Hiltzik: The Sam Bankman-Fried Falsehood and the “Fortunes” of Cryptocurrencies

The Greek tragedy unfolding in the financial press over the past week is the story of Sam Bankman-Fried, the would-be cryptocurrency tycoon and political kingpin whose multibillion-dollar empire sank like the Titanic after his encounter with the iceberg.

Bloomberg put it this way: “Bankman-Fried’s assets plummeted from $16 billion to zero in days.”

The story under that headline reported that Bankman-Fried’s entire fortune had been “wiped out” in “one of the greatest wealth destructions in history”.

In the end, I was supposed to be above it all. Clearly I failed at this. I’m sorry.

—Sam Bankman-Fried

Still, something doesn’t calculate here. It’s that $16 billion in assets can’t just disappear in a matter of days, not if they were real in the first place.

Bankman-Fried had $16 billion in assets early last week and still holds a sizable share of it today, or zero now and close to zero then. Both cannot be true.

Based on reports that Bankman-Fried and his cryptocurrency trading firm, FTX, are now under investigation by federal prosecutors and securities regulators, I vote that $16 billion was mythical and that zero is the right number.

This is not the narrative spread by the financial press and investment experts. Their story is that Bankman-Fried had it all, then lost it all. He played into this narrative himself, go a series of tweets last week in which he apologized for, among other things, overestimating how much he had available to pay clients who wanted to withdraw their funds from FTX.

“*I* should have been above it all in the end,” he tweeted. “I clearly failed at this. I’m sorry.”

In other words, things were booming, until FTX hit a hole. Bankman-Fried says he’s as surprised as you are.

Is it plausible?

What is known so far, according to an FTX balance sheet released by the Financial Times, is that the firm recently had about $900 million in liquid assets against nearly $9 billion in liabilities. That means FTX, the core of Bankman-Fried’s purported fortune, was up to $8 billion in the hole.

Not all of these liquid assets are worth what the balance sheet claims. It mentions about $472 million in stock of the brokerage Robinhood. But Robinhood’s shares have dropped in price about 20% over the past 11 days, so that figure could be, ahem, optimistic by nearly $100 million.

When the first news of FTX’s upside down capital structure leaked recently, clients staged a rush to the exchange, ordering withdrawals of billions of dollars in deposits that FTX could not provide. FTX has now filed for bankruptcy and Bankman-Fried has stepped down as CEO.

Reports have also surfaced that FTX has lent client assets to its related trading arm, Alameda Research, which has used it to fund risky investments of its own. If FTX were governed by the same rules that conventional stock and bond brokers must follow, client assets would have to be kept separate from brokerage business.

Among the assets the balance sheet describes as “illiquid” or “less liquid” — that is, perhaps unavailable to cover liabilities — are cryptocurrencies allegedly worth billions of dollars, including $554 million in FTT, a crypto token originated by the same FTP extension.

Another cryptocurrency, Serum, was listed with a value of $2.2 billion as of Thursday. The week prior, the extremely volatile cryptocurrency was valued at $5.4 billion, according to the balance sheet. Serum, by the way, is another crypto token originated by FTX, so its $2.2 billion balance sheet value is also extremely questionable.

Much of this was unknown to the financial community, since FTX has not made any public statements. What was known, however, was that Bankman-Fried’s alleged fortune stemmed entirely from cryptocurrencies, which are notoriously volatile in price. So why was he credited with a multi-billion dollar fortune?

One reason is the tendency of the financial press and other investment followers to take their subjects’ claims to wealth at face value. Forbes fell into the same trap as Bloomberg, ranking Bankman-Fried 41st on its list of the 400 richest Americans of 2022, with an estimated net worth of $17.2 billion as of Sept. 27. Both estimates were based on a speculative valuation of FTX at the time of a $420 million venture capital investment round in January.

But that’s a thin barrel on which to base a multibillion-dollar estimate.

One would have hoped that the financial press would have learned a lesson from his earlier mishap in ordaining a new billionaire. This was the case with Elizabeth Holmes, the creator of the scam known as Theranos.

Holmes duped a group of elderly male luminaries — including George Shultz and Henry Kissinger — into joining the board of directors of his company, which he claimed had invented a new way of testing blood that would “disrupt” the old and boring health care. In fact, Theranos didn’t have a technology that worked, just an enticing story.

