Hubris
Hiding in plain sight (FTX) / Spade or scalpel? (Twitter) (17 minute read)
Hiding in plain sight (FTX)
The scale of FTX is/was impressive. Before its recent failure, FTX was in the top 3 crypto exchanges worldwide, and was predominantly used for trading cyrptocurrency derivatives with the addition of leverage; a risky way to trade risky assets. In January it was valued at $32 billion in a private funding round, having purportedly made over $1 billion in revenue in the year before, with around $2 billion of average daily volume. There were apparently over 19,000 types of crypto currencies traded on the exchange, and over 60,000 daily active users. (1). It had raised c. $1.4 billion of equity. Now that it is bankrupt, it seems that more than $8 billion of value has been lost.
FTX's founder, Sam Bankman-Fraud -Fried is notable for, in the words of short-seller Marc Cohodes, 'looking like the inside of a gym shoe'. He can typically been seen in a baggy t-shirt and shorts with people who were previously political leaders of various Western nations, like this:
There were strong hints of what was afoot in Bankman-Fried's own interviews:
You start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that's gonna replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box ... And then this protocol issues a token, we'll call it whatever, ‘X token.’ And X token promises that anything cool that happens because of this box is going to ultimately be usable by, you know, governance vote of holders of the X tokens ... And of course, so far, we haven't exactly given a compelling reason for why there ever would be any proceeds from this box, but I don't know, you know, maybe there will be, so that's sort of where you start…And now what happens? Well, X token has some market cap, right? It's probably not zero. Let say it's, you know, a $20 million market. (2).
Smells fishy.
The best treatment of the demise of FTX and how it came about is from Mark Rubenstein, whom I shall quote below. (3)
He explains nicely that the very large liquidity crunch facing FTX was akin to a bank run. Bank runs do happen, and Mark mentions the frequency in the US:
Banks go bust more often than you might think. In the five years between 2016 and 2020, 21 of them went bankrupt in the US. The most recent was Almena State Bank of Kansas, which collapsed at the end of October, 2020. The surprise is that there have been no bank failures since.
As in a bank run, the catalyst to FTX's collapse was the fall in the reputation of its balance sheet. Concerns about Alameda's—and relatedly FTX's—balance sheet strength increased as the full relationship between these two entities was brought to light:
There has been a lot of speculation about what caused the collapse of FTX. Events began to unfold when Coindesk published excerpts from the balance sheet of Alameda Research. Alameda is a principal trading firm affiliated to FTX. According to the FT, it is 90% owned by Sam Bankman-Fried, who also owns 53% of FTX. Alameda was the vehicle through which Bankman-Fried made his first foray into crypto, exploiting arbitrage opportunities between bitcoin markets in 2017.
A very large chunk of Alameda's balance sheet was made up of FTT tokens, issued by FTX:
At first glance, the balance sheet looks solvent. On the other side of those assets are $8 billion of liabilities, leaving an equity cushion of $6.6 billion. But there’s quite a lot of concentration stacked on the asset side of the balance sheet, with FTT making up 88% of Alameda’s net equity. That amount of FTT was also an order of magnitude higher than the circulating supply, meaning it would have been very hard to sell and was likely overvalued on Alameda’s balance sheet.
So what is FTT? FTT is a token issued by Alameda’s sister company, FTX. Across the crypto universe, different tokens have different economic features – some look more like commodities, some more like equities. FTT was towards the equity end of the spectrum. The token gave FTX users discounts on their trading fees of up to 60%, making it popular among customers. FTX would use part of its commission income to buy and burn FTT tokens, analogous to a stock buyback process. And Sam Bankman-Fried would promote it regularly.
A similar arrangement would not have been allowed between banks though; the balance sheet would be adjusted as the result of regulation:
Given that it represents a kind of equity interest in FTX, it may be surprising to see FTT sitting on sister company Alameda’s balance sheet, especially in such size. Banking regulators have strict rules about reciprocal cross-holdings in capital structures. The Basel Committee on Banking Supervision insists that “reciprocal cross-holdings of capital that are designed to artificially inflate the capital position of banks” are fully deducted from capital.
Completing the circle on this extremely dodgy-looking structure: FTX gave Alameda the money to buy the FTT tokens which were themselves issued by FTX.
