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Sam Bankman-Fried's rise and fall shows how we live now: we tweet instead of read.
Sam Bankman-Fried doesn't read books. "I would never read a book," he said in a profile on Sequoia Capital's website, which will be used as a reading in journalism classes for the rest of time. "I have a lot of doubts about books," he said. "I don't want to say that no book is ever worth reading, but that's pretty close to what I think."
This mistake isn't impossible to fix because Bankman-Fried, who started the now-defunct cryptocurrency exchange FTX, will soon have a lot of time to read.
I, on the other hand, have a lot of doubts about Sam Bankman-Fried because I've written a lot of books. "There is a lot of loose talk among the crypto bros," I said on May 1.
How about this from Sam Bankman-Fried, … who was asked to explain the practice of yield-farming on Bloomberg’s “Odd Lots” podcast. Yield farming, to put it simply, is borrowing someone else’s crypto tokens in exchange for your own “governance tokens,” and then exchanging the borrowed tokens for higher-yielding DeFi (decentralized finance) instruments.
Like this is a valuable box as demonstrated by all the money that people have apparently decided should be in the box. And who are we to say that they’re wrong about that? … And so then, you know, [the governance] token price goes way up. And now it’s a $130 million market cap token because of, you know, the bullishness of people’s usage of the box. And now all of a sudden, of course, the smart money [goes and pours] another $300 million in the box and … it goes to infinity. And then everyone makes money.
"Forget about the Wild West. This is the Wacko West," I said.
Bankman-Fried was one of the people who talked about cryptocurrency at a conference I went to at the end of September. When this happens, I make notes. My first thought was, "He has a constant jiggling knee problem and an F-word problem." The moderator asked him in a nice way what cryptocurrency was all about. He said, "The industry needs to get its sh*t together," which wasn't very helpful. He said, "Who the f*** knows?" when asked when the "crypto winter" would end. He also said that he didn't want scams on the exchange and that unclear regulations were "more than half" of the problem.
"SBF" was said to be worth a bazillion dollars at the time of the conference (I forget the exact figure that was being bandied about). This has gone from "no money and probably jail" to "no money and probably jail" very quickly.
The most important thing to know is that as of November 10, FTX owed $8 billion more than it had in cash. For a while, people thought that it had been hacked for up to $477 million. In fact, these remaining assets were moved to a wallet that belonged to the Securities Commission of The Bahamas, where FTX was based.
Traders of cryptocurrencies like Genesis and Galois Capital have said that hundreds of millions of dollars are stuck on the FTX exchange. They have a lot of people with them. Shortly, a lot of people who gave SBF their money will never see it again. They might have thought that their crypto was in a safe. Their code is kept in a crypt.
So, what's the best comparison? This past week, I've heard a few: The Lehman moment for Crypto. Long-Term Capital Management is the time for crypto. Nope. In 1998 and 2008, the Federal Reserve stepped in to stop collapses from becoming financial crises. In the case of Lehman Bros., the Treasury had to help out. Some things are too important to fail. This isn't happening because neither FTX nor crypto is a very big deal.
The dot-com bust of 1999-2000 might be a better comparison. But in Web 2.0's mass-extinction event, there wasn't that much fraud. Cryptocurrency might be more like Enron in that it is a bubble and a fraud.
In reality, though, these modern comparisons don't do Bankman-rise Fried's and fall justice. To really understand what just happened, you have to go back 150 years to Anthony Trollope's brilliant book The Way We Live Now (1875). Partially based on the fall of Overend, Gurney and Co. in 1866, the novel tells the story of Auguste Melmotte's rise and fall. Victorian society praises Melmotte as a financial genius, not because he is one, but because he offers the wealthy the chance to get rich quickly.
Today, the internet seems like the best place to make easy money, if only we could "monetize" it. In the 1800s, railroads were another network that made it easy to make money. Melmotte lists the South Central Pacific and Mexican Railway Board on the stock exchange. This company is supposed to build a new railroad line from Salt Lake City, Utah, to Veracruz, Mexico. Even though the railroad doesn't exist, Lady Matilda Carbury and her son Sir Felix are interested in it because it will make them a lot of money in the future. Melmotte and the American businessman Hamilton K. Fisker go together like hand and glove.