Among those welcomed were the staff of Forbes, which in 2015 placed Holmes number one on its list of America’s richest self-made women, giving her a net worth of $4.5 billion. The following year, after the Theranos scam was exposed, Forbes reconsidered and placed her fortune at $0.

It should go without saying that Holmes never had $4.5 billion. The magazine’s estimate was based on his 50-50 ownership of Theranos, which had raised $400 million from venture capital firms that had acquired 4.4 percent of the company with that investment. But Theranos didn’t have $9 billion; it only had the $400 million investment.

The small number became the big number through the magic of venture capital math: If a 4.4% stake in a company is worth $400 million, then 100% must be worth about $9 billion.

The flaw in this reasoning should have been obvious: if the next round of investors demanded 50% of the company for their $400 million, then suddenly the firm would be worth only $800 million. What if there are no new investors?

The fundamental problem was that valuations of private capital are inherently suspect. Shares of private companies cannot be sold on the public market, which gives public investors the opportunity to acquire shares at an agreed price; instead, private companies are only as good as what their new investors think, and their opinion can change in the blink of an eye.

The same goes for the cryptocurrency space. Like private companies, the value of cryptocurrencies can be located anywhere. They don’t produce income like bonds, and their prices can’t be pegged to liquid markets like those in which public company stocks trade. No one has ever explained what cryptocurrencies are for, except to pay scammers who hold databases or computer systems hostage in ransomware attacks.

As I recently reported, even Bankman-Fried acknowledged that claims about the usefulness of cryptocurrencies involved “lots of flailing.”

At some point, Bankman-Fried must have had real money. He has contributed about $40 million to Democratic Party campaigns this current election cycle.

FTX paid $135 million for the naming rights to the NBA Miami Heat arena (Local Miami authorities say they’ve re-listed the naming rights to FTX Arena), and spent a lot to produce a TV commercial featuring Larry David and air it during this year’s Super Bowl.

Adding up all known expenses, however, it’s still nowhere near $16 billion.

Bankman-Fried’s rise and fall in public esteem is tied to our culture’s habit of compiling lists that rank everything: the best electric toothbrushes, the most profitable savings accounts, the richest plutocrats.

The reasons for many of these rankings are always murky or at least subjective, even when they seem to stem from hard numbers, as the Forbes and Bloomberg wealth lists are — just take a look at some of these numbers and deflate.

What made Bankman-Fried into a darling of the chattering classes in finance, journalism and politics is hard to fathom. For some, it may have been his pedigree: He is the son of two law professors and an MIT graduate.

For others, it may be his commitment to “effective altruism,” a nebulous philanthropic principle that seems to boil down to justification for making as much money in business and finance as you conceivably can, because ultimately you’ll give it all away.

In May, when presenting a proposal to a House committee to unburden the cryptocurrency industry of strict regulations, he said he had promised to donate 99% of his wealth to charity (an easy pledge, of course, when you have no wealth). ).

The most striking aspect of Bankman-Fried’s anointing as the richest and most solid of the newly minted billionaires is how little of it was based on factual information. Venture capital firm Sequoia Capital invested $150 million in FTX, and followed it up by posting a slavishly adoring article about Bankman-Fried on its website.

The article reported that Sequoia’s partners decided to make their investment after a single “last-minute” Zoom call with Bankman-Fried, known to movers and shakers as “SBF.” The article’s author, Adam Fisher, said after his first interview with SBF, “I was convinced: I was talking to a future trillionaire.”

Fisher, who says he has decades of experience talking to start-up entrepreneurs, added: “I don’t know how I know, I just know. SBF is a winner.

Sequoia deleted the article from its website (I retrieved it from the Internet Archive). The firm also assured its investors that its $150 million stake in FTX, which it has now reduced to zero, has been never a big deal — accounted for only about 3% of one estate it was parked in and 1% of another, Sequoia said.

The firm assured its backers that its investment in FTX was the product of “extensive research” and “a rigorous due diligence process.” (Must have been a Zoom call!)

Someone snowed here. Maybe Bankman-Fried was snowing himself, or maybe she knew he was living a lie. The truth will likely become clearer with time.

But all the talk about Bankman-Fried suddenly losing his entire fortune is not meant to explain to the layman what happened to FTX. It is designed to hide the fact that its fans and investors have made a terrible mistake. They trusted someone who hadn’t earned their trust. It’s not the first time and the saddest thing about this fiasco is that it won’t be the last.

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