The situation gets worse when we look at how Alameda funded its FTT position. Within the $8 billion of liabilities on Alameda’s balance sheet are $7.4 billion of loans. According to the WSJ, these loans come from sister company FTX.
Not only this but this money was not FTX's to lend, it actually belonged to FTX's clients. As this information become known about the founder of Binance, a competitor firm and initial backer of FTX, announced that he would sell $530 million of FTT sitting on his books. (Binance had such a large amount of FTT because they had been provided by FTX to buy out Binance's equity stake resulting from its prior investment in FTX.)
The value of FTT tokens then fell precipitously, and they are now worth <$2, having traded in the $20-$30 range in the months prior. This tore holes in Alameda's and FTX's balance sheets, such that FTX 'held just $900mn in easily sellable assets against $9bn of liabilities the day before it collapsed into bankruptcy' (4). This looks like something of a strategic master-stroke by Binance because it was their announcement which led to the rout in the FTT price.
FTX made investments across many nascent crypto firms too, with stakes in over 100 companies, with the usual implicit question mark around the level of due diligence done (5).
As Mark concludes, 'this time it's different' is a very economically dangerous assumption to make:
There’s a saying, “Those who cannot learn from history are doomed to repeat it.” Financial services has a rich history – of personality cults, cross shareholdings, risk concentration, excessive growth, underestimation of tail risks.
For a more aggressive take, Stephen Diehl makes the 'told you all along' case, and makes clear that he thinks some of the blame sits with the Effective Altruism movement (6):
The history of corporate scandals is littered with quasi-messianic figures, and Sam Bankman-Fried [...] is simply the latest in the long line of financiers so drunk on their egos and self-perceived intelligence to be blind to the portents of their inevitable downfall. Sam is unique in that his grandiosity stems not purely from unrestrained greed and narcissism—although there is plenty of that—but his philosophical north star of Effective Altruism, an extreme form of Benthamite utilitarianism which espouses the belief that we should extend our ethical locus of concern to all possible sentient beings that may exist in the future. The philosophy attempts to derive, from first principles, an ethical calculus by which we should optimize our actions according to some suppositional fitness function that maximizes the scope and happiness of all future minds. Its adherents believe themselves as ordained prophets sent by the future to guide the progress of humanity according to their oracular pronouncements.
The Effective Altruism philosophy is, in one word: insane. It is a philosophy of unbounded narcissism wrapped in a bizarre, autistically hyperrational framework concerning human existence that gives rise to hubris of cosmic proportions. And, of course, this plays out exactly like in Greek tragedy, as acolytes like SBF fancy themselves as agents of the future supposedly single-handedly able to steer humanity’s path through the future Great Filters of existential risk, all while his Bahamanian bucket shop couldn’t do effective risk management of their dog-themed money. His company’s downfall may have arisen from liquidity problems of the Ponzi finance operations they were running and the hilariously lax governance they were allowed to get away with, but the root problem of this business lies in the folly of one man.
The entire FTX operation screamed scam to anyone who could do even the most basic due diligence on the operation. Did anyone ever ask why hordes of mum-and-pop retail investors were wiring money to a shady entity called ‘West Realm Shires Services Ltd’ just so that they could become an unsecured creditor to a Bahamanian shell company to purchase derivatives of completely abstract financial assets whose only demand is driven by popular sentiment about a meme of a talking dog?
Somewhat more measuredly, Samo Burja agrees that it is a poor look for the movement:
As its name suggests, Effective Altruism’s claims to authority and legitimacy rest on the idea that the EA movement is better than others at allocating time and resources towards saving and improving human lives. In Sam Bankman-Fried, perhaps its most visible proponent has demonstrated the opposite. (7)
I think it's fair to say that the Effective Altruism movement ('EA') did at least prevent some questions being asked about Bankman-Fried's activities. 'Green-washing' is an allegation sometimes made of e.g. oil companies who aggressively burnish their ESG credentials while not, activists would claim, doing enough to address the negative externalities inherent in their business models. It seems obvious that 'purpose'—i.e. the purported positive impacts of businesses—carries significant weight within the US technology industry and within Silicon Valley in particular when it comes to getting investment and talent. Many notorious crypto frauds, such as OneCoin, perpetrated by Ruja Ignatova, who is currently on the FBI's top ten most wanted persons list, also purported to change the world (8).
