Crypto's former golden boy is now tarnished. What investors can learn from FTX's failure.
If you’re deciding to make an investment with a seemingly brilliant entrepreneur, do your due diligence on risk management and oversight.
“Let’s say there’s a game: 51%, you double the Earth out somewhere else; 49%, it all disappears. Would you play that game? And would you keep on playing that, double or nothing?” That’s what Sam Bankman-Fried, the former CEO of FTX, was asked in a March podcast with Tyler Cowen.
The vast majority of us would not take the risk of playing that game even once. After all, it seems morally atrocious to take a 49% chance of all human civilization disappearing for a 51% chance of doubling the value of our civilization – essentially a coin flip.
Yet, Bankman-Fried, also known as SBF, was quite willing to play the game and to keep playing it, over and over again. Cowen asked SBF about the high likelihood of destroying everything by going double of nothing on a series of coin flips. SBF responded that he was willing to make this trade-off for the possibility of coin-flipping his way into “an enormously valuable existence.”
SBF's luck finally ran out
That podcast reveals SBF's high-risk, high-reward decision-making philosophy that made his wealth possible but also fragile. Indeed, he was worth $26 billion at the peak of his wealth. He was the golden boy of crypto: lobbying and donating to prominent government figures, giving high-profile interviews and rescuing failing crypto projects. In fact, he was nicknamed crypto’s J.P Morgan.
His decision-making philosophy worked out for him. Until it didn’t.
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FTX filed for bankruptcy reorganization Friday, along with 130 other entities associated with it. The filing stemmed from the revelation of some shady bets and trades, which led to a run on the exchange and federal investigations for fraud.
SBF resigned as CEO as part of the bankruptcy filing. His wealth – all tied up in FTX and related entities – shrank to near zero. His coin-flipping luck finally ran out.
The underlying story here is of a fundamental failure of compliance and risk management. The inner circle of executives at FTX and related companies lived together at a luxury penthouse, and had strong personal and romantic bonds. This context of personal loyalty at the top makes it hard to have any oversight and risk management.
Such nonchalance stems fundamentally from SBF’s decision-making philosophy of high-risk, high-reward bets. The outcome of his risk-taking at FTX not only harms large investors. It also destroys the savings of more than 1 million ordinary people who held their money in FTX.
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Charities are left in limbo
SBF’s misdeeds also harm the many worthwhile evidence-based charitable causes to which he donated, such as pandemic preparedness. Many charity projects to which he promised funding are now in limbo, with their funding withdrawn.
The employees at SBF’s granting organization, the FTX Future Fund, resigned due to the revelations of misdeeds at FTX, saying they are concerned about the “legitimacy and integrity” of the CEO's business operations that were funding the grants.
Such harmful consequences from a lack of oversight and risk management highlight why it’s critical for founders to have someone who can help them make good decisions, manage risks and address blind spots.
Risk managers need to be in a strong position, able to go to the board of directors if needed. Even if this nuclear option is never used, its presence enables risk managers to rein in founders.
An important take-away: If you’re deciding to make an investment with a seemingly brilliant entrepreneur, do your due diligence on risk management and oversight.
If it seems like the entrepreneur has no one able to rein in their impulses, be wary. They will take excessive risks, and you’re gambling rather than investing your money wisely.