FTX’s Sam Bankman-Fried revealed his flawed decision-making months ago

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“Let’s say there’s a game: 51%, you double the land somewhere else; 49%, everything disappears. Would you play that game? And keep playing that one, double or nothing?” Tyler Cowen asked Sam Bankman-Fried, the now-disgraced founder of bankrupt cryptocurrency exchange FTX, on his podcast in March 2022.

The vast majority of us wouldn’t risk playing that game even once. After all, it seems morally egregious to assume a 49% chance of human civilization disappearing for a 51% chance of doubling our civilization’s value. It is essentially a coin toss.

But Sam Bankman-Fried isn’t like most people. He responded to this question by telling the podcast host that he is very willing to play that game and keep playing it over and over again. Cowen asked Bankman-Fried about the high probability of destroying everything by doubling nothing in a series of coin tosses. Bankman-Fried responded that he was willing to make this trade for the chance to flip a coin to become “an enormously valuable existence.”

Listening to that podcast made me realize the high-risk, high-reward decision-making philosophy that made his wealth possible, but what’s more fragile. In fact, he ended up in a hugely valuable existence, worth $26 billion at the peak of his wealth. He was the golden boy of cryptocurrency: he lobbied and donated to prominent government figures, gave interviews to numerous high-profile venues, and bailed out failed crypto projects. He was even nicknamed crypto’s JP Morgan.

His decision-making philosophy worked for him, until it stopped working.

FTX, the cryptocurrency exchange he founded, which represented the source of his wealth, filed for bankruptcy on November 11, along with 130 other associated companies. That filing stemmed from the disclosure of some very shady bets and trades, leading to a run on the exchange and federal fraud investigations.

Related: ‘I am sorry. That’s the biggest. Sam Bankman-Fried and Cryptoworld lose big in FTX Meltdown, company files for bankruptcy.

Bankman-Fried resigned as CEO as part of the bankruptcy filing. His wealth, all tied up in FTX and related entities, dwindled to near zero. His coin-tossing luck finally ran out.

So what happened? As his financial empire collapsed, Bankman-Fried tweeted: “Poor internal tagging of bank-related accounts meant I was substantially out of my users sense of margin.”

Certainly we shouldn’t just take Bankman-Fried at his word for the current situation, given the circumstances. However, at least the egregious accounting part of the explanation and the over-optimism about user funds is backed up by the only outside investigation of the matter so far.

Binance, the world’s largest cryptocurrency exchange, originally offered to buy FTX when FTX was crashing. However, after taking a look at the FTX books, they saw that the problem was too big to solve. Binance backed down, citing revelations of “mishandled client funds” and describing “the books” as “a nightmare” and a “black hole,” according to a person familiar with the matter.

Messing with client funds is a big no-no. The Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Department of Justice (DOJ) are investigating FTX’s handling of client funds. Specifically, they are examining whether FTX followed securities laws related to the segregation of client assets and trading against clients. Based on Binance’s statements when it backed out of the deal, and even Bankman-Fried’s own tweets, it is highly likely that FTX violated securities laws.

Indeed, Reuters reported that Bankman-Fried created what two senior FTX employees described as a “back door” into FTX’s accounting system, built using custom software. This backdoor allowed Bankman-Fried to execute commands that would not alert others, either at FTX or outside auditors. The two sources said Reuters that Bankman-Fried “secretly transferred $10 billion of client funds” from FTX to Bankman-Fried’s own trading company, called Alameda Research.

Bankman-Fried described her decision to move this money to Alameda as “a poor judgment decision.” This coin toss landed wrong side up. Double or nothing turned into nothing.

The underlying story here is a fundamental compliance and risk management failure. The inner circle of executives from FTX and related companies like Alameda lived together in a luxury penthouse and had very strong personal and romantic ties. CoinDesk reported that several current and former FTX employees described the inner circle as “a place rife with conflicts of interest, nepotism and lack of supervision.” Naturally, this context of personal loyalty at the top makes oversight and risk management difficult. It allows things like secret software backdoors, shady accounting, and mishandling of client funds to flourish.

Related: The FTX crypto empire was reportedly run by a group of roommates in the Bahamas who were hanging out together, according to the news site that helped trigger the company’s sudden collapse.

Such disregard for risk management stems fundamentally from the Bankman-Fried decision-making philosophy of high-risk, high-reward betting. Bankman-Fried is undoubtedly a visionary and a financial genius. One of the world’s leading venture capital firms, Sequoia Capital, invested $210 million in his venture, and a partner at the firm said Bankman-Fried had a “real shot” of becoming the world’s first trillionaire. . However, he ignored the serious dangers of the Bankman-Fried philosophy of decision-making.

Bankman-Fried isn’t the only billionaire ignorant of oversight and risk management. Consider Elon Musk’s approach to Twitter.

After taking over the company, he fired the vast majority of the existing executive team and replaced them with a select inner circle loyal to him. He then began experimenting with various features of Twitter, most notably selling verification badges with a blue check mark for $8 a month without any mechanism to confirm a user’s real identity.

Previously, Twitter only offered verification, free of charge, to those who had a public status and could prove it. After Musk’s offer, thousands of new accounts appeared with a blue checkmark posing as real people and companies, including one account that looked like Eli Lilly and claimed that insulin is now free. Musk seemed very surprised by this result and, in response, stopped the paid blue check mark program.

Let’s be honest: The outcome for Twitter introducing paid blue badges was clearly predictable, with many publicly predicting it would go wrong. However, there was no significant risk management and supervisory control over Musk’s stock, just as there was none over Bankman-Fried.

The result of Musk’s risk-taking on Twitter could be bankruptcy, which would mostly be a loss for some big banks and investors. The result of Bankman-Fried’s risk-taking at FTX is definitely bankruptcy. That bankruptcy not only hurts big investors, but also destroys the savings of thousands of ordinary people who had their money in FTX, since Bankman-Fried messed with client funds.

Bankman-Fried’s misdeeds also hurt the many worthwhile charitable causes to which he donated, such as pandemic preparedness. A committed philanthropist who has already donated many millions by focusing on evidence-based charities, Bankman-Fried raised hopes of inspiring billionaires to donate their wealth quickly, just like MacKenzie Scott. However, many charitable projects he promised funding for are now in limbo, with funding withdrawn from him; employees of Bankman-Fried’s grant organization, FTX Future Fund, resigned due to revelations of wrongdoing at FTX.

Such damaging consequences of 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 risk, and address blind spots. Such risk managers must be in a strong position, able to turn to the Board of Directors or other sources of knowledge. When serving consulting clients in this role, I insist on access to this oversight body as part of my consulting engagement. I hardly ever need to use this option, but having it available helps me control double-or-nothing impulses from brilliant founders like Bankman-Fried or Musk, since they know I have that option.

One important takeaway: if you’re deciding to make an investment with a seemingly brilliant businessman, do your due diligence on risk management and monitoring. If it seems that the entrepreneur has no one to curb his impulses, be careful. They will take excessive risks and you are gambling instead of investing your money wisely.

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