However it seems to me that William MacAskill, one of the originators of EA and its figurehead, is a thoughtful individual and someone who is serious about, in the net, improving the world we live in. While some criticisms about EA are valid, this could be a case where we shouldn't throw out the baby with the bathwater just yet.
Another subject of criticism is likely to be crypto writ large, a process that has already started amongst our true intellectual elite, Twitter anonymous accounts:
It is certainly true that the collapse of FTX will not be good for crypto, which much of the US West-Coast technology industry is in some way involved with:
the collapse of FTX will have a major impact on the cryptocurrency sector and, as a result, on the strategies and futures of the Silicon Valley elites who have increasingly tied their fortunes to it. Venture capital firm Andreessen Horowitz, for example, aggressively incubates cryptocurrency startups, with investments totalling over $7.6 billion. Mark Zuckerberg’s Meta (formerly Facebook) has twice attempted to enter the cryptocurrency market directly, first with the native cryptocurrency Diem (originally called Libra), then Novi, a cryptocurrency wallet. It is still aiming for “deep compatibility” with blockchain technology. Any cryptocurrency-based strategies will become harder not just because of the loss of a major institution and a drop in cryptocurrency prices, but because the incident will invite the further intervention of regulators in the U.S. government. (9)
One further interesting angle is the extent to which Bankman-Fried was knee deep in politics in the US. He was the second-largest donor to Democrats after George Soros, putting around $36 million to work in the latest midterm elections, compared to Soros' $126 million. Taking the political contribution of Sam Bankman-Fried, Ryan Salame (FTX co-CEO) and FTX.US together, they total nearly $72 million of donations to both Democrats and Republicans (10).
Bankman-Fried's girlfriend was the previous boss of Garry Gelsner, the current Chair of the U.S. Securities and Exchange Commission, and his mother runs one of the Democratic Party PACs.
Bankman-Fried's co-founder, Gary Wang, who also helped to advise the storied venture capital firm Sequoia Capital on its investment in FTX—since written down to $0—seems to exist without much trace on the internet, which is unusual to say the least, and has fuelled speculation.
The tale of FTX is not over yet, and just as in the case of Bernie Madoff's impressively long-running ponzi scheme which fell apart in 2008, there are likely to be more large numbers and details of malfeasance to come.
Spade or scalpel? (Twitter)
Elon Musk bought twitter for $44 billion and so far it is going to plan for almost no-one. It has not been a good deal for the banks—Morgan Stanley, Bank of America, Barclays, and Mitsubishi UFJ etc.—who have ponied up $13 billion of financing, which they are not able to sell off without taking a loss, primarily because of the rise in interest rates since the deal financing was first agreed. (11). It's not obvious the terms of the deal are good for equity holders either: after engaging in a weeks-long court battle trying to get out of it and having realised that lawyers had got the better of him, Musk abruptly decided he would close on his deal on the original terms. Musk himself has said: "Myself and the other investors are obviously overpaying for Twitter right now. The long term potential for Twitter in my view is an order of magnitude greater than its current value". The first part of this statement is almost certain; the second remains to be seen.
Musk personally has basically bet the farm on the deal and as a result has now used the vast majority of his shares in Tesla as collateral against which he has borrowed (12). He has apparently sold over $20 billion of Tesla stock since announcing the deal to fund his equity portion. (13)
To make the deal work best economically is an optimisation problem which is easy to say but hard to do; maximise revenue while minimising resulting costs.
