While the media focuses on the ongoing fallout of FTX and Alameda Research, what’s still curious and murky is how the two firms actually made money. Is it possible that Chinese capital flight helped fund the American-made cryptocurrency ‘saviour?’
Rumors suggest that Sam Bankman-Fried (SBF) had taken advantage of the ‘Kimchi Arbitrage’ and the Japanese arbitrage — the discrepancy between the price of cryptocurrencies in Korea or Japan with the prices of cryptocurrencies in the US, which meant buying in whichever country presented a discount and selling in the country presenting a premium.
While there absolutely was an arbitrage play during Alameda’s startup period, the idea that SBF — a twenty-something fresh off the heels of a stint at Jane Street — could make it work and sustain it, while billionaires and giant funds couldn’t, seems unlikely.
Risky loans for cash-strapped startup
Leading figures in the Effective Altruist movement SBF and Tara Mac Aulay co-founded Alameda Research in 2017 and, according to reporting by Semafor, received large loans from two key figures: billionaire Jaan Tallinn and cryptocurrency trader Luke Ding.
Supposedly, the loans totaled more than $110 million, but came at an extremely high price: interest rates of 43%.
Only, months later the wealthy duo asked for their money back — with said interest. This hiccup may have begun the unraveling of Alameda Research and, subsequently, FTX.
Possible arb play, but unlikely
Two incredibly wealthy investors bailing on a startup in a “tense” meeting while expecting an early payout with interest is a major obstacle that might make some entrepreneurs and founders give up.
That’s exactly what happened. A host of employees jumped ship in 2018, including co-founder Mac Aulay, who left just one month after the investors asked for their money back. Apparently, those who left had “concerns over risk management and business ethics.”
SBF was left to save the sinking ship. So how did he do it?
The main theory posited has been that SBF successfully navigated the Japanese arbitrage play for bitcoin. However, a consultant familiar with the Japanese banking system explained why that’s easier said than done.
“You’d have to go to substantial effort to find a bank okay with [cryptocurrency arbitrage],” they said. “As a foreigner, moving between yen and USD repeatedly looks like something out of the ordinary. Many [Japanese banks] would feel better if you were able to present as Japanese and socially established.”
This suggests that, unless SBF had a connection within Japan, his ability to perform the bitcoin arbitrage at size would have been significantly restricted.
Meanwhile, there’s no evidence to suggest that SBF ever took advantage of the so-called Kimchi Arbitrage (or any other arbitrage, for that matter).
It’s also worth pointing out that while arbitrage plays can net great returns, there’s usually a reason the arbitrage exists; from regulatory loopholes and travel costs to banking issues and safety concerns. SBF’s ability to wade through these financial minefields is dubious at best.
New money begets new money (Ponzinomics)
It’s unclear when exactly SBF decided he was going to start FTX, though the exchange didn’t open its doors until a year after the initial troubles at Alameda Research. SBF needed to pay out big investors fast.
The quickest way is a tale as old as time: with new investor money.
Unsurprisingly, this is when discrepancies in timelines and accounting practices begin to crop up. It’s entirely possible that SBF took incredibly risky trades and quickly earned enough to pay back the rich duo — who charged the interest rates of loan sharks — and then more on top so that he could sustain the trading business. But that’s unlikely.
Instead, what seems to be a far more reasonable conclusion is that SBF was willing to take on more loans and more investors to pay out the ones he owed money to.
A strange discrepancy reveals Chinese funding for FTX
FTX’s first seed round ever reported happened in 2019. It included cryptocurrency investors of note from the US, China, and Singapore. However, there’s a strange discrepancy on Crunchbase: a seed round from January 2018 with a single investor, Redline DAO.
It’s most likely an error in reporting on Crunchbase’s part, but upon further digging the questions only continue to mount.
Redline DAO was once simply called Redline Blockchain Capital — a venture capital fund based out of China that changed its name to Redline DAO… just because. There’s no mention of a governance token, no cooperative sharing of profits, no reason to be called a DAO at all.
Additionally, the DAO calls itself an “encrypted venture capital institution” — a concept that genuinely doesn’t make any sense.
Regardless, the DAO, according to its own blog post, is associated with Zhejiang Honglin Technology Group Co. LTD. Now, the company is called Zhejiang Hongyi Holding Management Co., Ltd.
The leadership of Redline DAO is a young, small team. Except, Protos research has unearthed that Chen Xuchong, chief of parent organization Zhejiang Hongyi, is a business veteran. Chen is connected to 92 companies; 31 as an ultimate beneficiary, 18 as a shareholder, and 14 as CEO.
Redline DAO claims to have six sub-funds of $20 million each and a portfolio consisting of at least 41 investments — almost exclusively web3 and DeFi related companies and products. Protos reached out to Redline DAO to ask when they invested in FTX and were only told that they “were an early stage investor of FTX.”
Genesis Block and bribes
Redline DAO, as one of the first investors in FTX, isn’t where the Chinese capital connections come to an end. As reported in FT, Genesis Block was a Hong Kong-based OTC desk partially owned by Alameda Research.
Executive leadership boasted of customers lining up with bags of cash and ownership over dozens of ATMs throughout the city, allowing for the easy exchange of HKD for cryptocurrencies or vice versa.
More directly, SBF has been charged with spending $40 million to bribe Chinese government and banking officials to have a billion dollars worth of cryptocurrencies unfrozen. The bribe, if true, apparently worked. By the time FTX and Alameda Research had moved to Hong Kong, SBF appeared to have established deep ties and connections on the mainland.
Chinese firm Redline exits the FTX investment
While Redline DAO wouldn’t expand on when they entered or exited their FTX investment, spokespeople did explicitly state that SBF bought them out of their investment. They refused to answer whether the firm was concerned about a possible clawback from the estate, saying instead that FTX and Alameda Research “were doing well financially back then.”
They insisted that customer funds weren’t used to pay out investors, and Redline DAO didn’t share how much it was paid upon exit, or whether fiat or cryptocurrency was used.
Yet all signs point to Alameda Research and SBF fueling their trading and gambling with early investor cash and FTX customer funds.
It’s unclear how much Chinese capital helped stave off the original problems facing Alameda Research or whether the mainland cash allowed SBF to perpetuate schemes. Undoubtedly, as more facts and figures come to light, more clawbacks occur, and more victims come forward, the answers will materialize.