Melmotte rises to the top of society in London, buys a country estate, and is elected to the Parliament. Of course, the whole thing is a huge scam, which becomes clear when Melmotte fakes documents to get the money for the country estate. Everything falls to pieces. Melmotte kills himself because he is ashamed.
Orlando Bloom, Tom Brady, Bill Clinton, Katy Perry, and all the other celebrities who recently flew to FTX's base in the Bahamas are today's Lady Carburys. So are the Miami Heat basketball team, for whom SBF paid $135 million to rename their arena, and Larry David, who was in an FTX Super Bowl ad.
But it wasn't only famous people. Some well-known organizations that invested with FTX were the Ontario Teachers' Pension Plan and the Temasek fund in Singapore.
One of the biggest names in venture capital, Sequoia, seems to have been fooled completely. In the 1800s, it was common for journalists to write about stocks. Let's look at that profile of Sequoia again. We read that SBF had a "vision about the future of money itself" and could "very well end up making the dominant all-in-one financial super-app of the future."
Bankman-Fried was superhuman. He could get a 10 out of 10 in a meeting with top venture capitalists while playing League of Legends at the same time. He was "as good as anyone in the world at explaining the basics of macroeconomics," but, unlike, say, Harvard's Greg Mankiw, SBF could teach macro "while playing Storybook Brawl round after round." The man was "clearly very smart." He was "a trillionaire in the making."
How do you explain how Bankman-Fried went from being a future trillionaire to being a nobody? The New York Times said some very moving things. Yes, SBF had lost "most of his fortune," but he was "surprisingly calm," slept pretty well, and still played Storybook Brawl during interviews. Had FTX done something wrong by using billions of dollars from customers to support his hedge fund Alameda Research? "He could only give a few details." He just wished he hadn't taken on so much.
Still don't know exactly what happened? Let's see what social media SBF has. On Nov. 10, he tweeted, "I screwed up and should have done better." But relax. "THIS IS ALL ABOUT THE NON-US EXCHANGE, FTX INTERNATIONAL. FTX US USERS ARE FINE!" (Cut to meme of dog in burning house.)
He went on to say, "At the moment, the total market value of FTX International's assets and collateral is higher than client deposits (prices change!). But this isn't the same as liquidity for delivery." SBF was shocked to find out that some FTX users were using margin credit to gamble on crypto tokens and that his exchange could have a run on it. "Because when it rains, it pours," she said. No kidding!
Last Tuesday, he shed more light on the situation. "After September 11, 2001... a) Alameda had more assets than liabilities M2M (but was not liquid!) b) Alameda had a margin position on FTX Intl." The Wall Street Journal in other words: "Behind the scenes, FTX used billions of dollars from customers to pay for risky trades by Alameda Research."
FTX was also spending money in a way that is usually associated with drunken sailors. From October 2021 to March 2022, the company spent $1.1 billion on acquisitions, $153 million on sales and marketing, and $122 million on real estate.
As financial historians, we have seen this movie many times before. Here's what I wrote about why SBF should try reading books when he has more free time in my 2008 book The Ascent of Money:
Since the first time people bought and sold stocks 400 years ago, there have been many financial bubbles. Share prices have gone up and down many times, reaching heights that can't be kept up. Skulduggery has always been a part of this process, as shady insiders have tried to make money at the expense of naive newcomers. This pattern is so common that it can be broken down into just five steps:
- Displacement: Some change in economic circumstances creates new and profitable opportunities for certain companies.
- Euphoria or overtrading: A feedback process sets in whereby rising expected profits lead to rapid growth in share prices.
- Mania or bubble: The prospect of easy capital gains attracts first-time investors and swindlers eager to mulct them of their money.
- Distress: The insiders discern that expected profits cannot possibly justify the now exorbitant price of the shares and begin to take profits by selling.
- Revulsion or discredit: As share prices fall, the outsiders all stampede for the exits, causing the bubble to burst altogether
In many ways, the rise and fall of SBF is a classic case. My advisory firm, Greenmantle, told its clients back in January that the price of Bitcoin, the first cryptocurrency that was supposed to be immune to inflation, was still likely to go down this year. We wrote, "The main reason is that big central banks are getting ready to tighten monetary policy." Since the start of the pandemic, monetary and fiscal stimulus have helped the price of Bitcoin a lot. But this will soon be over."
We thought wrongly that the price of Bitcoin would be "below $30,000" by the end of the year and that there was only a 10% chance it would fall below $15,000-$20,000. We thought this because we thought that if a lot of people used Bitcoin as a "option on digital gold," there would be a higher floor than in previous crashes. It was traded for about $16,500 on Friday.
