Be afraid of safe investments
Be afraid of safe investments
How FTX investors gave SBF $1.8B and didn't ask any details
The second in a multi-part series on the rise, fall and fallout of Sam Bankman-Fried and his cryptocurrency empire. The first post described what happened. This post discusses the causes and consequences. The final post talks about the conclusions we should draw.
A complete failure of corporate governance
Measuring the exact dollar size of massive fraud is difficult for the same reasons that measuring massive wealth exactly is difficult: how (and whether) you decide to sell an asset can change the price. Wealth isn’t a fixed number, context matters. Taking advantage of the difference between nominal price and actual value was exactly how Alameda was able to raise so much money on such weak collateral.
But the FTX/Alameda fraud was certainly historically large. The largest fraud in the history of crypto, obviously, but also probably one of the largest frauds ever. The exact losses are still being tallied up but for a start at least ~$8B user funds seem to be completely missing. By comparison Bernie Madoff stole ~$16.6B worth of funds in the course of his ponzi, of which ~$14.4B was eventually recovered.
Take a moment to contemplate not just the scale of the fraud but the scale of the incompetence. They were playing poker at their own casino. They could look at everyone else’s cards and they got their chips for free. They had every insider advantage you could hope for. And they still lost billions! Not great.
Perhaps the most famous fraud in recent American history was Texas energy and commodities firm Enron, which used faulty accounting to hide a few billion dollars worth of bad debt and failed ventures. It turns out the same CEO brought in to manage the Enron bankruptcy was hired to manage the FTX bankruptcy as well. Here is what he said about FTX’s corporate governance in the initial filing:
FTX kept private keys controlling funds unsecured in a group email account. They did not have a complete list of bank accounts or a complete list of employees. They approved payments to employee via discord emojis. FTX bought properties in executives’ names using company funds and it gave billions in unsecured loans to SBF and other executives. SBF wrote backdoor software to let him secretly alter the company’s financial records. The FTX board of directors had three people on it (including SBF himself) and apparently never met.1
This is what their corporate structure looked like:
Obviously you shouldn’t try to decipher all that — by all accounts even FTX didn’t bother to keep track. Neither did the ~$1.8B worth of investors including Blackrock, Sequoia, Paradigm, Tiger Global, SoftBank, Circle, Ribbit, VanEck, and Temasek — none of whom requested representation on the board of directors or any other form of traditional corporate oversight.
These things weren’t unknowable. Here is an analysis of the on-chain evidence of Alamada and FTX commingling user funds.2 Here are Alameda/FTX’s risk management problems being discussed on Reddit a year ago. It’s possible that the total absence of oversight from investors was just astonishingly lax due diligence — but it’s hard not to wonder if some investors deliberately avoided board seats because they knew or suspected that FTX wasn’t legitimate and wanted the profit without the liability. On the other hand it’s also possible they were just idiots:
Be afraid of safe investments
In general the more an asset or institution is seen as 'safe' by the market the more violently catastrophic the backlash if it ever fails. The reason subprime mortgages took down the entire economy in 2008 isn’t because they were high risk but because they were seen (incorrectly) as low risk, at least when bundled together. This makes a kind of rough, structural sense — investors must allocate their wealth across assets and are likely to allocate most of their wealth to 'safe' investments. Investments that are widely seen as safe become load-bearing — when they fail, the side-effects of that failure are more sweeping and destructive.
We’ve spent a lot of time talking about how FTX was always a risky, suspect business so it can be easy to forget that until this month FTX was still widely seen as one of the safest institutions in the industry. SBF was the face of an unprecedented charm offensive in Washington. His parents were compliance lawyers who advised the SEC and Elizabeth Warren. Here he is on stage with Bill Clinton and Bill Gates. Here is Chair of the House Financial Services Committee Maxine Waters blowing him a kiss.
Savvy traders who were way out ahead of the Terra/Luna and 3AC collapses like algod and Galois Capital were holding their trading portfolio on FTX. Dozens of startups kept their treasury on FTX, which was generally seen as prudent. The court-appointed lawyers managing the Hodlnaut bankruptcy were storing the $13M worth of remaining customer funds on FTX for safekeeping.
SBF was famous not just for his wealth but for his supposed ethics — he was a major advocate for effective altruism. He had pledged hundreds of millions in philanthropic and political donations. He knew just what to say to get people to trust him:
Cause and Consequence
Through their debts, services and investments FTX/Alameda were deeply interwoven into the crypto economy — especially Solana, where FTX invested in most of the major projects, managed many of the larger treasuries and custodied the assets backing wrapped tokens like soBTC and renBTC. Most significantly FTX contagion has reached Genesis (the only prime broker servicing the crypto industry) and is threatening Genesis' parent company, Digital Currency Group. DCG also owns Bitcoin trust GBTC, which we talk about pretty regularly. You can see a chart of all the companies impacted by the FTX bankruptcy here.
There are other consequences beyond just the direct aftermath of unwinding FTX’s bad debt. Silvergate (another major crypto friendly bank) may face regulatory consequences for letting users deposit money on FTX by transferring it to Alameda. FTX users have been targeted by a scam where a deepfake SBF apologizes and promises to double any currency sent to the scammer.3 Obviously politicians are starting to announce new regulatory efforts to "reign in" crypto even though the failure here was already illegal. Particularly interesting to me though is the impact on bitcoin users across every exchange, who have been withdrawing bitcoin at an unprecedented rate. Nothing like the largest bank panic in history to remind people about the value of self-custody.
The second in a multi-part series on the rise, fall and fallout of Sam Bankman-Fried and his cryptocurrency empire. The first post described what happened. This post discusses the causes and consequences. The final post talks about the conclusions we should draw.
On thing FTX did have was excellent ESG ratings — better than Exxon, in fact. A good example of why ESG ratings are a well-meaning but terrible idea.
Fun fact! Blockchain analytics firm Chainalysis was an FTX creditor. I guess they are better at detecting small-scale crime.