Another FTX Scandal: A Secret Software Change Allowed FTX to Use Client Money

Now that former FTX CEO is in custody and is facing serious charges, another story popped up to ignite the fire even more.

In mid-2020, FTX's chief engineer made a secret change to the cryptocurrency exchange’s software.

He tweaked the code to exempt Alameda Research from a feature on the trading platform that would have automatically sold off Alameda's assets if it was losing too much borrowed money.

In a note explaining the change, the engineer, Nishad Singh, emphasized that FTX should never sell Alameda's positions.

"Be extra careful not to liquidate,” Singh wrote in the comment in the platform's code, which it showed he helped author. Reuters reviewed the code base, which has not been previously reported.

In fact, the exemption allowed Alameda to keep borrowing funds from FTX irrespective of the value of the collateral securing those loans. That tweak in the code got the attention of the U.S. Securities and Exchange Commission, charging Bankman-Fried with fraud on Tuesday.

The SEC said the tweak meant Alameda had a “virtually unlimited line of credit.” Furthermore, the billions of dollars that FTX secretly lent to Alameda over the next two years didn't come from its own reserves, but rather were other FTX customers' deposits, the SEC said.

The SEC and a spokesperson for Bankman-Fried declined to comment for this story. Singh did not respond to several requests for comment too.

The regulator, which called the exchange “a house of cards,” alleged Bankman-Fried concealed that FTX diverted customer funds to Alameda in order to make undisclosed venture investments, luxury real estate purchases, and political donations. U.S. prosecutors and the Commodity Futures Trading Commission also filed separate criminal and civil charges, respectively.

The complaints – along with previously unreported FTX documents seen by Reuters and three people familiar with the crypto exchange – provide new insights into how Bankman-Fried dipped into customer funds and spent billions more than FTX was making without the knowledge of investors, its customers and most employees.

The auto-liquidation exemption written into FTX code allowed Alameda to continually increase its line of credit until it “grew to tens of billions of dollars and effectively became limitless,” the SEC complaint said. It was one of two ways that Bankman-Fried diverted customer funds to Alameda.

The other was a mechanism whereby FTX customers deposited over $8 billion in traditional currency into bank accounts secretly controlled by Alameda. These deposits were reflected in an internal account on FTX that was not tied to Alameda, which concealed its liability, the complaint said.

It is important to note that The Securities and Exchange Commission (SEC) has officially charged FTX founder and former CEO Sam Bankman-Fried with defrauding investors.

The charges against SBF come just a day after his arrest by Bahamian authorities at the request of U.S. authorities. Just hours after Bankman-Fried’s arrest, SEC announced they were preparing to file charges against him, which will be separate from the ones leading to his most recent arrest in the Bahamas.