A new generation of industry leaders has set up offshore trading exchanges largely beyond the reach of American regulators.
It is just after midnight in Hong Kong, and Sam Bankman-Fried stares at the trading data on his six monitors, watching a global cryptocurrency crash happening in real time.
Bankman-Fried, a 29-year-old from California, often works around the clock, as he was on that May evening. He naps on a beanbag set up near his computer. A folded-up blanket sits on the floor. He is worth at least US$8 billion on paper.
That is even after the downturn that started in the spring, where total global losses in the value of all cryptocurrency eventually topped US$1.3 trillion. And as Bankman-Fried saw it play out, he knew his business played a role in the collapse.
Cryptocurrency — digital money not backed by any nation — is famous for its wild and frequent gyrations. But FTX, the cryptocurrency trading platform that Bankman-Fried runs, specialises in a kind of trade that was accelerating the global crash.
Most of his customers are betting on future cryptocurrency price fluctuations rather than buying and selling Bitcoin, and they are borrowing to make those bets even bigger.
It is a risky approach. But it can generate big wins.
Now Bitcoin's value was dropping — way down — crushing the highly leveraged bets of bullish traders on FTX and other exchanges and forcing sales of their positions in wave after wave of account liquidations. These forced sales were helping undermine cryptocurrency prices.
"In terms of price movements, the biggest part of it is liquidations," he wrote to The New York Times on May 24 from Hong Kong.
This is precisely the type of situation that US regulators have tried to avoid by prohibiting cryptocurrency exchanges like FTX from selling high-risk futures to non professional investors in the United States. And it is why Bankman-Fried moved to Hong Kong — as he wanted to offer these products, called derivatives.
Bankman-Fried is a crypto nomad, one of a group of industry leaders who once lived in the United States or Canada and have since set up companies with bases of operation where they are to some degree beyond the reach of U.S. regulators.
Others include Changpeng Zhao, 44, Chinese Canadian founder of Binance, who now lives in Singapore; and Arthur Hayes, 35, a Buffalo, New York-born trader who helped create BitMEX, which is based in the Seychelles islands.
It is a tribe that never turns off; trading takes place 24 hours a day, 365 days a year. (Bankman-Fried said he sleeps when he has no meetings and works "the hours when this counterparty is awake and the hours when that counterparty is awake.")
These crypto nomads have built a global playground, inspired by multiplayer online games, with "leaderboards" for customers who go by aliases like Dark Crypto Lord and can win prize giveaways of Teslas or iPhones.
The highly leveraged form of trading these platforms offer has become so popular that the overall value of daily purchases and sales of these derivatives far surpasses the daily volume of actual cryptocurrency transactions, industry data analyzed by researchers at Carnegie Mellon University shows.
It is all supposed to be off-limits to US investors, but it is not. Trading data provided to the Times also shows that billions of dollars' worth of investments from customers with ties to the United States have moved to at least one of these global sites, despite the ban.
"I am not saying this is going to cause the next financial crisis," said Timothy Massad, a former chair of the Commodity Futures Trading Commission, the federal agency that regulates derivatives trading. "But could this be something like the butterfly that flaps its wings in Brazil that sets off a tornado in Texas?"
Zhao, founder of Binance, conceded, in an interview, that "volatility is amplified by the leverage. So that is for sure."
But he and other industry advocates argue that highly leveraged futures trading is widespread on Wall Street and foreign currency exchanges. Some also say they had to relocate because US regulators have not adequately embraced these creative investment opportunities.
"This is not going away," said Mark Cuban, the billionaire entrepreneur, television personality and cryptocurrency enthusiast who is also a backer in a fund that is helping FTX raise capital. "But we're losing a lot of jobs and a lot of financial depth by pushing it overseas."
In fact, FTX just this past week raised US$900 million in capital to help it expand its global operations, and it was valued at US$18 billion. That transaction could push Bankman-Fried's wealth to US$16 billion, Forbes estimated, making him the "wealthiest known crypto billionaire," given that he owns nearly 60% of the company's shares.
Betting On the future
Bankman-Fried was four years out of Massachusetts Institute of Technology when he entered the cryptocurrency industry.
He was still living in California — where both of his parents are law professors at Stanford — and he noticed that Bitcoin and other tokens were at times selling for different prices in different nations.
It was an open invitation for a creative player to make money, with a classic arbitrage manoeuvre: Buy it at the lower price in the United States and sell it at the higher price in Japan.
That ended up being complicated. As he tried to quickly transfer large sums of money, financial institutions moved to shut down his accounts. He also needed Japanese nationals to complete transactions in local banks. But he ended up making tens of millions of dollars on these early moves.
A three-day crypto conference he attended in China in 2018 led to two weeks of meetings and his effectively settling in Hong Kong. "I guess there's a point at which I canceled my lease back in the Bay," he recalled. He decided instead to create a new company, FTX, which specialises in derivatives.
