Thursday, December 7, 2023

FTX owner Sam Bankman-Fried’s conviction: how Crypto’s largest “Fraud Triangle” played out

By Dev Chandrasekhar

Late last week, after a five-week trial, the founder and former CEO of bankrupt crypto exchange FTX, Sam Bankman-Fried, was convicted by a New York jury of fraud and conspiracy on all of the seven counts on which he was tried.

A tentative sentencing date has been set for March 28, 2024. Bankman-Fried faces up to 115 years in prison.

Bankman-Fried’s conviction is the first high-profile crypto scalp of the US Department of Justice. It has sent shock waves in the cryptocurrency industry, as the founders and top executives of several other firms being investigated on similar charges face the prospect of big jail time. Besides, a significant overhaul is imminent on the regulation of digital assets.

Bankman-Fried was arrested last December and tried on allegations of defrauding FTX investors and customers, and sister crypto trading firm Alameda Research’s lenders of billions of dollars.

Bankman-Fried’s unsuccessfully argued that Bankman-Fried was a “gifted entrepreneur” who made some bad decisions.

Who is Sam Bankman-Fried?

Bankman-Fried rose to fame in 2019 as the founder of FTX, which quickly became one of the largest cryptocurrency exchanges in the world. He became a well-known figure in Washington, DC, where he advocated for cryptocurrency regulation.

He briefly held the title of world’s richest 30-year-old and pledged to pursue “effective altruism,” donating most of his wealth to popular causes. His fame rose as he differentiated his company from its competitors via a publicity campaign based on these stated “good intentions.”

FTX collapsed in November 2022 after it was revealed that Bankman-Fried had used customer funds to fund risky investments in his personal companies. He was arrested in December 2022 and charged with fraud.

Donald Cressey’s “Fraud Triangle” framework

Bankman-Fried and FTX are just one example of how the rise of cryptocurrencies like Bitcoin and Ethereum, while creating vast opportunities for wealth creation and financial innovation, also created a breeding ground for fraudsters.

The likes of FTX and other fraud-accused firms such as Tether, Three Arrows Capital, TerraLuna, Celsius, FTX, and Terraform show that, in the complex and often opaque world of cryptocurrencies and digital finance, the infamous ”Fraud Triangle”, introduced by criminologist Donald Cressey way back in 1953, might become increasingly relevant to explain and predict rogue behaviors. This framework, traditionally used to analyze white-collar crime, involves three key factors that must be present for fraud to occur: motivation, opportunity, and rationalization.

Motivation: Greed, revenge, power. The dark desires that fuel fraud.

Opportunity: Weak controls, lax oversight, collusion. The openings that fraudsters exploit.

Rationalization: Self-justification, entitlement. The lies fraudsters tell themselves to sleep soundly at night.

ALL three elements of the fraud triangle must be present for fraud to occur.

How FTX and Bankman-Fried fit the Fraud Triangle

In FTX’s case, Bankman-Fried may have been motivated to commit fraud by a desire for personal gain. He used customer funds to fund risky investments in his personal companies. If these investments had been successful, he would have made a lot of money. However, the investments failed, and he lost billions of dollars in customer funds.

Bankman-Fried had the opportunity to commit fraud because of his position as CEO of FTX. He had control over customer funds and was able to use them for his own purposes without being detected. The lack of regulation in the cryptocurrency industry also made it easier for him to commit fraud.

Bankman-Fried may have rationalized his actions by believing that he was acting in the best interests of FTX. He may have convinced himself that the risky investments he was making would ultimately benefit the company. However, he did not disclose these investments to customers or shareholders, and he used customer funds without their permission.

Overall, FTX fits the Fraud Triangle because all three factors were present: motivation, opportunity, and rationalization. Bankman-Fried had the motivation to commit fraud (personal gain), the opportunity to commit fraud (his position as CEO of FTX), and he rationalized his actions by believing that he was acting in the best interests of the company.

Crypto players facing similar charges exhibit a behavioural pattern

FTX apart, the reported charges against, investigations or arrests involving Three Arrows Capital, TerraLuna, Celsius, and Terraform appear to fit the Fraud Triangle nicely.

They were motivated by greed, power, and arrogance. They had the opportunity to commit fraud because of the lack of regulation in the cryptocurrency industry, the complexity of their products and services, and their opaque business practices. They rationalized their actions by believing that they were acting in the best interests of investors, that they were smarter than everyone else, and that they deserved to be rich and powerful.

As the crypto universe soars, investors and regulators must unite to pierce the veils of motivation, opportunity, and rationalization, illuminating the fraud triangle that casts a shadow on this nascent industry. Through this lens, we can chart the rise and fall of cryptocurrencies, shaping the regulations we need to ensure the promise of blockchain technology is realized, while mitigating the risks of fraud and other nefarious shenanigans.

(Dev Chandrasekhar advises corporates on the “Big Picture”. The views expressed are personal opinion of the author.)

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