It turned out that the trend of adoption had stopped, and what mattered more was how rising rates affected players with a lot of debt. This year, one of the risky things Alameda did was sign a $500 million loan agreement with a failed crypto lender called Voyager Digital. Soon after, Voyager Digital filed for bankruptcy because it was connected to Three Arrows Capital (3AC), a hedge fund whose investment strategy was to "lever long" on crypto. 3AC's main idea was that the world was in a crypto "supercycle" where the prices of tokens could only go up.
But 3AC was one of the biggest losers when the Terra stablecoin and its sister token Luna crashed. In just a few days, 3AC lost between $200 million and $500 million. This made it hard for everyone in the industry to get credit, and as prices fell and interest rates went up, 3AC got margin calls it couldn't meet. Counterparties to 3AC took a hit, and Blockchain.com lost $270 million in loans to 3AC. From 3AC to Voyager to Alameda to FTX, there was a chain reaction.
The ghost of John Law, the Scottish banker who blew up the Mississippi Bubble in early 18th-century France, would not be surprised by anything in this story. Almost always, cheap credit is used to blow up bubbles. When monetary conditions get tighter, the players with the most debt go down first. This causes a chain reaction of illiquidity, which leads to bankruptcy as asset prices fall.
The role of shady political influence is another classic part of the FTX story. In the same way that Law made friends with the Duke of Orleans, who was the regent when Louis XV was too young to rule, financial fraudsters have always relied on friends in high places to keep them out of trouble with the law or regulators.
Take Enron, a company that traded in energy and went bankrupt in December 2001. Ken Lay, the company's CEO, couldn't have built his "castle in the air" without Alan Greenspan's "put" on monetary policy. However, Enron also bought protection for itself by giving about $6 million to political campaigns, of which a third went to Republicans. The company also tried to buy fame by paying the Houston Astros to change the name of their ballpark to "Enron Field."
Do you recognize it? In 2020, Bankman-Fried gave at least $10 million to Joe Biden's campaign. During the midterm elections in 2022, he gave $39.8 million to Democrats, making him the second-largest donor after George Soros. Most of these donations, about $27 million, went to the Protect Our Future PAC, which backed candidates who put an emphasis on stopping pandemics.
Not everyone who blows bubbles acts like a philosopher king. Law did, but not as much as Lay. As the son of two law school professors, SBF was very good at making himself look good. There are a lot of gems in the Sequoia profile:
Q: You just happen to be alive in the most important time in the history of the future race. The existential point! Really?
SBF: It certainly would not be one’s prior — at least, not naively. But if you want to really needle on that, there are some anthropic considerations by which that might not be as crazy as it sounds.
People often think that a young man who wants to make billions of dollars very quickly is driven by greed. By raising him to be a strict utilitarian, professors Bankman and Fried gave their son the perfect excuse: he was only making money to do "effective altruism," which is the utilitarian version of "get rich quick." Because you can only do the most good for the most people if you start by making the most money.
Effective altruism also seems to have helped SBF and Caroline Ellison, the CEO of Alameda and one of his girlfriends at the time, make sense of the crazy risks they took as investors. In an interview with my Bloomberg Opinion colleague Tyler Cowen, Bankman-Fried almost agreed that it would be worth playing a game where there was a 51% chance you could "double the Earth out somewhere else" but a 49% chance the Earth would disappear.
This was great news for the people who give money to Democrats. A young man who was willing to take huge risks to make billions, give it all away to solve all the problems in the world, and help Democratic candidates win close congressional races. Will you meet with someone who is so smart? You will, of course. If he's lucky, he'll be the first trillionaire in the world. Don't mind that there's a 90% chance he will blow up.
There are still three questions about FTX that need to be answered. Each of these questions shows how this bubble is different from others in history. First, what in the world did the regulators think they were doing? Last week, we read in the Financial Times that the US Securities and Exchange Commission is looking into FTX's lending of crypto and how it handles customer funds. Bankman-Fried is being looked into by the SEC now? instead of months ago?