In traditional markets, derivatives are used to help farmers or other businesses hedge against price changes in commodities like oil or grain.
There is some trading of cryptocurrency derivatives in the United States, on platforms like Chicago Mercantile Exchange, which has long offered commodities options and futures in things as diverse as agriculture, energy and metals. But the CME is a classic exchange that has greater restrictions — and federal government oversight — with lower leverage caps available only to professional traders.
Cryptocurrency innovators like Arthur Hayes, one of the founders of BitMEX — short for the Bitcoin Mercantile Exchange — took this classic approach and turned it into a much more lucrative idea, at least for the platforms.
BitMEX began what Hayes called the perpetual swap — a bet on a future price change that does not expire — and eventually offered 100 times leverage. That meant a US$1,000 investment could be instantly translated into a US$100,000 bet on the future price of Bitcoin.
From inception, BitMEX was explicitly intended to attract not only professional traders but also retail investors with a taste for gambling and gamers inclined to risky play, as Hayes explained in an industry talk in 2016. "There are people who offer similar types of products but are focusing on degenerate gamblers, aka retail traders in Bitcoin," he said. "So why don't we do the same?"
The exchange targeted social media advertising to potential customers based in the United States and boasted that to "sign up takes less than 30 seconds."
At least initially, there was minimal effort on the part of some exchanges like BitMEX to screen investors to determine their true identities, as banks and other trading companies in the United States are required to do, or to confirm their actual locations, despite the ban on US participants. Many of the platforms, including BitMEX and Binance, have recently tightened enforcement to try to curb trades by US investors.
This came after the Justice Department filed charges against Hayes late last year, with the government asserting that he and other BitMEX executives were illegally operating a cryptocurrency exchange that handled about US$11 billion in transactions involving at least 85,000 user accounts with ties to the United States. He has since left the company.
But the business model he helped create has only grown in scale.
FTX and Binance are among more than a dozen global cryptocurrency platforms — most of them based in Asia — that now offer perpetual swaps. FTX alone has 1 million users across the world and handles as much as US$20 billion a day in transactions, most of them derivatives trades.
Like their customers, the platforms compete. Bankman-Fried from FTX, looking to outpromote BitMEX, moved to offer up to 101 times leverage on derivatives trades. Zhao from Binance then bested them both by taking it to 125.
#Binance Futures Will Launch #BTC/USD Coin-Ⓜ Perpetual Contract With Up to 125x Leverage
— Binance (@binance) August 10, 2020
➡️https://t.co/ZlNkg0FN8I pic.twitter.com/lP4QQgI98o
Losses for traders can translate into big gains for exchanges.
The platforms earn a transaction fee based on the forced sales caused when the price of the underlying cryptocurrency moves against the trader. The crash in May was started by regulatory rumblings in China and a cryptocurrency move by Elon Musk. But liquidations then helped propel it.
Some executives, like Bankman-Fried, also own related companies that do algorithmic trading to instantly cash in on market distortions that occur during these sell-offs. Bankman-Fried said that he sees no conflict in his businesses playing the two roles, as these moves help keep the markets liquid during major declines.
FTX's, Binance's and BitMEX's founders have each argued that only a small share of their customers actually use high leverage. But even for those making smaller bets, problems can crop up quickly if cryptocurrency prices start to fall. On May 18 alone, there were a total of $1.6 billion worth of liquidations on BitMEX, Binance and FTX, according to Bybt, a crypto derivatives data firm. Collectively, there were US$20 billion in forced liquidations in mid-May.
1) Ok, so something which I think is relevant:
— SBF (@SBF_FTX) May 23, 2021
1) Over the last week, ~$20B of longs have been liq'd
2) Right now, OI ~ $20Bhttps://t.co/6MfnHVmyjJ
"If you play poker, let's say for futures trading, if you go all-in on maximum leverage every single time, the markets are going to move at one time against you, and you're going to be wiped out," said Zhao. "The professional futures traders, they manage risk."
But Michael Green, a crypto critic and the chief strategist at Simplify Asset Management, said the derivatives market is inherently stacked against novice traders. "The math of highly volatile instruments is that the house almost always has to win," Green said, adding that from his perspective, "These are unregistered casinos."
From Shanghai to Malta
Zhao is so focused on the branding of Binance that he has the company logo — two diagonal squares representing bids and asks in trading — tattooed on what he now calls his "crypto arm."
He and his fellow crypto nomads have become global celebrities with millions of followers on Twitter, podcasts and even livestreams on YouTube of their poker games. They are the diplomats of a renegade industry, attached to no particular state.
Binance set up its offices in Shanghai in July 2017. But two months later, when the Chinese government announced a crackdown on crypto exchanges, the company moved to Tokyo.
Japan then announced new crypto exchange rules. "So we said, well, that doesn't fit," Zhao explained. "So we had to move again."
The next stop was Malta, the tiny island nation in the central Mediterranean. Now Zhao does not identify any location as the company's headquarters.
