A few months before the collapse of FTX, a group of employees discovered a backdoor in the exchange’s code that allowed subsidiary trading firm Alameda Research to have a negative balance of $65 billion, writes WSJ.
According to the publication’s sources, the team reported the discovery to its management, who discussed the problem with one of the assistants to FTX founder Sam Bankman-Fried (SBF). The backdoor was not removed, and one of the managers who raised concerns was fired.
It is expected that preferences for Alameda will be discussed during the ongoing trial of SBF. Among the charges, prosecutors allege that the former head of FTX stole client funds by ordering “special functions” in the software that enabled the trading firm to use the exchange as a lending fund.
According to court documents, investigators discovered a deeply hidden line in the FTX code that gave Alameda the ability to have a negative balance. The positions of an ordinary user in such a situation were automatically liquidated.
Who found the backdoor and what was it?
In the spring of 2022, a small group of employees discovered these software features. They were running LedgerX, a crypto derivatives trading platform that US-based FTX acquired in August 2021.
The team explored the possibility of using the code of a major international exchange registered in the Bahamas in the United States, where regulatory rules are much stricter.
“Just wanted to point out that currently in […] There are several places in the code base where Alameda receives special attention in one way or another,” the publication quotes a message from platform employee Jim Auten dated May 5.
His boss, LedgerX chief risk officer Julie Schoning, responded that “there are less stringent rules on an offshore exchange.”
“But yes, we need to clean up these things,” she added.
Previously, a specialist with a degree in physics worked at the US Futures Trading Commission, where she analyzed high-frequency trading and market manipulation.
According to WSJ interlocutors, the team discovered a number of problems in the methods of risk management and liquidation, including relief for Alameda.
Schoning told her immediate superior, the head of LedgerX, Zach Dexter, about the discoveries. He discussed the liquidation issue with FTX technical director Nishad Singh, who was part of SBF’s inner circle. After the latter removed part of the code, Dexter considered the situation resolved.
Schoning was fired in early August. The reason was allegedly inappropriate messages that she sent to other employees. The document with their screenshots was distributed by some FTX executives.
According to sources, the posts were doctored or taken out of context. They suggest that Schoning irritated her superiors by highlighting problems with risk management.
In June, FTX’s bankruptcy management team said the company sometimes paid “whistleblowers who threatened to expose the true fraudulent nature of the enterprise.”
According to the WSJ, Schoning hired a lawyer and threatened to go to court over her dismissal. The parties allegedly agreed to settle the dispute for $5 million. However, the deal could not be completed before the stock exchange collapse in November.
Singh has pleaded guilty to fraud and is expected to testify against SBF at trial. Prosecutors allege that the ex-CTO knew about FTX’s special relationship with Alameda and helped implement a loophole in the exchange’s software.
What can Bankman-Fried admit?
SBF denies all charges. Former head of institutional sales at FTX Zane Tackett, in an interview with The Block, suggested a possible line of defense for the founder of the exchange on one of the main questions: whether he had illegal access to client funds or whether mismanagement led to the collapse of the exchange.
He believes SBF will try to “overwhelm” the jury with confusing technical details.
“I think he will argue that it was just a spot margin loan – FTX clearly tolerated this practice. Then he’ll go into the intricacies of how that process worked and how Alameda was able to borrow because they had significant collateral, throwing out big numbers like $100 billion,” Tackett said.
He said SBF could also accept that “the margin systems were not as robust as they should have been.”
However, Tackett believes that these statements will face obvious contradictions. The exchange had a discount system in place to prevent risks arising on any particular asset.
“FTX was designed so that the larger the position in a particular asset, the higher the margin discount or the higher the collateral requirement,” the former manager explained.
According to him, it will be clear that SBF and Alameda borrowed without the margin system that worked for the others.
“He obviously knew what he was doing,” Tackett concluded.
During the third day of the trial of the FTX founder, former exchange developer and close friend of SBF Adam Yedidia testified, The Block reports. He spoke about fiat@ftx.com’s automated system for tracking FTX client deposits. In fact, Alameda kept the funds in the bank account of its subsidiary, North Dimension.
“I thought the firm was just holding on to the money,” he said.
Yedidia said that at one point after playing padel tennis with SBF, he asked if everything was okay.
“Last year we were super reliable, this is not the case,” he quoted the FTX founder as saying.
The programmer added that SBF wanted to attract additional funding from Saudi Arabia or the UAE.
Let us remind you that ForkLog spoke about the first days of the trial of the founder and ex-CEO of FTX.
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