Greatest Ponzi Schemes In History

Greatest Ponzi Schemes In History: The collapse of any multi-billion dollar company impacts the larger market, but the sudden, stunning disintegration of crypto exchange FTX threatens to upend entire industries. FTX, which was valued at $32 billion in February 2022, declared bankruptcy on November 11, 2022.

FTX’s founder and CEO, Sam Bankman-Fried, stepped down from his role immediately, and his replacement, John Ray, is left to sort out the mess as best he can. Fortunately, Ray has experience in this type of epic failure. Twenty years ago, he presided over the liquidation of Enron after its disastrous collapse.

Billions in FTX customer assets are unaccounted for, and it will take months to determine what happened to the funds. In the meantime, industry experts and analysts have posited a number of theories – none of which reflect well on Bankman-Fried and FTX.

It appears that FTX allowed sister company Alameda Research to “borrow” customer assets, and some investors have suggested that the entire company is nothing more than a Ponzi scheme.

What Is A Ponzi Scheme?

Charles Ponzi wasn’t the first con artist to defraud investors, and he wasn’t even the first to use the method that bears his name. However, when Ponzi swindled roughly $15 million from tens of thousands of people in the Boston, MA, area in 1920, it was a stunning crime that seared his name into financial history.

The basic structure of Ponzi’s scheme was this: Ponzi persuaded would-be investors that he could deliver 50 percent returns if they trusted him to put their money into “risk-free” international coupons managed by the US Postal Service. He would, of course, “facilitate” all of the transactions.

As Ponzi pulled new investors in, he used their cash to pay the promised returns to earlier investors. Often they put their profits back into the program. The con expanded exponentially until 40,000 people were involved in Ponzi’s scheme. Then the bottom dropped out.

The US Post Office publicly stated that its international coupons couldn’t possibly deliver the sort of returns Ponzi promised, and they started an investigation. The US Attorney General and the Boston Post launched investigations of their own. Ponzi’s investors caught wind of the trouble and attempted to withdraw their funds.

At first, Ponzi tried to pay, but the redemptions kept coming – and there were no new investors to provide a desperately needed influx of cash. Before long, the pyramid collapsed in spectacular fashion.

The destruction touched thousands of investors and caused six banks to fail. Ponzi went to prison. Perhaps the only winner was the Boston Post, which won a Pulitzer Prize for its investigative journalism.

What Are The Most Notorious Ponzi Schemes In History?

In 2022 dollars, Ponzi’s $15 million scam would be valued at roughly $224 million. While it was an enormous amount of money, both then and now, Ponzi’s con pales in comparison to more recent Ponzi schemes.

Some of the biggest Ponzi schemes in history include:

  • Lou Pearlman – Though he is known for his success in entertainment as the “additional member” of the Backstreet Boys and ‘NSYNC, Pearlman is better known for defrauding investors out of approximately $300 million through a Ponzi scheme. Pearlman was convicted of this and related crimes in 2008.

  • Scott Rothstein – Clients assumed they could trust a reputable Florida attorney when he encouraged them to invest in large legal settlements. However, it was nothing more than a Ponzi scheme that cost them more than $1.2 billion. Rothstein was convicted of this and related crimes in 2010.

  • Reed Slatkin – Well before Slatkin co-founded the internet service provider EarthLink, he was building the foundation for a Ponzi scheme. The con lasted for more than a decade, during which he stole an estimated $500 million from investors. Slatkin was convicted of this and related crimes in 2003.

  • R. Allen Stanford – With nearly 30,000 investors in at least 100 countries, Stanford’s scheme was one of the most expansive. He managed to steal $7 billion through the sale of non-existent certificates of deposit (CDs), and he used that money to fund a luxurious lifestyle. Stanford was convicted of this and related crimes in 2012.

Of course, no conversation about the greatest Ponzi schemes in history would be complete without mention of Bernie Madoff. Though it has never been precisely determined exactly when he started defrauding his clients, it appears that his massive Ponzi scheme might have gone on for 30 years or more.

In that time, Madoff stole $20 billion in client funds – and that’s just the principal amount they invested. Overall, the scheme was valued at approximately $64.8 billion when Madoff confessed in 2008. As with most Ponzi schemes, Madoff’s downfall was too many redemptions and not enough new investors due to the global financial crisis.

So, how do FTX and Sam Bankman-Fried fit into this group? Was FTX simply a Ponzi scheme all along?

Who Is Sam Bankman-Fried?

So far, major publications are reluctant to call Sam Bankman-Fried a con artist. After all, he appeared to be brilliant, successful, and generous. He was vital to ushering in the age of cryptocurrency through the companies he founded, and based in part on his work, blockchain technology moved from the edges of the economy to a prominent position.

Bankman-Fried, better known as SBF, seemed committed to supporting average investors in the transition to a digital economy. He knew how to attract Millennials and Gen Z to non-traditional assets. After all, at just 30 years old, he is one of them.

SBF graduated from the Massachusetts Institute of Technology (MIT) in 2014 with a degree in physics, and he immediately moved into the world of finance. He began his career as a trader with Jane Street Capital, where he worked with exchange-traded funds (ETFs).

It wasn’t until the end of 2017 that SBF was introduced to cryptocurrency. At the time, Bitcoin was valued at roughly $10,000, and investors were desperate to buy. However, cryptocurrency trading was still in its infancy, and it was nearly impossible to buy and sell bitcoin through conventional trading channels.

