Oh the irony...

While questions remain over what was known and by whom about commingled FTX client funds being used to fill a vast and leaking bucket of a balance sheet at Alameda, it appears, based on a report from The New York Times (NYT), that the catalyst for this whole debacle could have been none other than the world's (second) greatest Democrat donor and (ineffective) altruist - Sam Bankman-Fried.

NYT reports that federal prosecutors are investigating whether FTX founder Sam Bankman-Fried and his hedge fund orchestrated trades in a way that led to the collapse of two cryptocurrencies in May - TerraUSD and Luna.

Specifically, Manhattan prosecutors (US attorney for the Southern District of New York) are examining the possibility that Bankman-Fried steered the prices of two algorithmically-interlinked currencies to benefit entities he controlled, including FTX and Alameda Research.

According to two people with knowledge of the matter, NYT reports that the focus on possible market manipulation adds to the legal storm brewing around Mr. Bankman-Fried.

It is illegal for an individual to knowingly stage market activity designed to move the price of an asset up or down.

TerraUSD was a so-called stablecoin, but unlike other stablecoins, its value wasn’t backed directly by the U.S. dollar. Rather, it maintained its value from a second coin called Luna through a complex set of algorithms. Traders within the digital ecosystem could mint these coins, the prices of which would fluctuate based on how many were in circulation. Anytime the price of TerraUSD fell, the supply of Luna would increase, as traders created more Luna to try to capitalize on the difference.

In May, major cryptocurrency market makers — exchanges or individuals who arrange for buyers and sellers to be matched — noticed a flood of “sell” orders coming in for TerraUSD, said one person with knowledge of the market activity.

The orders were in small denominations, but they were placed very quickly, the person said.

The sudden jump in sell orders for TerraUSD overwhelmed the system, making it hard to find matching “buy” orders for them. Under normal conditions, any sell orders that remained unfulfilled for too long would be matched with buy orders at a lower price.

The longer the orders lingered without being matched, the more they forced down the price of TerraUSD and caused a corresponding drop in Luna prices because of the way the two coins were linked..

(Click on image to enlarge)

The exact causes of the collapse of the two cryptocurrencies remain unclear. However, the bulk of the sell orders for TerraUSD appeared to be coming from one place: Sam Bankman-Fried’s cryptocurrency trading firm, which also placed a big bet on the price of Luna falling, according to the person with knowledge of the market activity.

[ZH: Note the action in late January, early February, when pressure to the downside on Luna saw a positive reaction (flight to safety perhaps) into FTX's Token (FTT). Did Bankman-Fried and his girlfriend think the same would happen when they tried to pressure Luna lower in May?]

Had the trade gone as expected, the price declines in Luna could have yielded a fat profit.

Instead, the bottom fell out of the entire TerraUSD-Luna ecosystem.

The collapse caused more trouble in the cryptocurrency industry, sending several prominent companies into bankruptcy and erasing about $1 trillion in value from the crypto market.

The ripple effects from the Luna crash ultimately contributed to the collapse of Mr. Bankman-Fried’s business empire.

Bankman Fried reportedly told NYT that he was “not aware of any market manipulation and certainly never intended to engage in market manipulation."

“To the best of my knowledge, all transactions were for investment or for hedging,” he added.

NYT does note that the investigation in early stages and that it is unclear if prosecutors have determined any wrongdoing by Bankman-Fried. All of which would be glorious for the screenplay of this whole farce as the 'smartest man in the room' - having been trained on 'arbing' such assets for 'months' - suddenly fell victim to the first lesson learned in any veteran arb-trader's risk management book - volatility wounds but liquidity kills - just ask the Nobel-prize winners at LTCM.

Not realizing that the interlinked and levered chaos that his Luna short's success could cause is perhaps the greatest sin of someone who - for all intent and purpose - could see almost the entire market (positioning, inter-linkage, leverage, and liquidity) through his two toys - FTX and Alameda.

And don't forget that FTX is also under investigation for violating U.S. money-laundering laws that require money transfer businesses to know who their customers are and flag any potentially illegal activity to law enforcement authorities (but we are sure Bankman-Fried had no knowledge of any of that).

On Tuesday, Binance Chief Executive Changpeng Zhao called Bankman-Fried a “master manipulator” and “one of the greatest fraudsters in history.”

Still, we are sure that Maxine Waters will ask him all about this during the hearing next week.

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