FTX, Cryptomania and Fake Wealth

In October 2021, Sam Bankman-Fried (SBF) was on the cover of Forbes magazine. Forbes estimated his net worth at $26.5 billion, making him one of the richest people in the United States, despite being only 29 years old.

By October 2022, his wealth had declined considerably, due to the crypto-crash of the preceding year, which saw bitcoin fall from over $60K to less than $20K. However, his net worth was still over $10 billion.

On November 8, 2022, his wealth fell to less than one billion, due to the collapse of his company FTX and its associated tokens. By November 11, his net worth was estimated to be zero.

Of course, this “wealth” never really existed. It was just an illusion. That illusion was created by two things: hype and the fallacy of composition.

The fallacy of composition is the false assumption that what is true of the parts is also true of the whole. A single unit of an asset class has a market value. The asset class as a whole, or any large amount of it, does not have a market value.

Just because you can sell one bitcoin right now for $16K, that doesn’t mean a million bitcoins have a collective value of $16B. You can’t just multiply the current price for a single unit by the number of units to get a market value for a large number of units. The reason is that if you started selling a million bitcoins, you would cause the price to fall. You might sell the first for $16K, but not the last.

You can determine the market value of a single unit of an asset by trying to sell it. The market value is whatever someone is willing to pay for it. But selling one unit is not the same as selling a million or a billion units, or all the units. There is no way to know how much money you could get by selling a large number of units.

So, if you ever hear a pundit talking about the “market capitalization” of a company, they are talking nonsense. Likewise if they talk about the net worth of billionaires. The wealth of a billionaire typically consists of a very large number of units of a single asset class, such as Tesla stock. There is no principled way to place a monetary value on that wealth. Naturally, we want to put numbers on these things, so we can talk about who is richer and make lists of the richest people, etc. But it’s all nonsense.

One day, Sam Bankman-Fried is one of the richest people in the country. A week later, he has zero wealth, even though he has the same assets as before.

The collapse of SBF’s “net worth” was due to a sudden reevaluation of his assets. In particular, a shitcoin issued by FTX, the FTX token, crashed when a large amount of it was dumped on the market by Binance, another crypto-currency company. The token has no practical uses. It is not like copper pipes or oil, which can be stored for use or sale later. The only use of the token is to sell it. Once a large supply of it was on the market, the price crashed. It fell by about 80% in a single day, and continued to decline further. This caused a reevaluation of the assets of FTX, which caused a run on the exchange and its eventual bankruptcy. But I’m getting ahead in the story. Let’s back up.

In 2017, SBF founded Alameda Research, a trading company. Essentially, it raised money from investors and lenders, and used that money to speculate on crypto-currencies. It had some early success doing arbitrage on bitcoin prices between Japan and the United States. Generally speaking, arbitrage requires a lot of leverage. The amount you make per unit of the asset is small, so you have to buy and sell a lot of it. Somehow, this fledgling company was able to borrow enough money to make this scheme worthwhile. SBF was well-connected, and that was part of the secret of his transient success.

There was a bitcoin bubble in 2017, which peaked at roughly $20K. The bubble helped to create a lot of hype around crypto-currencies in general. Bitcoin crashed in 2018, falling to a low of about $3K, but then it rebounded in 2019, regaining some of the lost ground to end the year at roughly $7K.

In 2019, SBF created FTX, a cryptocurrency exchange company. He raised funding from investors, including the CEO of Binance, Changpeng Zhao, who bought a 20% stake in FTX for $100M. Already, this seems rather dubious, because Binance would be a competitor of FTX, and also because that is a lot of money to throw at a startup with neither tangible assets nor a functioning business. However, SBF was able to raise money from other investors, and eventually he bought out Changpeng Zhao for $2B. (CZ made a nice profit there.)

During this time, the second crypto bubble was emerging, due to a combination of hype and the massive amounts of money created by central banks during the covid-19 pandemic. The huge influx of new money initially caused a bubble in financial assets, and is now causing consumer price inflation. Bitcoin soared to a peak of $67K in October 2021. However, as the speculative fever cooled, the price started falling. By January 2022, bitcoin had fallen to $35K.

Bubbles are self-organizing pyramid schemes. The price of assets goes up because people expect it to go up, so they buy the asset, causing it to go up. This feedback loop can continue for a while, but eventually the asset runs out of buyers, either because all the potential buyers have spent their money, or because the asset is so insanely over-valued that nobody believes it will go up more. Once the price stops growing, it typically crashes, after a brief Yosemite Sam moment when it hangs suspended in mid-air over the chasm.

When people are buying an asset just to sell it later, it is not grounded. It can rise to insane heights, and then crash.

