Hiltzik: The Sam Bankman-Fried Hoax and Crypto ‘Fortunes’

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 an iceberg.

Bloomberg put it this way: “Bankman-Fried’s assets drop 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.”

I, in short, should be above it all. I clearly failed at that. I’m sorry

—Sam Bankman-Fried

However, something is missing here. It’s just that $16 billion in assets can’t just disappear in a matter of days, if they weren’t real in the first place.

Bankman-Fried had $16 billion in assets at the beginning of last week and still has a significant portion of those today, or zero now and close to zero then. Both things cannot be true.

Based on reports that Bankman-Fried and his cryptocurrency exchange company, FTX, are now under investigation by federal prosecutors and securities regulators, I’m voting that $16 billion was mythical and that zero is the correct number.

That is not the narrative being peddled by the financial press and investment pundits. His story is that Bankman-Fried had it all and then lost it all. He himself played in this narrative, via a series of tweets last week in which it apologized, among other things, for overestimating how much it had available to pay customers who wanted to withdraw their FTX funds.

“*I* should ultimately be above it all,” he wrote on Twitter. “I clearly failed at that. I’m sorry.”

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

Is this plausible?

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

Not all of those liquid assets are worth as much as the balance sheet indicates. It mentions about $472 million in shares of the Robinhood brokerage. But Robinhood’s stock is down about 20% over the past 11 days, so that number may be, um, optimistic by almost $100 million.

When initial reports of FTX’s inverted capital structure leaked recently, customers ran on 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 resigned as CEO.

Reports have also surfaced that FTX lent client assets to its related trading arm, Alameda Research, which used them to fund its own venture investments. If FTX were to be regulated by the same rules that conventional stock and bond brokerages must follow, client assets must be kept separate from brokerage assets.

Among the assets the balance sheet describes as “illiquid” or “less liquid,” meaning possibly unavailable to cover liabilities, are cryptocurrencies reportedly worth billions of dollars, including $554 million in FTT, a token cryptographic originated by FTX itself.

Another cryptocurrency, Serum, was trading last Thursday with a value of $2.2 billion. Last week, 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 even its $2.2 million value on the balance sheet is extremely questionable

Much of this was unknown to the financial community, as FTX made no public disclosures. What was known, however, was that Bankman-Fried’s alleged fortune was derived from cryptocurrencies, which are notoriously volatile in price. So why has a multi-million dollar fortune been attributed to him?

One reason is the tendency of the financial press and other investment followers to accept their subjects’ claims to wealth at face value. Forbes fell into the same trap as Bloomberg, placing Bankman-Fried at No. 41 on its 2022 list of the 400 richest Americans, with an estimated net worth of $17.2 billion as of September. 27. Both estimates were based on a conjectural valuation of FTX at the time of a $420 million investment round in January.

But that’s a thin reed on which to base a multi-billion dollar estimate.

One would hope that the financial press would have learned a lesson from their previous misadventure in anointing a new billionaire. This was the case with Elizabeth Holmes, the creator of the scam known as Theranos.

Holmes tricked a group of elderly illustrious men, including George Shultz and Henry Kissinger, into joining the board of directors of his company, which he claimed would invent a new way to draw blood that would “disrupt” the old health care business. In fact, Theranos didn’t have a working technology, just a compelling story.

Among the guests was the staff of Forbes, which ranked Holmes No. 1. 1 on its list of America’s richest self-made women in 2015, giving her a net worth of $4.5 billion. The following year, after the Theranos scam was revealed, Forbes reconsidered and placed his fortune at $0.

It should be obvious that Holmes never had $4.5 billion. The magazine’s estimate was based on its 50% ownership of Theranos, which had raised $400 million from venture firms that had acquired 4.4% of the company with that investment. But Theranos didn’t have $9 billion; it only had an investment of $400 million.

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 be obvious: If the next round of investors demanded 50% of the company for their $400 million, then suddenly the company would be worth only $800 million. What if there were no new investments?

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

The same goes for the crypto space. Like private companies, the value of cryptocurrencies can be placed anywhere. They do not produce income like bonds, and their prices cannot be linked to liquid markets such as those in which the securities of public companies are traded. No one has ever explained what cryptocurrencies are useful for, except to pay crooks who hold databases or computer systems hostage in ransomware attacks.

As I reported recently, even Bankman-Fried acknowledged that claims about crypto’s utility involved “a lot of hand-waving.”

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

FTX paid $135 million for the naming rights to the NBA’s Miami Heat stadium (local Miami officials say they’ve put the naming rights back on FTX Arena) and spent heavily to produce and air a TV commercial with Larry David during this year’s Super Bowl.

Add up all the known expenses, though, and it still doesn’t come close to $16 billion.

Bankman-Fried’s rise and fall in public estimation is related to our culture’s habit of compiling lists that rank each and every thing: the best electric toothbrushes, the highest-yielding savings accounts, the richest plutocrats.

The foundations of many of these rankings are always murky, or at least subjective, even when they appear to emerge from hard numbers, such as the Forbes and Bloomberg wealth lists.

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

For others, it may be their commitment to “effective altruism,” a nebulous philanthropic principle that seems to boil down to a justification for making as much money in business and finance as possible, because in the end you’re going to give it all away. far.

Last May, when presenting to a House committee a proposal to ease the crypto industry from strict regulations, he said he promised to donate 99% of his wealth to charity (an easy commitment, obviously, when you don’t have wealth).

The most striking aspect of Bankman-Fried’s anointing as the richest and only of the newly minted billionaires is how little it was based on solid information. Venture firm Sequoia Capital poured $150 million into FTX and continued to post a slavish adoration article about Bankman-Fried on its website.

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

Fisher, who claims to have decades of experience talking to start-up entrepreneurs, added, “I don’t know how I know, I just know. SBF is a winner.”

Sequoia has removed 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, was never a big deal – only accounted for about 3% of one fund where it was parked 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.” (That must have been some Zoom call!)

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

But all the talk about Bankman-Fried suddenly losing their entire fortune is not designed to explain to laymen what happened to FTX. It is designed to hide the fact that their fans and investors have made a terrible mistake. They trusted someone who didn’t earn their trust. It’s not the first time, and the saddest part of this fiasco is that it won’t be the last.

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