Sam Bankman-Fried, founder and CEO of FTX, testifies during a House Financial Services Committee ... [+]
Imagine betting on human civilization: there’s a 51% chance it doubles, and a 49% chance that it disappears. Would you play that, double or nothing?
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 when asked exactly that in a March 2022 podcast with Tyler Cowen, Sam Bankman-Fried was quite willing to play that game–and keep playing it, over and over again. Cowen asked Bankman-Fried about the high likelihood of destroying everything by going double of nothing on a series of coin flips. Bankman-Fried responded that he was willing to make this trade-off for the possibility of coin-flipping his way into “an enormously valuable existence.”
Hearing that podcast made me realize the 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.
FTX filed for bankruptcy on Nov. 11, along with 130 other entities associated with it. That filing stemmed from the revelation of some very shady bets and trades, which led to a run on the exchange and federal investigations for fraud.
Bankman-Fried 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.
As his financial empire was collapsing, Bankman-Fried tweeted: “I f**ked up… a poor internal labeling of bank-related accounts meant that I was substantially off on my sense of users' margin.”
Certainly, we shouldn’t simply take Bankman-Fried’s word for the situation at hand, given the circumstances. Yet at least the atrocious book-keeping part of the explanation and excessive optimism about user funds is supported by the only external investigation of the matter so far.
Binance, the world’s biggest cryptocurrency exchange, originally offered to buy out FTX as it was collapsing. However, after taking a look at FTX’s books, Binance saw that the problem was too big to solve. Binance backed out, citing revelations of “mishandled customer funds” and describing “the books” as a “a nightmare” and “black hole,” according to a person familiar with the matter.
Messing around with customer funds is a big no-no. The Securities and Exchange Commission, Commodity Futures Trading Commission, and Department of Justice are all investigating FTX’s handling of customer funds. Specifically, they’re examining whether FTX followed securities laws related to separation of customer assets and trading against customers.
Reuters has reported that Bankman-Fried built what two senior employees at FTX described as a “backdoor” in FTX's book-keeping system, created using bespoke software. This backdoor enabled Bankman-Fried to execute commands that would not alert others, whether at FTX or external auditors. The two sources told Reuters that Bankman-Fried “secretly transferred $10 billion of customer funds” from FTX to Bankman-Fried’s own trading company, called Alameda Research.
In conversations with investors, Bankman-Fried reportedly described his decision to loan $10 billion to Alameda “a poor judgment call.” This coin flip landed wrong side up. Double or nothing turned into nothing.
The underlying story here is of a fundamental failure of compliance and risk management. The inner circle of executives at FTX and related companies such as Alameda lived together at a luxury penthouse, and had very strong personal and romantic bonds. Fortune spoke to several former and current employees at FTX who described the inner circle as “a place full of conflicts of interest, nepotism, and lack of oversight.” Naturally, this context of personal loyalty at the top makes it hard to have any oversight and risk management. It allows things like secret software backdoors, shady bookkeeping, and mishandling of client funds to flourish.
Such nonchalance toward risk management stems fundamentally from Bankman-Fried’s decision-making philosophy of high-risk, high-reward bets. Bankman-Fried is unquestionably a visionary and financial genius. One of the most prominent venture capital firms in the world, Sequoia Capital, invested $210 million in his company and a partner at the firm said that Bankman-Fried had a “real chance” of becoming the world’s first trillionaire. Yet it ignored the serious dangers of Bankman-Fried’s decision-making philosophy.
Bankman-Fried is not the only multi-billionaire who ignores risk management and oversight. Consider Elon Musk’s approach to Twitter.
After taking over the company, he fired the vast majority of the existing executive team, as well as the Board, and replaced them with a select inner circle loyal to him. Then, he started experimenting with various Twitter features, most notably selling blue checkmark verification badges for $8 a month without any mechanism for confirming a user’s real identity.
Previously, Twitter only offered verification–for free–to those who had some public status and could prove it. After Musk’s offering, thousands of new accounts popped up with a blue checkmark impersonating real people and companies, such as an account that looked like Eli Lilly claiming that insulin is now free. Musk seemed very surprised by this outcome, and paused the paid blue checkmark program in response.
The outcome of introducing paid blue badges was clearly predictable. Yet there was no meaningful risk management and oversight check on Musk’s actions, just like there was none over Bankman-Fried.
The outcome for Musk’s risk-taking at Twitter might be bankruptcy, which would mostly be a loss for some big banks and investors. The outcome for Bankman-Fried’s risk-taking at FTX is definitely bankruptcy. That bankruptcy not only harms large investors: it also destroys the savings of many thousands of ordinary people who held their money in FTX.
Bankman-Fried’s misdeeds also harm the many worthwhile charitable causes to which he donated, such as pandemic preparedness. A committed philanthropist who already gave away many millions focusing on evidence-based charities, Bankman-Fried raised hopes for inspiring billionaires to give away their wealth rapidly, just like MacKenzie Scott. However, many charity projects to which he promised funding are now in limbo, with their funding withdrawn. The employees at Bankman-Fried’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 Bankman-Fried’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 blindspots. Such risk managers need to be in a strong position, able to go to the Board of Directors–which needs to have true control over the CEO, and not have the CEO able to fire the Board, as did Musk. When I serve consulting clients in this role, I insist on being able to access an oversight body as part of my consulting contract. I almost never need to use this option–but having it available helps me rein in the double-or-nothing impulses of brilliant founders such as SBF or Musk, since they know I have that option.
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.
