The FTX fiasco evokes the great financial scams in history

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The FTX fiasco evokes the great financial scams in history

In his interviews, Sam Bankman-Fried showed awareness of the fragility of the cryptobubble

Sam Bankman-Fried claims to be more interested in gambling than literature. Not long ago, the founder of failed crypto exchange FTX declared: “I don’t want to say that any book is worth reading, but I actually believe something pretty close to it. I think if you’ve written a book, you’ve screwed up, and it should have been a six-paragraph blog post.”

If SBF, as it is known, had opened the Oxford English Dictionary, it would have discovered that the original meaning of the word bubble is “anything fragile, insubstantial, empty or worthless, a spectacle deceitful”. That pretty much describes the ecosystem that FTX operated in. Delving into financial history, Bankman-Fried could have identified that their activities bore many similarities to some of the frauds that accompanied bubbles of the past…with a possible twist.

The bubbler preys on the gullibility of investors. It is not difficult in moments of market euphoria. As Walter Bagehot wrote in Lombard Street in 1873, “the good times, also of high prices, almost always engender a lot of fraud. All people are most gullible when they are most content; and when a lot of money has just been made, when some people are really making it, when most people think they are making it, there is a happy opportunity for clever mendacity.”

SBF convinced some of the most reputable investors in the world, such as Sequoia Capital, the asset managerhedge fund Paul Tudor Jones, the Ontario Teachers’ Pension Scheme and Singapore’s Temasek sovereign wealth fund, to inject money. Fortune hailed him “the next Buffett.”

The next trick is to sell worthless assets to the public. The Dutch burghers fell for this back in 1630, when they paid the equivalent of an Amsterdam mansion for a single tulip bulb. But nowhere has wealth been more virtual than in cyberspace, with its cryptocurrencies and tokens. To liven things up, it’s a good idea to offer leverage. Once again the Dutch were pioneers: the tulip mania was carried out with futures, aptly named windhandel (short sale; literally, business on the air). In 1719, the Scottish economist John Law issued shares in the Mississippi Company (which had a monopoly on the business of the French colonies in North America) on a partial payment basis. FTX also offered leverage to its clients.

Big con artists cultivate political connections. In the 18th century, the heads of the British South Sea Company (which supplied African slaves) gave shares to King George I and bought out members of Parliament, in the so-called South Sea Bubble. SBF made large campaign contributions to Joe Biden and other Democratic candidates. It also hired a lawyer who previously worked for Gary Gensler, now chairman of the SEC.

By their nature, frauds are opaque. The stated maxim of Sir John Blunt, the mastermind of the South Seas bubble, was: “The more confusion the better; people shouldn’t know what you’re doing, which will make them more eager.” FTX’s multiple subsidiaries make Enron look simple.

Scammers often claim that their investment success is due to exploiting market inefficiencies. Nick Leeson, the trader which sank Barings Bank in 1995, claimed its profits came from arbitrage. Similarly, SBF started by arbitrating the crypto markets. When scams unravel, the scammer may resort to buying companies whose imminent collapse threatens to expose them. When the value of crypto fell, FTX gave a line of credit to BlockFi, a struggling crypto lender. It also agreed to buy the assets of another, Voyager Digital, after its bankruptcy.

Finally, there is the embezzlement of client funds, a common feature of financial scandals, from Scotland’s Ayr Bank in 1772 to that of Bernie Madoff. SBF secretly transferred some $10 billion of client funds into its security vehicle. trading, Alameda Research. In a 2018 marketing pitch, Alameda offered loans with 15% annual interest. “These loans don’t have any drawbacks,” he said.

SBF attributes the collapse to a “confusing internal account” that underestimated Alameda’s leverage, combined with a liquidity crisis as clients rushed to withdraw their assets. But previous interviews show awareness of the fragility of the cryptobubble. In April, Bloomberg columnist Matt Levine asked him if “yield farming” – the practice of lending and borrowing against digital currencies – was a Ponzi scheme. “It’s quite a reasonable answer,” SBF responded. The problem is that “in the end they liquidate you.”

In another interview with Levine, SBF said that some crypto firms were dipping into client funds and “valuing their assets at whatever.” These companies, he said, only care about liquidity, not net asset value. They trade with very high leverage and accept “random junk as collateral”. There is no transparency: institutional investors do not see the complete books. Recent revelations suggest that these descriptions could also apply to SBF’s operations.

These interviews, to which he used to go dressed in his characteristic shorts, now seem to predict his own downfall. There were other omens. His firm launched a product based on a basket of cryptos that he called Shitcoin Index Perpetual Futures, with the unsubtle ticker SHIT-PERP. He invited Michael Lewis, author of such classics as the big gambleto keep track of him. He commissioned a Super Bowl ad in which comedian Larry David questions the viability of FTX.

Government investigators and bankruptcy experts studying FTX’s remains will establish whether Bankman-Fried and his colleagues are responsible for mismanagement or outright fraud. But, in a way, it could all be interpreted as a joke. If so, it would be the biggest joke ever perpetrated.

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Brian Adam
Professional Blogger, V logger, traveler and explorer of new horizons.