FTX employees discovered Alameda's backdoor to withdraw billions

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FTX employees discovered Alameda's backdoor to withdraw billions

Years before the collapse of FTX, some of its U.S.-based employees discovered the so-called backdoor that Alameda Research used to withdraw billions of dollars from the cryptocurrency exchange, people familiar with the matter said.

The employees who made the discovery reported it to the boss of their division, who discussed it with one of FTX founder Sam Bankman-Fried's lieutenants, some of the people said.

The head of the team that raised concerns about Alameda's special privileges was fired in the summer of 2022.

The back door figures prominently in the case against Bankman-Fried, whose trial for criminal charges of fraud began in a New York federal court this week. The former head of FTX has pleaded not guilty to all charges.

Prosecutors say Bankman-Fried stole money from FTX customers, in part by secretly ordering the programming of'special features' that gave Alameda, his crypto trading firm, the ability to treat FTX as a giant slush fund. Court filings revealed that Alameda has a negative balance of $65 billion on the exchange, based on a line buried in FTX's code.

FTX was subject to an automatic liquidation process when they sold their assets if their balances fell below zero. But that didn't apply to Alameda.

In the spring of 2022, a small group of employees discovered some of those special features in FTX's computer code. They were working for FTX, a small U.S. crypto-derivatives exchange acquired by FTX last year. It was being considered whether the code for FTX's main international exchange, based in the Bahamas, could be used in the U.S., where regulations were much tighter.

In May 2015, a LedgerX employee, Jim Outen, wrote a message viewed by The Wall Street Journal.

The LedgerX team unearthed several problematic practices with how FTX managed risk and handled liquidations, including Alameda's ability to go negative and its exemption from normal auto-liquidation procedures. The team was led by Schoening, a Ph.D. in physics, who had previously worked at the Commodity Futures Trading Commission, where she analyzed high-frequency trading and market manipulation.

At the time, the significance of the discovery was not fully clear to LedgerX employees. FTX was still a recognized crypto exchange that would still be half a year before it collapsed, revealing the misuse of customer funds.

The team's leader was sufficiently worried about Alameda's treatment that she reported it to the chain of command. Schoening raised concerns about her team's discoveries with her boss, LedgerX head Zach Dexter, sources familiar with the matter said.

The auto-liquidation issue with Dexter was later discussed with Nishad Singh, FTX's director of engineering and a member of Bankman-Fried's inner circle, the people said. Dexter believed that the problem was solved when Singh removed a section of code, one of these people said.

Singh has pleaded guilty to a crime and is expected to testify against Bankman-Fried at his trial. Prosecutors say Singh knew about FTX's special treatment of Alameda and helped program it.

In early August 2022, Schoening was fired. The firing came after some employees at FTX circulated a file containing what were purported to be screenshots of inappropriate messages she had sent to other employees. Some of the people said the messages were doctored or taken out of context, and suggested that Schoening irritated her bosses by identifying problems with FTX's risk management.

FTX sometimes paid off Whistleblowers who threatened to expose the true fraudulent nature of the FTX Group enterprise, according to a June court filing from the management team that has been steering the crypto exchange through bankruptcy.

The people say they hired the lawyer Banks, who threatened to sue over Schoening's termination. The two sides havehemed out a $5 million settlement but hadn't completed the paperwork for the deal when FTX collapsed in November.

The Miami International executive spokesman declined to comment on the reason for Schoening's firing. She was also told that she is subject to a nondisclosure agreement.