Oct 17, 2023 - Economy

Case against Sam Bankman-Fried crystalizes around witness burned in wrong way risk

Two men walking on a small street along a gothic fence in business suits, heading from light to shadow.

Zac Prince, CEO of BlockFi, leaves federal court Friday in Manhattan. Photo: Yuki Iwamura/Getty Images

The prosecution's case against Sam Bankman-Fried seemed to crystallize last week as Zac Prince, CEO of bankrupt crypto lender BlockFi, concluded his testimony.

Details: BlockFi was both a user of SBF's exchange and a lender to his hedge fund. Worse than that: It used the exchange, FTX, to hold some of the digital assets that served as collateral for loans made to the fund, Alameda Research. That collateral became trapped when FTX halted withdrawals.

The big picture: Prince's testimony Friday appeared to nail both how convincing Alameda was to business partners about its solvency and how safe FTX appeared to its users.

  • Which all becomes more compelling following the parade of testimony from Samglomerate insiders the last two weeks that FTX and Alameda were never what they seemed.

Be smart: A "wrong-way risk" in finance is when your insurance is exposed to the same risk it's meant to protect you from.

  • As Prince testified, he was aware of some degree of wrong-way risk in BlockFi's business with SBF's companies. His firm's risk team flagged the fact that Alameda wanted to secure its loans — largely — with FTT, the exchange token for FTX.
  • FTX and Alameda were closely linked, so bad news for either was likely bad news for the value of FTT.
  • BlockFi made some loans anyway. That's part of the game for a crypto lender, where it could be argued that nearly all assets in the market are highly correlated.

Yes, but: Prince testified that BlockFi took its risk with Alameda and FTX on a calculated basis, based on information that, per the testimony of prior witnesses, SBF intentionally obscured.

The intrigue: Prince got unaudited financials from Alameda.

  • Though he testified that this was endemic with crypto firms, with so few auditors willing to serve them, the expectation was that the presentations were constructed in good faith.
  • "We always relied on the information we got from counterparties to be truthful and accurate," Prince told the jury.

He now believes statements by Alameda were not that.

  • He testified that the existence of loans to Alameda and company executives from FTX — both of which were not disclosed — would likely have dissuaded BlockFi from partnering with any of SBF's companies.
  • "I think we wouldn't have worked with them, because that's not appropriate," Prince said.

The big picture: Prince was a dream witness for the prosecution because his firm got hit by the FTX disaster on so many fronts.

  • When FTX went bankrupt, BlockFi had about $650 million in unpaid loans to Alameda and $350 million in funds stuck on FTX.
  • While BlockFi had other issues in 2022, it would have been able to keep going if not for the default from Alameda, Prince testified.

The bottom line: BlockFi was willing to tolerate some wrong-way risk. According to Prince, it had no idea how wrong way it really was.

Go deeper: The eight balance sheets of Alameda

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