Ten Things To Know About Sam Bankman-Fried & FTX
Recently, Sam Bankman-Fried (SBF) has been on the news for the wrong reasons.
SBF is another extremely smart person who sprinkled magic pixie dust over nothing to create billions in theoretical value. At the heart of the SBF saga is an exchange for trading and storing cryptocurrency, called FTX.
Over the last month, FTX has imploded evaporating more than $50 billion of crypto-related value. SBF, himself, reportedly lost more than $20 billion. This leads many to question whether a flaw in blockchain technology backing cryptocurrencies failed. This does not appear to be the case.
Rather, this story is more about Lehman Brothers, Enron and Long-Term Capital Management than technology flaws.
All these dealt with extremely smart people who could not see flaws in their logic. They never anticipated what could go wrong. They used immense leverage. Leverage does not make you right or wrong, but magnifies decisions. Making matters worse, FTX very likely, with SBF’s knowledge used customer deposits to prop up other investments only benefitting SBF’s inner circle.
Whether you are a crypto aficionado or not, there are fundamental business lessons for everyone from this debacle. Before chasing the hot deal of the day, consider these questions first.
- What gives a business value? Warren Buffett invests in predictable and consistent businesses that are understandable. If that works for Buffett, it should guide you, too.
- What can go wrong? It is humorous when people discuss the un-ending merits of an investment. If the stars align, things are great. However, the wise investor spends far more time figuring out what can go wrong. Once you identify the landmines, then see if an investment remains viable.
- Leverage kills. Borrowed money allows rapid growth, until it doesn’t. It may be a recession, pandemic or war that triggers a downturn. However, when downturns happen unexpectedly, borrowed money can quickly disappear forcing a snowball of liquidations.
- Beware of celebrity endorsers. Tom Brady was a consistent endorser for FTX. Common-sense dictates that skill as an NFL quarterback has nothing to do with ability evaluating blockchain technology and cryptocurrency. Talent or fame in one area rarely translates to other areas.
- Who holds your assets? FTX not only provided a platform to trade cryptocurrencies, but also a place to store crypto. However, FTX is based in the Bahamas with very little regulation, audit or oversight.
- Who values your assets? If you hold assets at a US based broker like Schwab, Fidelity, or Vanguard they are responsible for making sure assets are properly valued based upon established trading exchanges. In many cases, FTX was reporting loosely derived, if not manipulated, values. With any illiquid asset (land, buildings, private equity) extra scrutiny should be used since valuations have wide-ranging possibilities, including fraud.
- Who can pledge your assets? It appears that SBF used customer deposits to collateralize investments held by himself, personally. If I call Schwab and ask them to pledge client assets for a pet project, they will laugh hysterically and then report me to regulators. Make sure your assets are held, and protected, for your benefit.
- Who regulates a given industry or investment? SBF and FTX had no regulator and operated in the Bahamas. It typified the wild west crypto show. Conversely, an operation such as Coinbase chose to operate and be regulated in the US. Although regulators can be fooled by some, a healthy level of oversight helps protect investors in general. Furthermore, US investors should tread very lightly when allowing foreign laws to dictate how assets are protected or litigated.
- Is there an internal system of checks and balances? Traditional US banks and brokerages have well-defined infrastructure with auditors and compliance officers. Conversely, SBF and FTX evolved such that it was nearly a one man show. There was no independent board of directors, or other respected professionals, to which SBF had to answer.
- Greed kills. Whether outright greed or the fear of missing out, slow down and make logical investment decisions. The Fear Of Missing Out is quite real. Chasing the hot deal of the day will hurt you. You don’t have to be in on every deal. Slow and steady wins the most important race…yours.