the events. in the Middle East, unquote. And then straight into portfolio implications, the macroeconomic impact, scenario planning to protect and grow capital. Nothing on the human costs, the tragedy, the injustice. I'm not saying they should be commenting on the human toll. They're doing their job and doing it well. But it still feels cold how quickly bankers shift to the financial ramifications of tragic events. So, obviously the biggest event of the last few days is Hamas' attack on Israeli civilian and

military targets and the subsequent declaration of war. Now, the breakdown is, of course, a show about big-picture power shifts, and war tends to create exactly those types of shifts. However, at the same time, this is not primarily a show about geopolitics and conflict, but about economics with a special focus on crypto and Bitcoin. So when it comes to what we'll be covering with this war, I'm going to keep it as strictly as possible to those economic considerations and aspects. That's not because I don't have strong feelings about it. I think I might be the only crypto or economics podcaster to have stayed both with Israeli youth organizations in Jerusalem, as well as Palestinian social organizations in the West Bank, and maybe at some point I'll decide it's worth sharing my perspective.

However, at the moment, the conversation is so intense that I don't really think I have all that much of value to add. That is, of course, outside of trying to as dispassionately as possible, keep an eye on the economic dimensions of it, so that's where we'll stay for now. If you have other thoughts on how I should be covering this, feel free to share them in the Discord, but that will be the working plan for the moment. Now, given all that, the most Most obvious and immediate ramification in terms of global economics is in the oil markets. Oil is up as much as 5% since the attacks. Now, neither Gaza nor Israel have significant oil production, but geopolitical instability in the region

could of course have wide-ranging effects. The 1973-Yom Kippur War saw Saudi Arabia put in place oil embargoes on Israel and its allies, which caused a massive oil shock. And while there are no signs so far that Saudi Arabia is looking to repeat that history, further constriction of Iranian oil supply could have a similar effect. Iran is still one of the largest oil producers in the Middle East despite Western sanctions. What's more, Iranian oil experts are rumored to unofficially reach beyond the Arab world and circumvention of sanctions, with Western officials largely turning a blind eye to this practice.

For many reasons, one of the big questions is what Iran's role in these attacks was, and it's not unreasonable to expect that one of the possible outcomes of this is even tighter sanctions. Now, when it comes to other markets, as always, the stock market provides a grim reminder of who benefits from a world at war. All major U.S. stock indices were down on Monday, while the I shares U.S. aerospace and defense ETF surged more than 4%. That increase was led by a 9% rise for Lockheed Martin, an 11% boost to Northrop Grumman, and a 5% bump for Raytheon. Lockheed Martin's increase was its largest on a non-earnings day since March of 2020, even slightly larger than its increase following the Ukraine invasion. In addition to those broad signals, individual investors

are also certainly paying attention. Bloomberg ran a headline this morning, billionaire investor Paul Tudor Jones calls geopolitics, quote, most threatening he's seen. Now, it's clear to Jones that the main question is this Iran question and what the implications are for a further cascade, but whatever the case, he's predicting a recession in the first quarter of next year and argued that the U.S. is in its weakest fiscal position since World War II. Now, if you're in the Bitcoin Twitter space, you probably saw that he also said that he liked Bitcoin and gold right now because those two investments typically perform well during a recession, but that's obviously sort of a secondary story to this analysis. Now, lastly, while the crypto implications are a distant, tertiary

consideration here, for the sake of completeness, there are some elements worth revisiting. In March, the CFTC lawsuit against Binance alleged that executives were made aware that the exchange had been used for transactions related to Hamas in February 2019. Then compliance chief Samuel Lim Lim had noted that terrorist groups usually send, quote, small sums, as quote, large sums constitute money laundering. Lim's colleague allegedly responded that you can, quote, barely buy an AK-40 seven with 600 bucks. Now, given that Hamas is formerly recognized as a terrorist organization and is heavily sanctioned, their attack on Israel will likely see a renewed focus on the financing of terrorist groups via crypto transactions and put Binance even more squarely in the sites of policymakers looking

to crack down. There has already been a groundswell of senators looking to put even tougher anti-money laundering provisions for the crypto industry, and these attacks could provide justification to get that legislation across the line. Now, obviously, these very short-term, immediate response type of things are much less significant than the implications of what a broader conflict might look like. And so, like I said, I will keep an eye on that dimension of the story and bring you what I think is most important to share. And now a word from our sponsor. Today's episode of The Breakdown is brought to you by Cracken. Cracken Pro gives advanced traders a customizable all-in-one interface for trading and buying about 200, depending on your region,

crypto assets, stable coins, and fiat currencies. In addition to deep liquidity, world-class security, and a dedicated mobile interface, Cracken Pro also has some of the best in class support, with average support resolution time less than five minutes this year. Go to crackin.com slash the breakdown to get started. Disclamer, not investment advice. Cryptotrating involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc., PVI, DBA, DBA, Cracken. But with that, we move to our main topic, which is, as I said, former FTX CTO and co-founder Gary Wang's test. Indeed, the next couple days is likely to be a little SBF trial heavy, as Gary was on the stand

last week and finished this morning, and then Carolyn Ellison was on the stand starting today. Given that the prosecution considers her their star witness, there should be lots and lots to report. But first, we need to finish up with Gary. Now, Wang, as I said, was a co-founder and CTO at FTX and wrote much of the early code for the exchange by himself. A huge part of his testimony discussed the improper relationship between FTX and Alameda Research. Thursday's testimony set the stage for the jury. As the first substantive question, Wang was asked whether he committed crimes at FTX. He said that he had with Nishad Singh, Carolyn Ellison, and Sam Bankman-Fried.