There are two ways to make money during a bubble. One is to ride the bubble to the top, and then get out before the crash. The other is to enable the people who are jumping on the bandwagon. Those who sell picks and shovels during a gold rush usually make out better than the prospectors.

SBF was doing a bit of both. Alameda Research rode the crypto bubble up and down. FTX was selling the digital equivalent of picks and shovels. It was enabling normies to store and exchange their shitcoins and money. So, it operated somewhat like a bank and somewhat like a stock exchange. Customers had deposits of cash and shitcoins in their FTX accounts.

Every bubble has its myth. The speculators believe that the asset is the “next big thing". There is often some pseudo-intellectual nonsense that “explains” why the asset is so highly valued, and why it will be worth even more in the future. The reality is that the asset is highly valued because of the hype surrounding it, and it will crash in the future.

People join speculative bubbles because they are greedy. They want to get rich without doing any productive work. They also want status. They view themselves as clever and cool for having recognized the next big thing. They dismiss critics as losers who are stuck in the past and don’t understand the new thing.

SBF played the role of the cool genius. He had messy hair. He was a billionaire, but he dressed in shorts and t-shirts, and drove a cheap car. He lived an unconventional lifestyle (polyamorous). He believed in the latest pseudo-intellectual fad, “Effective Altruism”. These affectations made him appear more, not less, credible to his investors and customers. He appeared confident, sure of himself and his businesses. Faith is contagious.

But it was all a sham, of course. There was nothing really there. The pseudo-intellectual facade was covering up a simple strategy of making risky bets with leverage. This is not a new idea, and it usually ends badly.

As the crypto-crash played out, Alameda Research was losing money. It had only been successful in the past because it rode the bubble up. As the bubble deflated, it lost money.

On November 2, 2022, CoinDesk published an article reporting that a large percentage of Alameda Research’s assets were FTX tokens.

On November 7, CZ announced that Binance would sell its FTX tokens. Since the FTX tokens were barely trading at all, dumping a large number of them would naturally crash the price. It seems that CZ wanted to crash FTX, because why not? There was some bad blood between him and SBF.

As the FTX token price started to fall, CZ announced that Binance was going to purchase FTX, due to a liquidity crisis at FTX. However, CZ changed his mind the next day. Already, the FTX token had lost most of its market price. Then a run started on FTX deposits. Customers started withdrawing their deposits en masse. FTX stopped processing withdrawals.

As FTX went into its death spiral, the news came out that client deposits had been lent from FTX to Alameda Research, presumably to pay back loans. I don’t know the precise legal details, but this looks like theft to me. Client assets should not have been used by FTX. It’s as if someone “borrowed” your car without telling you, and then crashed it. Even if they meant to bring it back, it’s still theft. Between $1B and $2B of customer deposits appear to be lost.

On November 11, FTX, FTX US and Alameda Research filed for bankruptcy, along with a complex web of affiliated companies. Perhaps the complex web was part of a creative accounting scheme, or perhaps a money laundering scheme. Who knows?

The story gets weirder. $473M disappeared from FTX in “unauthorized transactions” — apparently stolen by someone.

A Vox writer, Kelsey Piper, managed to contact SBF and ask him some questions in twitter DMs. The champion of "Effective Altruism" had some interesting things to say.

KP: so the ethics stuff - mostly a front? people will like you if you win and hate you if you lose and that's how it all really works?

SBF: yeah

I mean that's not *all* of it

but it's a lot

the worst quadrant is "sketchy + lose"

the best is "win + ???"

"clean + lose" is bad but not terribel

KP: you were really good at talking about ethics, for someone who kind of saw it all as a game with winners and losers

SBF: ya


I had to be

it's what reputations are made of, to some extent

I feel bad for those who get fucked by it

by this dumb game we woke westerners play where we say all the right shiboleths and so everyone likes us

If you want to read the full discussion, it is here. (Be warned, Vox’s website is awful.)

There is even more weird stuff, about the lifestyle of SBF and his minions in the Bahamas. Apparently it involved a “polycule”: a network of sexual/romantic relationships. Of course it did.

SBF was the second-biggest donor to the Democratic party, after George Soros, in the recent midterm elections. That has inspired interest in his political connections, and his background. He was a very well-connected person. His parents were both professors at Stanford Law School, for example. He was born into the elite, and into the establishment.

There is an accusation of money-laundering floating around, relating to Ukraine and donations to the Democratic party. The accusation is that there was a money-laundering loop running from the US government to Ukraine and back to politicians via FTX. I haven’t seen any evidence to back that up.

There are ongoing criminal investigations and potential lawsuits. This story is not over.