Second, what will happen to crypto exchanges in the future? On one level, SBF's demise was caused by a fight between FTX and Binance, a bigger exchange that was started in 2017 by Changpeng Zhao, also known as CZ. CZ still had a lot of FTT, the FTX token, even though he used to invest in FTX. In an article from November 2, the cryptocurrency news site CoinDesk showed how much generously priced FTT Alameda had on its balance sheet. Four days later, CZ said on Twitter that he was selling about $530 million worth of FTT for "risk management" reasons.
This wasn't the only reason he did it. He wrote, "We won't act like we're in love after the divorce." "We won't back people who try to hurt other people in their industry behind their backs." This was the war declaration that caused the price of FTT to drop and people to rush to buy FTX.
"A competitor is spreading false rumors about us to hurt us," Bankman-Fried tweeted on Nov. 7. "FTX works well. The assets are good." (Again, a dog in a house on fire meme.) For a short time, Zhao looked like he was willing to buy out his competitor, who was sick. But then he sent SBF and his team a Signal message. "Sam, I'm sorry, but we won't be able to keep this deal," he wrote. Way too much trouble. CZ.” Bankman-Fried told his team that Binance "probably never really intended to go through with the deal."
Anyone who has studied the history of money in the 19th century will recognize the dynamic. It was how banks and railroads with joint stock fought for market dominance. But there is a puzzle when it comes to crypto. Why do these conversations even happen? The original idea, which goes back to the white paper that Bitcoin's pseudonymous creator, Satoshi Nakamoto, wrote about the currency, was that it would let people pay each other directly without the need for a middleman. The blockchain would record all transactions in a way that could not be changed.
Pure supporters of decentralized finance, like my Hoover Institution colleague Manny Rincon-Cruz, have said for a long time that the exchanges are an oddity, an unwelcome intrusion from the world of traditional finance into the world of DeFi (traditional finance). Sure, exchanges were helpful, especially for speculative day traders who wanted to make money quickly. But they could also be seen through. Transparency was a problem for an effective altruist who wanted to make a lot of money quickly. This is why SBF pushed for the Digital Commodities Consumer Protection Act of 2022 to "kill" DeFi.
I never used FTX because I preferred to try out Cryptoland with a more reputable US-based exchange. But as soon as the crypto bubble started to burst—the collapse of Terra's $15 billion UST stablecoin was the proverbial canary in the coal mine—I took everything out and put it on a Ledger hardware wallet. Those who kept trusting FTX found out the hard way that the old crypto saying "not your keys, not your coins" was true.
After spending a few anxious hours trying to remember how Ledger, Uniswap, and MetaMask work, I would say that DeFi is about as easy to use as PC software was before Windows. As long as this is the case, crypto exchanges will have a role to play. It's possible that, like with Web 2.0, a single exchange will become the most important one, centralizing what was supposed to be a decentralized network, just as Amazon centralized e-commerce, Google centralized search, Facebook centralized social networking, and Twitter centralized outrage. But I think the idea behind trying to call crypto Web 3.0 something else was a bad one. When financial services instead of personal information are traded online, the stakes are just too high.
Lastly, what will happen to cryptocurrency if exchanges aren't necessarily the future? People like my friend Nouriel Roubini, who have been saying for a long time that "sh**coins" will fail, have had a good year in 2022. In his new book, Megathreats, he calls crypto a giant Ponzi scheme made up by "scammers and carnival barkers" to take advantage of naive retail investors with FOMO brought on by the internet. Many crypto coins and tokens will go to zero; in fact, many have already done so. But I'm still not sure that the blockchain-based finance experiment will turn out to be a total failure.
If Roubini had lived in the 1720s, he probably would have said the same kind of funeral prayers for stocks. But the end of equity financing and stock trading did not come with the collapse of the Mississippi and South Sea Bubbles, any more than the many financial panics of the 19th century ended joint-stock banking.
On the other hand, both stock markets and banks were very important in the later stages of the Industrial Revolution, when more money was needed. Antonio Garcia Martinez said, "Innovation begins in mad genius, grift, and bubbles, and ends in institutions of the establishment." Every Web giant you see around you, like Square, Stripe, Twitter, Facebook, Airbnb, and Uber, all started or grew a lot after another panic. Then came the biggest tech boom in a generation after that."
Will there be a DeFi boom after this crypto winter? Or will it always be winter and never Christmas, like in C.S. Lewis's Narnia? The history of money is more on Martinez's side than on Roubini's.
And that’s another reason why Sam Bankman-Fried should read books. I suggest starting with The Ascent of Money.
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