Sam Bankman-Fried’s Arrest Shows Crypto Cops Are Catching Up

Working with breathtaking speed, US prosecutors and regulators on Dec. 13 unveiled criminal and civil fraud cases against Sam Bankman-Fried, the disgraced founder of bankrupt crypto exchange FTX, a day after his arrest in the Bahamas. The bombshell moves show how US authorities are combining new technological expertise to crack crypto’s complexity with old workhorse laws against money laundering, securities fraud and wire fraud to protect investors and customers.

The FTX meltdown, along with earlier failures by exchanges, hedge funds, brokers and lenders tied to the crypto industry, had given the impression that the cryptosphere was a lawless, dog-eat-dog arena. But authorities are showing they can combine warp-speed investigations with patient, multiyear searches to nab fraudsters.

Ask James Zhong. In 2012, as a 22-year-old computer science student at the University of Georgia, he accidentally figured out how to pull off one of the biggest cryptocurrency heists ever. While taking out some Bitcoin he was storing on Silk Road, the notorious online black market, he double-clicked the withdrawal button by mistake, getting back twice as much as he’d put in. He deposited more coins and quickly withdrew them, double-clicking each time, to parlay the glitch into a windfall of 50,000 Bitcoin, each worth about $12 at the time.

Turns out, that kind of cheating, even on an illicit enterprise like Silk Road, which the federal government shut down in 2013, is considered wire fraud. Many other crypto crimes can be prosecuted with some of law enforcement’s most versatile tools such as money laundering and securities fraud statutes.

When federal agents figured out Zhong was behind the massive theft years later, they seized the stolen Bitcoin, making it the largest crypto seizure and second-largest financial recovery in US Department of Justice history. Internal Revenue Service agents, working with prosecutors in the Southern District of New York, got a break in 2017, when Bitcoin split into two cryptocurrencies in an upgrade to the blockchain known as a hard fork. Zhong kept his 50,000 Bitcoin, but he also got 50,000 tokens known as Bitcoin Cash, which were worth far less money.

Zhong’s undoing came when he used an overseas cryptocurrency exchange to convert his Bitcoin Cash into 3,500 Bitcoin, according to an IRS affidavit. That helped agents figure out an internet protocol address, says Tyler Hatcher, head of the IRS criminal office in Los Angeles. “From the IP address, we traced it back to Mr. Zhong,” Hatcher says. “We had to do some regular investigative work, put eyes on him and figure out where he is living, what kind of business is he in.” Last month, Zhong pleaded guilty to one count of wire fraud, and the US is recommending 27 to 33 months in prison. Zhong’s lawyer declined to comment.

The case shows how law enforcement agents are mastering a steep crypto learning curve. They’ve analyzed data seized from darknet sites such as Silk Road and formed partnerships with firms that analyze the movement of Bitcoin on the blockchain that serves as a database of most transactions. Crypto-related crime hit a high of about $14 billion in 2021, according to Chainalysis, a blockchain analytics company. While the vast majority of scams go unreported, the Federal Trade Commission in June said 46,000 people had reported losing a combined total of more than $1 billion, primarily from investment scams, in the 15 months ended in March.

Zhong’s case is part of a trio of recent seizures that has resulted in the US sitting on one of the world’s largest Bitcoin caches—about 1.1% of the tokens in circulation. The winning streak began in November 2020, when the IRS seized 69,370 Bitcoin stolen from Silk Road. The hacker, identified only as Individual X, gave up tokens valued at $1 billion. The $3.36 billion bounty from Zhong was eclipsed just a few months later, when the government recovered 94,636 Bitcoin, then valued at $3.6 billion, that had been stolen from the Bitfinex cryptocurrency exchange. In that case, Ilya Lichtenstein and Heather Morgan, a married couple, were charged in February with money laundering. They’ve pleaded not guilty.

Zhong seems an unlikely candidate to pull off a record-setting crypto caper. He was a top student at Central Gwinnett High School in suburban Atlanta before enrolling in 2008 at the University of Georgia. His crime spree began when he took advantage of the software anomaly and opened nine new Silk Road accounts, including one called “thetormentor.” He deposited 500 Bitcoin and netted 2,000 digital tokens in five rapid withdrawals. Over five days, he made more than 140 such withdrawals.

For almost a decade afterward, Zhong enjoyed a rollicking life. Prosecutors can’t account for 2,148 of the Bitcoin he’d amassed, and court records show he moved some of it through so-called mixers that make it harder to trace transactions by jumbling tokens together. He flew on private jets, drove fast cars, partied with a young crowd and invested millions of dollars in Memphis real estate projects, according to affidavits and interviews with friends, neighbors and a business partner, Clayton Kemker.

In 2019, Kemker and Zhong started a real estate business in Memphis. Zhong put down $9 million and pledged $32 million to secure a $60 million loan for two construction projects, says Kemker, who believed Zhong was “some sort of computer genius who figured out Bitcoin early and that’s how he made his fortune.”

It all ended in November 2021. Federal agents had raided his homes and were investigating him for money laundering, Zhong told Kemker. Agents found 50,491 Bitcoin on devices in a safe under floorboards and on a single-board computer stowed in a popcorn tin under blankets in a bathroom closet. Kemker only learned what Zhong had done when prosecutors announced his Nov. 4 guilty plea in federal court in New York.

Zhong agreed to forfeit $42.7 million, representing the value of the missing 2,148 Bitcoin, and his stake in the Memphis projects. At his plea hearing, Zhong seemed chastened. “I knew that my conduct was wrong, and I am truly remorseful for what I did,” he said. He was released on a $310,000 bond and is set to be sentenced in February.

• Read more: The Only Crypto Story You Need, by Matt Levine

To contact the authors of this story:
David Voreacos in New York at dvoreacos@bloomberg.net

Ava Benny-Morrison in New York at abennymorris@bloomberg.net

To contact the editor responsible for this story:
Paula Dwyer at pdwyer11@bloomberg.net

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