Hiltzik: The fakery of Sam Bankman-Fried and crypto ‘fortunes’

The Greek tragedy unfolding within the monetary press over the previous week is the story of Sam Bankman-Fried, the would-be cryptocurrency tycoon and political kingmaker whose multibillion-dollar empire has sunk just like the Titanic after its encounter with the iceberg.

Bloomberg put it this way: “Bankman-Fried’s Assets Plummet From $16 Billion to Zero in Days.”

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

I, finally, ought to have been on high of all the things. I clearly failed in that. I’m sorry.

— Sam Bankman-Fried

Yet, one thing doesn’t compute right here. It’s that $16 billion in belongings can’t merely disappear in a matter of days — not in the event that they had been actual within the first place.

Bankman-Fried both had $16 billion in belongings in the beginning of final week and nonetheless has a large share of it in the present day, or zero now and near zero then. Both issues can’t be true.

Based on reviews that Bankman-Fried and his cryptocurrency trade agency, FTX, at the moment are beneath investigation by federal prosecutors and securities regulators, I’m voting that $16 billion was legendary and that zero is the precise quantity.

That’s not the narrative being wholesaled by the monetary press and funding pundits. Their story is that Bankman-Fried had all of it, then lost all of it. He has performed into this narrative himself, through a series of tweets final week during which he apologized for, amongst different issues, overestimating how a lot he had out there to pay clients who wished to withdraw their funds from FTX.

“*I*, ultimately, should have been on top of everything,” he tweeted. “I clearly failed in that. I’m sorry.”

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

Is this plausible?

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

Not all those liquid assets are worth as much as the balance sheet states. It mentions about $472 million in stock of the brokerage Robinhood. But Robinhood shares have fallen in price by about 20% over the last 11 days, so that figure may be, um, optimistic by nearly $100 million.

When initial reports of FTX’s upside-down capital structure leaked out recently, customers staged a run on the exchange, ordering withdrawals of billions of dollars in deposits that FTX couldn’t provide. FTX has now filed for bankruptcy, and Bankman-Fried has stepped down as CEO.

Reports have also emerged that FTX lent customers’ assets to its related trading arm, Alameda Research, which used them to fund risky investments of its own. If FTX were 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” — that is, possibly unavailable to cover liabilities — are cryptocurrencies purportedly worth billions of dollars, including $554 million in FTT, a crypto token originated by FTX itself.

Another cryptocurrency, Serum, was listed with a value of $2.2 billion as of last Thursday. The previous week, the extremely volatile crypto 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-billion value on the balance sheet is extremely questionable.

Much of this was unknown to the financial community, since FTX didn’t make public disclosures. What was known, however, was that Bankman-Fried’s purported fortune was all derived from cryptocurrencies, which are notoriously volatile in price. So why was he credited with a multibillion-dollar fortune?

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

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

One would have hoped that the financial press would have drawn a lesson from its previous misadventure in anointing a fresh billionaire. This was the case of Elizabeth Holmes, the creator of the scam known as Theranos.

Holmes beguiled a passel of elderly male luminaries — George Shultz and Henry Kissinger among them — into joining the board of her company, which claimed to have invented a new way of drawing blood that would “disrupt” the stodgy old healthcare business. In fact, Theranos didn’t have a technology that worked, only an enticing story.

Among those taken in were the staff at Forbes, which placed Holmes at No. 1 on its list of America’s richest self-made women in 2015, awarding 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 be obvious that Holmes never had $4.5 billion. The magazine’s estimate was based on her 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 the 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% of it must be worth about $9 billion.

The flaw in this reasoning should have be obvious: If the next round of investors demanded 50% of the company for their $400 million, then suddenly the enterprise would be worth only $800 million. And what if there were no new investors at all?

The fundamental problem was that private capital valuations are inherently suspect. Stock in private companies can’t be sold on the public market, which gives public investors a shot at acquiring shares at an agreed-on price; instead, private companies are worth only as much as its newest investors think, and their opinion can change in the blink of an eye.

The same is true of the cryptocurrency space. Like private companies, the value of cryptocurrencies can be placed anywhere. They don’t produce income like bonds, and their prices can’t be pegged to liquid markets like those on which public company securities are traded. No one has ever explained what cryptocurrencies are useful for, other than paying off crooks holding databases or computer systems hostage in ransomware attacks.

As I reported recently, even Bankman-Fried acknowledged that claims for the usefulness of crypto involved “a lot of hand-waving.”

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

FTX paid $135 million for the naming rights for the NBA Miami Heat arena (local authorities in Miami say they have put the naming rights to FTX Arena back out for bid), and spent heavily to produce a television commercial featuring Larry David and air it during this year’s Super Bowl.

Add up all the known expenditures, 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 ranking any and all things — the best electric toothbrushes, the highest-yielding savings accounts, the richest plutocrats.

The grounds for many of these rankings are always murky or at least subjective, even when they seem to arise from hard numbers, as the Forbes and Bloomberg wealth lists are — poke at some of these numbers, and they deflate.

What turned 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’s the son of two law professors and the holder of a degree from MIT.

For others, it might be his 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 you conceivably can, because eventually you’re going to give it all away.

Last May, in presenting a House committee with a proposal to relieve the crypto industry of stringent regulations, he claimed to have promised to donate 99% of his wealth to charity (an easy commitment, obviously, when you have no wealth).

The most striking aspect of the anointing of Bankman-Fried as the richest and soundest of newly-minted billionaires is how so little of it has been based on hard information. The venture firm Sequoia Capital put $150 million into FTX, and followed that 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, who is known to movers and shakers as “SBF.” The article’s author, Adam Fisher, related that after his first interview with SBF “I was convinced: I was talking to a future trillionaire.”

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

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

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

Someone got 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 his entire fortune isn’t designed to explain to laypersons what happened to FTX. It’s designed to hide the fact that his fans and investors made a terrific blunder. They trusted someone who hadn’t earned their trust. It isn’t the first time, and the saddest aspect of this fiasco is that it won’t be the last.

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