He went on to explain that, quote, we allowed Alameda to withdraw unlimited funds. He also explained that special privileges for Alameda were coded into the exchange. Now, while Wang owned a 10% stake in Alameda and a 17% stake in FTX, he said that if there was a disagreement, quote, in the end it was Sam's decision to make. And that I think, as you will see, was really the big theme of this entire testimony. Now, that brief amuse-bush of testimony on Thursday really only scratched the surface for what would be revealed on Friday. Prosecutors resumed by discussing the special privileges allowed for Alameda, which again, Wang had said were written into the code. An exhibit was presented which showed the backend wallet management on FTX with an ominous checkbox

labeled Allow Negative. Wang explained that the Alameda account, quote, had Allow Negative to trade more than it had in its account. They had a large line of credit and it could trade faster than others. Wang said that these undisclosed advantages had been used by Alameda throughout the history of FTX and ultimately resulted in their accounts being overdrawn by around $8 billion in Fiat and crypto. Wang said that the money came, quote, from FTX customers. Now, digging into how the allow negative status had come about, Wang said, quote, Sam asked Nishad and I to do it in 2019. Wang later specified that this change was made in July 2019 just a few months after FTX was launched. The DOJ asked how Sam had explained the need to implement this allow negative status. Wang said,

it was about FTT, a cryptocurrency recreated to act as equity in FTC. But it wasn't only used for FTT. Alameda used it to do trading when its account balance was below zero. The implication was, of course, that Alameda had a massive balance sheet of FTT tokens, which later would be revealed to be true, and that while these tokens were not priced at their full value as collateral for other users of the exchange, Sam had decided that they were sufficiently valuable to allow Alameda to go negative without being liquidated. Wang then discussed just how negative Alameda's position had become. He explained that Alameda effectively had no limits on their negative position. He claimed that in 2019, Alameda had been between 50 and 100 million in the red. He said, in early 2020,

I did a database query. Alameda's balance was negative more than FTX revenue. Elaborating, Wang claimed that Alameda had a negative $200 million balance compared to annual FTC's revenues at that time of $150 million. Wang was asked what he thought about this arrangement, which effectively allowed Alameda to borrow customer funds and said, the money belonged to the customers and they didn't give us permission to use their funds for other things. Wang said that he increased Alameda's credit line with FtX multiple times at Sam's direction. He said that after multiple incremental increases, Alameda was granted a $1 billion credit line, and that after even that number was hit, Sam directed him to create an even higher

number, ultimately landing on $65 billion, which was effectively infinite. Wang noted that no other customer, including other market makers, were given a line of credit anywhere near that figure. His recollection was that only a handful of other firms were given credit lines over a million dollars. The prosecution then moved to the backstop fund, which was established in 2019, and Wang said was entirely fabricated. In 2021, FTX claimed this fund held over $5 million in USD and $95 million worth of FTT tokens. Sam promoted it as a $100 million insurance fund. Wang explained, quote, For one, there is no FTT in the insurance fund, it's just the USD number. And two, the number listed here does not match what was in the database. Wang went on to explain the code used to generate this

publicized number, which simply multiplied daily trading volume with a figure around 7500. And yet, according to Wang's testimony, this fund was insufficient to deal with losses accrued by Alameda. In 2021, one trader exploited a bug in the FTX margin lending system to take a large position in a token called Mobilecoin. FTX took a loss in the hundreds of millions of dollars range during this incident, and according to Wang, Sam had told him to make Alameda, quote, take on the loss. He said that this seemed like an attempt to hide the loss on Alameda's balance sheet, rather than realize it on FTX's books, which were being scrutinized by venture capital firms at the time. Now, the cross-examination started on Friday and then went into today, and from what I've read so far, it seemed to me to be a lot of trying to sow little tiny bits of discord and doubt in the jurors. For example, at one point, Sam's lawyer said, Mr. Wang, do you know the difference between solvency and liquidity? Wang said yes. Sam's lawyer said, so you said Sam's tweet about being solvent was true. Wang said, I said it was true.

but misleading. The defense also took quite a bit of time to make sure that the jury knew that Wang was cooperating with the government in hopes of reducing his sentencing. Now, in terms of community reactions, I think that the biggest, biggest thing, the real most damning part of this was just how endemic and early this was to the entire organizational structure. There was a thought that I know many people had when all of this started to come to light. Let's call it the give the benefit of the doubt view. That perhaps this dipping into the customer pot happened over the course of the summer of 2022, in the wake of the Three Arrows collapse and other bankruptcies, that perhaps, in other words, it was a move born of desperation, stupid, illegal, unethical, moral, but based on desperation.

