Opinions expressed by australiabusinessblog.com contributors are their own.
“Let’s say there’s a game: 51%, you double the Earth somewhere else; 49%, it all disappears. Would you play that game? And would you keep playing that, doubling or nothing?” Tyler Cowen asked Sam Bankman-Fried, the now-disgraced founder of bankrupt cryptocurrency exchange FTX, about his podcast back in March 2022.
The vast majority of us wouldn’t risk playing that game even once. After all, it seems morally atrocious to take a 49% chance of human civilization disappearing for a 51% chance of doubling the value of our civilization. It is essentially a coin flip.
But Sam Bankman-Fried is not like most people. He responded to this question by telling the podcast host that he’s quite willing to play that game – and keep playing it over and over again. Cowen asked Bankman-Fried how likely it is that everything will be destroyed by doubling doing nothing in a series of coin flips. Bankman-Fried responded that he was willing to make this trade-off for the opportunity to work his way into “an enormously valuable existence”.
When I heard that podcast, I realized the high-risk, high-reward decision making philosophy that made his wealth possible — but also brittle. Indeed, he ended up in a hugely valuable existence – worth it $26 billion at the height of his wealth. He was the golden boy of crypto — lobbying and donating to prominent government figures, giving interviews in numerous high-profile locations and to rescue failed crypto projects. He was even nicknamed cryptos JP Morgan.
His decision-making philosophy worked for him – until it stopped working.
FTX – the crypto exchange he founded, representing the source of his wealth – filed for bankruptcy on November 11, along with 130 other companies associated with it. That filing stemmed from the disclosure of some very shady bets and transactions, which led to a run on the stock market and federal investigations for fraud.
Related: ‘My apologies. That is the most important.’ Sam Bankman-Fried and Cryptoworld Lose Big in FTX Meltdown, Company Files for Bankruptcy.
Bankman-Fried resigned as CEO as part of the bankruptcy filing. His wealth – all tied up in FTX and related entities – shrank to almost zero. His luck at flipping coins had finally run out.
So what happened? While his financial empire was collapsing, Bankman-Fried tweeted: “Bad internal labeling of bank-related accounts seriously messed up my sense of user margin.”
Certainly, given the circumstances, we shouldn’t just take Bankman-Fried’s word for the current situation. Still, at least the horrifying accounting portion of the statement and over-the-top optimism about user funds is backed up by the only outside investigation into the matter to date.
Binance, the world’s largest cryptocurrency exchange, originally offered to buy out FTX when FTX collapsed. However, afterwards Take a look in FTX’s books, they saw that the problem was too big to solve. Binance backed out, citing revelations of “misused customer money” and describes “the books” as “a nightmare” and “black hole,” according to a person familiar with the case.
Messing with customers’ money is a big no-no. The Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and the Department of Justice (DOJ) are all to research FTX’s handling of customer money. Specifically, they are investigating whether FTX followed securities laws regarding the segregation of client assets and trading against clients. Based on Binance’s statements when it pulled out of the deal, and even Bankman-Fried’s own tweets, FTX was most likely violating securities laws.
Indeed, Reuters reported that Bankman-Fried built what two senior employees at FTX described as a “backdoor” into FTX’s accounting system, created using custom software. This backdoor enabled Bankman-Fried to execute commands that would not alert others, both to FTX and external auditors. That’s what the two sources say Reuters that Bankman-Fried “secretly transferred $10 billion in client funds” from FTX to Bankman-Fried’s own trading company, called Alameda Research.
Bankman fried described his decision to move this money to Alameda as “bad judgment”. This coin flip ended up wrong side up. Double or nothing became nothing.
The underlying story here is of a fundamental failure of compliance and risk management. The inner circle of executives at FTX and related companies, such as Alameda, lived together in a luxury penthouse and had very strong personal and romantic ties. CoinDesk reported that several former and current employees of FTX described the inner circle as “a place full of conflicts of interest, favoritism and lack of oversight”. Of course, this context of personal loyalty to the top makes it difficult to oversee and manage risk. It allows things like secret software backdoors, shady accounting, and mishandling of client funds to flourish.
Related: FTX’s crypto empire was reportedly run by a bunch of roommates in the Bahamas who were dating each other, according to the news site that contributed to the company’s sudden collapse
Such casualness about risk management stems fundamentally from Bankman-Fried’s decision-making philosophy of high-risk, high-reward betting. Bankman-Fried is without a doubt a visionary and financial genius. One of the world’s leading venture capital firms, Sequoia Capital, invested $210 million in its company and a partner in the company said Bankman-Fried had a “real chance” of becoming the world’s first billionaire. Yet it ignored the serious dangers of Bankman-Fried’s decision-making philosophy.
Bankman-Fried is not the only multibillionaire to ignore risk management and supervision. Consider Elon Musk’s approach to Twitter.
After taking over the company, he fired the vast majority of the existing executive team and to replace them with a select inner circle that is loyal to him. Then he started experimenting with different Twitter features, in particular selling blue check verification badges for $8 per month without any mechanism to confirm a user’s real identity.
Previously, Twitter only offered verification – free of charge – to those who had public status and could prove it. After Musk’s offer, thousands of new accounts popped up with a blue check mark imitate real people and companies, such as an account that resembled Eli Lilly claiming that insulin is now free. Musk seemed very surprised by this outcome and interrupted the paid blue tick program in response.
Let’s face it: the outcome for Twitter in introducing paid blue badges was clearly predictable, and much publicly predicted it would go bad. Yet there was no meaningful risk management and oversight of Musk’s actions, just as there was none at Bankman-Fried.
The result of Musk taking risks on Twitter could be bankruptcy, which would be a loss especially for some major banks and investors. The result of Bankman-Fried’s risk-taking at FTX is sure bankruptcy. Not only does that bankruptcy hurt big investors, it also wipes out the savings of thousands of ordinary people who kept their money in FTX, as Bankman-Fried has been tampering with customer money.
Bankman-Fried’s misdeeds also harm the many worthy charities to which he has donated, such as pandemic preparedness. Bankman-Fried, a committed philanthropist who has already given away millions and focused on evidence-based charities, hoped to inspire billionaires to give away their wealth quickly. like Mackenzie Scott. However, many charitable projects to which he promised money are now in limbo funding withdrawn; the employees of Bankman-Fried’s grant-making organization, the FTX Future Fund, resigned over the revelations of wrongdoing at FTX.
Such damaging consequences of a lack of oversight and risk management highlight why it is critical for founders to have someone to help them good decisionsmanage risks and tackling blind spots. Such risk managers must be in a position of strength, able to go to the board of directors or other sources of insight. When I serving advisory clients in this role I insist on having access to this oversight body as part of my consulting contract. I hardly ever need to use this option, but having it available helps me curb the double-or-nothing impulses of brilliant founders like Bankman-Fried or Musk, since they know I have that option.
An important takeaway: If you decide to make an investment with a seemingly brilliant australiabusinessblog.com, do your due diligence on risk management and oversight. If it seems that the australiabusinessblog.com has no one to curb his impulses, be wary. They will take excessive risks and you will gamble instead of investing your money wisely.