There was clearly opportunity on multiple fronts, and SBF waded right in. In November 2017, he started his own quantitative trading firm, Alameda Research. Then, in May 2019, he launched an advanced crypto-exchange platform called FTX (an abbreviation of Futures Exchange).

Are Alameda Research And FTX The Same Company?

Alameda Research and FTX are two separate companies, and they were presented to investors as independent entities. Sort of. Alameda came first, and it was initially headquartered in Berkeley, CA.

However, the decision was made to move Alameda to Hong Kong for one simple reason: a favorable regulatory environment. Specifically, in Hong Kong, Alameda could operate with minimal government oversight.

Alameda Research kept its headcount as low as possible, and its small staff worked around the clock to make profitable trades. It’s important to note that Alameda relied on investors and lenders to supply funds for trading.

Essentially, Alameda made money through cryptocurrency arbitrage. Traders bought cryptocurrency like bitcoin in one country and sold it in another country at a higher price. For example, bitcoin procured in the United States could be sold in Japan for up to ten percent more than the purchase price.

When Alameda Research started out, it was one of the only firms in a tiny niche. Of course, as it became clear that there was money to be made in cryptocurrency, other firms – including large hedge funds – became interested. That limited the profits available to Alameda. Fortunately, with bitcoin prices going up, there was no problem with liquidity.

In fact, SBF was so confident in his ability to generate returns that he included phrases like “no downside” and “high returns with no risk” in his investor presentations.

As anyone who has studied Ponzi schemes knows, such assurances should set off alarm bells. Perhaps they did because SBF decided that borrowing money and attracting investors was too difficult.

How Alameda Connects To FTX

FTX launched as a separate company with financial support from Alameda Research, but the ultimate goal was for FTX to generate funds for Alameda.

FTX was headquartered in the Bahamas, where there is even less regulation, and it generated revenue by charging fees each time clients used the platform to trade cryptocurrency. It’s crucial to note that FTX explicitly assured its account holders that their funds would never be invested or used for any purpose.

In addition to transaction fees, FTX invented a token of its own and encouraged account holders to buy them. Account holders received discounted transaction fees when paying with FTX’s native tokens, FTT, which in turn made the tokens more valuable.

The company’s position as one of the world’s top three crypto exchanges attracted high-profile investors and spokespeople.

Just before the 2022 Super Bowl, FTX raised slightly less than $2 billion in new capital, and it quickly went to work on enhancing its brand. The marketing plan included one of the coveted Super Bowl ad slots. FTX’s ad featured comedian Larry David.

FTX was at its peak during this time. It had a valuation of approximately $32 billion, and Sam Bankman-Fried’s net worth topped $15 billion. That put him on the list of the world’s 100 wealthiest people.

Eight months later, FTX and Alameda declared bankruptcy, and FTX account holders discovered that their assets were gone. What happened?

Why Did FTX Go Bankrupt?

It will be months – if not years – before the details are known, but the basics of the companies’ unraveling come down to this: FTX and Alameda relied heavily on each other – and on the FTT token invented by FTX. When FTT tokens lost value, the entire crypto empire came tumbling down.

Alameda was able to manage the price of FTT because it handled most of FTT’s trades on the open market. FTT hit its highest price in September 2021, when it traded for more than $84. For context, FTT now trades below $1.50.

Alameda held a large quantity of FTT tokens on the FTX exchange, and it valued those assets in the billions. The company used its FTT holdings as collateral for loans and invested billions into crypto startups. That concerned lenders, and some demanded repayment. Then, crypto prices tanked, including Bitcoin, which lost more than 60 percent of its value.

Many more of Alameda’s lenders lost faith in FTT as collateral, and they wanted their money back. It appears that this was when SBF betrayed his account holders. It seems that FTX moved customer funds to Alameda for the purpose of repaying Alameda’s loans – perhaps as much as $10 billion.

The entire situation might have gone unnoticed much longer, but for the researchers at the digital currency news site CoinDesk. An article published on November 2nd suggested FTX’s solvency was precarious, given its dependence on FTT. Researchers had discovered that Alameda’s balance sheet included $14.6 billion in unlocked FTT and $2.16 billion in FTT collateral.

Major FTT investors began selling off their tokens en masse, and retail investors started pulling funds from their accounts. However, redemptions were stopped because FTX didn’t have enough cash to cover account holders’ deposits. Sam Bankman-Fried abruptly resigned, and FTX, Alameda, and all subsidiaries declared bankruptcy on November 11th.

Was FTX A Ponzi Scheme?

John Ray, who is now responsible for sorting out the FTX mess, hasn’t said that the company was a Ponzi scheme. What he did say was this:

Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.

From compromised systems integrity and faulty regulatory oversight abroad to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.

However, the situation does have the hallmarks of Charles Ponzi’s scheme. At a fundamental level, FTX invented its own token, FTT, and sister company Alameda assigned it value. Alameda borrowed against FTT, and when it was time to repay those loans, it used FTX account holders’ funds to do so. Approximately $8 billion is missing.

FTX has suggested that hackers may be responsible for unauthorized funds transfers, and it’s too soon to tell whether that’s true. However, even if cybercriminals made off with a small portion of FTX’s assets, the fact remains that the company’s value was almost entirely dependent on FTT – an asset that FTX created from nothing.

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