That view never really resonated with me once everything started to come out. It felt to me, like if Alameda had suffered a catastrophic loss at that time, the sensible course of action would have just been to let it fail. FTX was at the time by all accounts a money printing machine, making millions of dollars a day in trading fees. So why would you jeopardize it, right? Well, the only answer that made sense to me at the time was that there was some much deeper rot that went way farther back and that created a scenario where it was impossible to simply let Alameda die because it would reveal too much. It would reveal, in other words, some original sin. Effectively what Gary testified to is the fact that at no point in FTC's history, did Sam ever even consider reasonably separating

these two businesses? They were for him one big financial sandbox. There was never any meaningful distinction, and never, ever a sense of the sacred responsibility to manage people's funds. It sounds like a matter of months that it went from Alameda being allowed into the negative territory to Alameda being able to just borrow anything it wanted, including from FTX customers, including more than FTX customers even had. And this happened in 2019, just months after the exchange was founded. As Autism Capital put it, this was orchestrated from the beginning. Now, extremely problematically for SBF's defense is the fact that Gary also made it very clear

that at every point in all of these decisions, the decisions being made were Sam's. It wasn't Sam not really understanding what's going on. We're not having visibility into Alameda. It's Sam watching the ballooning Alameda debt at every stage and making proactive decisions to have them go into the proverbial customer cookie jar. Now, lawyer Brian Klein noted how devastating this $65 billion line of credit could be for the defense. He said, put yourself in the shoes of these jurors. These are incredible amounts of money for anybody.

They are eye-popping amounts of money. If it was like $300,000 or something, people can be like, okay, it's a line of credit like I get with my house. Those are numbers people can relate to. When you're talking about $65 billion, nobody can relate to that. It's just an incredible amount of money. It's a devastating fact for the defense. I don't know how they're going to spin that. Now, speaking of the defense, multiple commentators have noted just how much of a struggle the last few days of witness testimony have been for the defense. Cross-examination is often

delved into unrelated or repetitive topics, with the judge specifically calling out the defense on this issue. As Friday's hearing day came to a close, for example, the defense asked Wang whether he had attended math camp with Sam and whether he wrote code. The judge said this line of questioning appear to be designed to run out the clock and called the hearing to an early close. On top of that, the defense has often been admonished for their imprecise or meandering questioning. Prosecutors have been consistently objecting to questions that fall outside of the rules of procedure. On Thursday, for example, most of their 84 objections were recognized as legitimate. One particularly noteworthy question was about whether FTX developer Adam Yadidia had ever seen a Toyota Corolla,

which was used as a symbol of Sam's frugal existence. The question was not allowed to proceed, with the judge stating, I don't think there's anybody in the room who has never seen a Toyota Corolla, so let's get on with it. Now, one other interesting note, on Sunday, prosecutors asked the court to prohibit the defense from introducing evidence or argument about FTX's investment in Anthropic. This is that $500 million investment into an AI Foundation model startup that appears to be worth $3.5 or $4 billion based on a reported fundraising round that Anthropic is currently seeking in the $20 to $30 billion valuation range.

Many reports have suggested that the value of that equity in Anthropic may be enough to make customers almost entirely whole. The defense sought to introduce this notion to the jury, but prosecutors said, quote, such evidence would therefore be wholly irrelevant and present a substantial danger of unfair prejudice, confusing the issues, misleading the jury, undue delay, and waste of time. Basically, the defense wants to say this because they think the jury's going to be more sympathetic if people didn't actually lose money ultimately, even if it was a pain in the butt to get it back. And the prosecution is saying, Sam isn't just charged with losing people money. He's charged with fraud. Now, on Monday night, something that we anticipated happening happened, when Sam's lawyers asked the court's approval to introduce the advice of counsel defense during their continued cross-exam.

examination of Gary Wang. Specifically, they requested permission to ask questions concerning the involvement of counsel in structuring the loans issued to Mr. Wang by Alameda research. During preparations for trial, Sam was expected to claim that he was heavily reliant on the advice of legal counsel in making decisions regarding FTX's and Alameda's finances. The argument was barred from being mentioned during opening statements, although the judge was undecided if they would allow it to be introduced during witness testimony. Overall, the strong sense of the community is still that this is just a crazy uphill battle for SBF's defense. As Sean Tuffy put it,

My favorite part of the SBF defense is that after years of cultivating a reputation as unique genius, he's pivoting to claiming he's dumb as a sack of hammers. Unfortunately or fortunately, depending on your perspective, my strong guess based on what I've seen so far of her testimony, is that tomorrow we will be back once again on the SPF trial, with everything shared by Carolyn Ellison on the stand. But until then, be safe and take care of each other. Peace.