The 30-second summary of what happened
A bunch of arrogant, immature kids, sitting in the Bahamas and juiced up on mood-altering drugs, gambled away their customer funds with extremely poor / non-existent risk management. That’s the FTX saga in a nutshell. It’s a story of spectacular greed, hubris and corporate immaturity that has already shocked the guy who was in charge of liquidating Enron (and now liquidating FTX).
Did SBF and his cronies commit fraud at FTX?
All indicators and SBF’s own relentless tweeting points to fraud. But in the immortal words of Denzel Washington in Training Day – it’s not what you know, it’s what you can prove!
It seems like all the key aspects of running a viable business were missing at FTX – accounting, book keeping, independent audits, corporate controls, etc. Everything ran on “faith” and the notion that SBF is a brilliant trader and quant genius who knows what he’s doing, so don’t even think of challenging him. A good lawyer (Saul Goodman?) would argue that his client was just reckless and stupid with the money, but he never intended to commit fraud. It was bad luck, bad timing, etc. The market turned against him at the worst possible time, what can you do?
But, there is a silver lining here. FTX US which is a US-regulated entity also declared bankruptcy, despite Sam claiming numerous times on Twitter that FTX US is fine. So a savvy prosecutor can go after that angle and try to prove “wire fraud” in federal court. Mismanaging client funds and transferring funds for Alameda’s trading (gambling) is wire fraud, plain and simple.
Why big-name VCs have egg on their face right now
Big-name VCs like Sequoia pumped in 200+ million to bankroll a kid who pretended to be a genius and suckered them hook, line and sinker. As many media sources have reported, this investment came after a 30-min Zoom call in which SBF was playing video games while outlining his vision of how you can buy a “banana” with Bitcoin, and how FTX will make that possible. Pumping in that kind of money with very little due diligence and “no strings attached” is a recipe for disaster, and disaster is exactly what happened!
Sequoia just wrote off their entire 200+ MM investment to a big fat ZERO. More importantly, they proved once and for all that despite all their “knowledge” and their access to the books, they know nothing better than the average investor in Crypto.
Why did investors ignore the massive red flags?
If you were an investor or customer, there were 3 huge red flags over the course of 2022:
- SBF going around and buying a bunch of bankrupt Crypto firms, acting like a white knight visionary but in reality wasting money on useless assets. Now it seems like the only reason to purchase these assets was to save FTX from the domino effect.
- The corporate structure of FTX and Alameda which makes it impossible to rule out a conflict of interest. As it turns out, the two entities were operating like a circular piggy bank and Alameda in particular was indulging in extremely risky trading with customer funds. And they were caught with their pants down at the worst possible moment.
- The leaked balance sheet – this entire sequence of events was triggered by someone (an insider?) leaking Alameda’s balance sheet to CoinDesk, who published their article on November 2nd. For at least a few days after that revelation, there was still an opportunity for investors to sell their FTT token in the 20-25$ range and also pull their funds from FTX. Yes, it’s very hard to time these things but if you are a Crypto investor you need to be nimble and start looking for an exit at the first hint of trouble. That’s the game!
I also know some people who took all their money out of FTX after the Luna crash earlier this year (good for them). Luna was a clever piece of financial engineering that’s doomed to fail eventually once customers lose confidence in the token. FTX on the other hand was a fraudulent enterprise from the very beginning, now that we are learning about the all the backdoors that SBF managed to put into the software.
Human psychology and Gambler’s ruin
FTX also offers good insights into human nature / human psychology, and why people get sucked into obvious bubbles and keep doubling down even after the bubble has burst. This happened with tulips in the 1600s (Tulipmania), and it happened in the DotCom boom/bust as well. Speculative bubbles are generated and fueled by events that might have been harmless in isolation but often combine to form a toxic brew that takes on a life of its own. This is a topic worthy of its own post, so stay tuned for another article (coming soon!).
Conclusion – this will happen again