On the revenue side, some of his previous utterances have probably not helped to steady the nerves of advertisers, who provide the vast majority (c. 90%) of the platform's revenue: (14)
Adding to this is the unforced error of reforming the 'blue-check' system. For the benefit of non-Twitter users: the blue check is a little symbol which has historically denoted that the account labelled 'Nike' or 'President of the United States of America (POTUS)' are indeed whom they say they are. By allowing people to sign up for these with little in the way of checks, certain accounts were able use names close to existing corporate entities and also have the blue-check, giving the appearance of being official. Threads like this give examples:
It seems that turning Twitter into a Wechat-style super app, as previously mooted by Musk himself, may not be possible, with former board members having been quoted as saying that super apps are "not possible at this point in the evolution of the mobile internet" (15)
A partial move in that direction could be to add payments functionality to Twitter, and a banking license in Washington DC has been sought which may be used for this (16)
Work on the cost side begun immediately, with about 50% of the staff being laid off (about 3,700 individuals), such layoffs having already sparked a class action suit.(17)
It seems that having got they keys to the kingdom, Elon holed himself up in a room with his advisors, which include VC-bods-cum-media-personalities Jason Calacanis, David Sacks, Sriram Krishnan (a partner at Andreessen Horowitz), Jared Birchall (who runs his family office) and at that time some of the (remaining) senior bods of the previous regime, such as Yoel Roth ('trust and safety') and Robin Wheeler ('the company’s de facto head of sales'). (18) & (19)
Since then certain of the senior bods, such as Yoel Roth have left, which is not that surprising given that Musk had said that a full working week had to be done in the office and half of their colleagues are no longer there. (20). As the FTC put Twitter on the naughty step in 2011 for not properly looking after user data, Musk opens himself up to a material risk if he is not able to retain at least some people who have the institutional background, because the FTC can issue very large fines.
How did we get here? To understand the rise of twitter we have to go back to 2009-10, when it was perhaps the trophy asset of social media. Nick Bilton's 2014 book 'Hatching Twitter' gives a good impression of Twitter in its heyday:
Every aspect of the company was growing. The number of sign-ups, the number of people visiting the site each minute, and every other Twitter-related metric continued to double, triple, and quadruple. In 2007 people had been sending 5,000 tweets a day. By 2008 the company had been processing 300,000 tweets each day. As 2009 rolled on, that number grew by 1,400 percent to 35 million tweets sent each day.
Down the hall, through the doors that led to the Twitter office’s main foyer, copies of the New Yorker, the Economist, and the New York Times were fanned out on the white square coffee table in the waiting area. Each publication contained articles about Twitter’s role in the revolutions now taking place in the Middle East—rebellions that, through Twitter and other social networks, would eventually see the fall of dictators in Tunisia, Egypt, Libya, and Yemen and spark massive protests in Bahrain, Syria, and Iran.
Indeed at this time it arguably had the upper hand even over Facebook:
Although Mark had been publicly disregarding the 140-character competitor, once telling a group of close friends that Twitter was “such a mess it’s as if they drove a clown car into a gold mine and fell in,” he was actually worried about the company. In a recent interview with the blog Inside Facebook, Mark had admitted, “I looked at their growth rate and thought if this continues for 12 months or 18 months, then in a year they’re going to be bigger than us.” But then he downplayed his worry. “It just turned out that their growth rate was kind of unnatural,” he said. “They got a lot of media attention, and it grew very quickly for a little period of time.” But that wasn’t actually correct. [...] Each week Twitter continued to break records. After Facebook had shut down Twitter’s latest feature, Mark had reached out to Ev and suggested the two meet “to figure out how we can work together better.”
(The feature mentioned was one that allowed the 'importing' of Facebook friends into Twitter, which was shut down at the Facebook end shortly after launch.)
As well as Facebook, Yahoo!, Google, Microsoft, and a 'former VP' (Al Gore?) had also put in offers, so Zuckerberg was not alone.
In any event Twitter, admittedly with other platforms, has done for opinion what Henry Ford did for the motor car:
How has Granit Xhaka come to anchor and elevate this Arsenal team after six so-so seasons in it? A teenage tactics nut in Des Moines can explain in 280 characters. What is an original but plausible thought about Xi Jinping? A China hobbyist, on a lunch break at a bank, will tweet a thread’s worth of them. (21)
Or, more topically:
The number of takes is indeed remarkable. Let's get meta for a moment though and remind ourselves that it is not their existence but the fact that we are reading them that comprises Twitter's until now surprisingly effective business model.
The last decade and a half has shown that the network effects for social media platforms are so strong they are practically natural monopolies. Unless Musk has killed it with leverage, I suspect that Twitter will continue whatever the user experience, for want of a better alternative.
Glad you didn't throw the baby out with the bath water on effective altruism. I doubt I will ever be able to get near "max giving", but I'm glad there are people who are, and who are influencing others to give more. Sam Harris is one (partial) convert