Binance's shifting home base, in a way, reflects his own life story. Born in China to academics, he moved to Canada when he was 12, interned in Japan while studying computer science at McGill University and went on to jobs developing trading products in Tokyo, New York, Singapore, Hong Kong and Shanghai.
"I've been moving around quite a bit in my life," Zhao said. This international exposure gives him "a broader worldview" that informs his business and its borderless mentality.
Other companies have also moved. Dutch cryptocurrency exchange Deribit announced last year that it would be operated by a subsidiary company called DRB Panama, and several of its executives moved to Central America, company officials said. Palm trees and tropical vistas now feature in the executives' social media posts. BTSE, another exchange that specialises in derivatives, moved its headquarters from Dubai, United Arab Emirates, to the British Virgin Islands.
But in some cases, the claimed offshore base of operations is little more than a ruse. BitMEX listed its headquarters as in the Seychelles, an island republic in the western Indian Ocean, yet federal investigators found that most of its employees worked in New York, Hong Kong and San Francisco.
Hayes, the founder, claimed it cost just "a coconut" to bribe Seychellois authorities — less than buying favors from regulators in the United States and elsewhere, federal prosecutors said when they charged him in late 2020. Hayes pleaded not guilty in April, and his case is pending. He now lives in Singapore.
"Arthur Hayes and his co-defendants in this case are innocent, and they look forward to defending themselves in court," Nate Johnson, a spokesperson for Hayes, said.
Until recently, Hong Kong was a gathering place for cryptocurrency gurus, who at least before the pandemic frequently met up at industry conferences held there or at local bars and cafes.
Zhao said the community was what sold him on cryptocurrency. What he found at conferences around the world, he said, "was a very geeky, honest community."
These personal associations sometimes lead to financial ties. Zhao's company was an early investor in Bankman-Fried's exchange, while Bankman-Fried's trading company is a client of Zhao's platform. They talk to each other regularly.
"I think I met him in Taiwan, Hong Kong, Singapore and maybe even Europe," Zhao said of his fellow crypto nomad. "But mostly in Asia."
Bankman-Fried and Zhao said in separate interviews that they are committed to honouring US regulations, even if their global exchanges are based abroad.
But globally, the cryptocurrency derivatives market continues to surge — and there are clear signs that major US players are still pouring money into the game.
More than a dozen major private trading firms with US roots have set up offices in the Cayman Islands and other offshore locations, creating new corporate entities to push money through Binance's and FTX's overseas derivatives platforms on a huge scale, traders involved told the Times.
"I'm not a US person," said one trader who has moved to the Cayman Islands on behalf of a major fund and initially left his family behind in the Midwest to set up the operation. "But I'm still a U.S. citizen."
The trader asked not to be named, as he did not have authority to discuss the arrangement publicly.
This stateless approach to running these cryptocurrency exchanges — mixed with the constant introduction of new, unregulated and often highly risky products — is now facing perhaps its most important test.
Just since June, Binance has been targeted by financial regulators with warnings or other enforcement actions in Britain, the Cayman Islands, Hong Kong, Lithuania, Italy, Poland and Thailand, many of them eyeing its high-leverage derivatives offerings or a new product line introduced this spring that allows customers to buy cryptocurrency-linked versions of stocks like Tesla and Apple.
Facing a backlash, Binance announced in mid-July that it was abandoning the new stock token products.
"The crypto industry is a very nascent industry and the landscape, including the way that cryptoexchanges are regulated, continues to evolve," the company said in a statement to the Times. It attributed the recent scrutiny in part to mainstream embrace of crypto over the last year and said "it's right" for regulators to examine the industry.
Bankman-Fried, toward the end of a three-hour series of interviews with the Times, said it may be time for the industry to pull back on its most extreme offerings, like leverage on derivatives trades as high as 125 times.
"It would just be easier to get rid of it than to keep having to talk about it," he said, proposing a cap of perhaps 10 times, mostly, he added, to fight the perception that the industry is encouraging risky bets, a view he thinks is unfair.
Binance and FTX are also looking to secure a sanctioned space in the U.S. market. They have, within the last two years, opened US-based platforms that do not offer derivatives but instead focus on the buying and selling of actual cryptocurrencies.
FTX also recently bought the naming rights to the Miami Heat arena and put its corporate logo on a patch worn by MLB umpires as it works to build name recognition here. Bankman-Fried, via US$5.6 million in donations, was also one of the biggest givers last year to help President Joe Biden's election effort — although he said in an interview that it was unrelated to his corporate endeavours.
For now, these operations in the United States generate little profit compared to their overseas counterparts. They do follow U.S. rules, though. That does make a difference.
"It's a much less exciting product," Bankman-Fried said.
This article originally appeared in The New York Times.
Written by: Eric Lipton and Ephrat Livni
Photographs by: Lam Yik Fei and Ore Huiying
© 2021 THE NEW YORK TIMES