How to Lose a Lot of Money Quickly (or The Saga of Sam Bankman-Fried)

John J. Ray III, new FTX CEO, in testimony before the

House Financial Services Committee, December 2022

Over the years, the Bradley, Foster & Sargent quarterly investment commentaries have covered many topics — including some of the greatest financial frauds and scams that have taken place over the past century. In 2005, we wrote about Charles Ponzi and his famous “Ponzi scheme” which took place in 1920. The Oxford English Dictionary defines Ponzi scheme as follows: “A form of fraud in which belief in the success of a fictive enterprise is fostered by payment of quick returns to first investors from money invested by others.” We never devoted an entire commentary to the Bernie Madoff scandal, which was uncovered in 2008 after many years of fraud and deceit, but we have referred to it frequently. It is estimated that actual losses in the Madoff scandal were $18 billion, of which approximately $14 billion has been recovered and returned to investors. But we did write a commentary in 2019 on Elizabeth Holmes and the Theranos story; and since then, both she and her boyfriend, Sunny Balwani, were sentenced to 11 and 13 years in jail, respectively.

During the last several months, another fraud of breathtaking proportions has taken place. While all the facts are still not known, media reports confirm that a minimum of $8 billion was embezzled by Sam Bankman–Fried and his merry band of offbeat millennials. As the story unfolds, we learn more and more about their remarkably immoral (or perhaps amoral) behavior, as client deposits were used to fund contributions to politicians and their PACs, donations to charities, and their own lavish lifestyles. Sam Bankman–Fried donated approximately $40 million in the 2022 election cycle primarily to various PACs and candidates. He ranked second to George Soros in total contributions in last year’s elections. Little wonder that Sam Bankman–Fried met with a senior advisor to President Biden, Steve Ricchetti, in the White House at least three times in 2022. The purpose of this commentary is to seek to assemble the pieces in this puzzle of how this 30–year–old math wizard and his colleagues duped so many professional investors and celebrities. It is another cautionary tale about ways to lose a lot of money quickly. 

2022 was a difficult year in the capital markets. After a 13–year bull market in U.S. stocks, the markets turned. With the highest inflation in 40 years and the Federal Reserve Bank raising interest rates throughout the year, stock market valuations contracted, and bond prices dropped precipitously. The tech–laden, high–flying NASDAQ Composite lost –32.54% in 2022. The S&P 500 did somewhat better, but the total return was a painful –18.13%. The total return of the 10–year U.S. Treasury note was –16.28%. However, these declines were modest compared to those in the cryptocurrency markets. Bitcoin was down over –60% in 2022 and down approximately –73% from its peak in October 2021. The other leading cryptocurrency, Ethereum, was down –68% in 2022 and –73% from its peak in 2021.

Things were even bleaker if you owned FTT tokens — the cryptocurrency launched by Sam Bankman–Fried (hereafter called SBF in this commentary) through his cryptocurrency exchange FTX. It appears as if speculators in FTT tokens and FTX suffered a total loss. And if you were one of the venture capital or private equity investors who invested over $2 billion in FTX, such as the legendary firm Sequoia Capital, there is little likelihood of getting any of your money back. Sequoia has written its $150 million investment down to zero.

Having made a lot of money in financial assets in a lengthy bull market, investors can be tempted to throw caution to the wind. And when interest rates are at rock bottom, there is little cost of capital to worry about. Moreover, if enterprising entrepreneurs appear brilliant and well–connected to leading national figures and politicians, many normally prudent investors are ready to plunge into speculative investments. And that is the backdrop for the saga of SBF and his colleagues.

In the simplest terms, this was not a Ponzi scheme nor a Madoff scandal, where investors are promised high returns, and funds from new investors are used to pay off investors who withdraw their money. This is a tale of pure embezzlement, as noted in the quote by John Ray at the start of this commentary. The perpetrators of the fraud all worked at two companies controlled by SBF — Alameda Research, a hedge fund with global operations, and FTX, a cryptocurrency exchange. Alameda Research’s trading desk lost billions of dollars, and FTX funneled billions of client deposits to Alameda Research to cover the losses. As SBF is at the center of this saga, we will start this account with a portrait of his life, followed by his three colleagues who were also key players in the story.

SBF was born in 1992 in California; his parents, Joseph Bankman and Barbara Fried, are both lawyers and professors at Stanford Law School. His aunt is Dean of Columbia University Mailman School of Public Health, and his brother is a former Wall Street trader. Both of SBF’s parents are politically well–connected. His father has testified before Congress, and helped draft Massachusetts senator Elizabeth Warren’s proposed tax legislation in 2016. His mother was co–founder of a left–leaning super–PAC helping to elect Democratic political candidates.

SBF was a precocious math student and was sent to Canada/USA Mathcamp. He attended high school at Crystal Springs Uplands School in Hillsborough, California — an independent, private day school with a tuition topping $56,000. From there, SBF went to MIT, where he graduated with a B.A. in physics and a minor in mathematics. At MIT, he lived in an off–campus co–ed fraternity house, Epsilon Theta, which promoted itself as an alcohol–free residence for those who sought intellectual pursuits. At MIT, he met and was influenced by William MacAskill, a founder of the “Effective Altruism” movement — a philosophical and social approach to life which encourages people to earn as much money as they can and to use the money to benefit others as much as possible. As we will see below, SBF adopted and practiced this philosophy. 

Upon graduation from MIT in 2014, SBF joined Jane Street Capital — a large and successful quantitative proprietary trading firm with offices in financial capitals around the world. In his early years there, he focused on arbitrage trading strategies dealing with ETFs. In early 2017, he began executing arbitrage trades in cryptocurrencies — exploiting the difference in prices in Japan and in the U.S. for various cryptocurrencies. Shortly after turning 25, he left Jane Street and founded Alameda Research together with a young woman, Tara Mac Aulay. Within months of its founding, Alameda was profiting handsomely from SBF’s trading expertise. However, within months of opening its doors, his co–founder left the firm, citing, in recent tweets, that she left because of concerns about SBF’s business ethics. Several months later, Caroline Ellison joined Alameda and in time, became co–CEO and later CEO of the firm. In 2019, SBF started FTX, a cryptocurrency exchange whose business model was to issue its own cryptocurrency token, FTT, trade cryptocurrencies, accept client deposits, and custody their cryptocurrencies. A fraternity brother at MIT, Gary Wang, co–founded FTX, but SBF owned the majority of the stock. 

Caroline Ellison was born in 1994 and grew up in the Boston area; her parents, Glenn and Sara Fisher Ellison, are both economics professors at MIT. At Newton North High School, she was captain of the Math team and competed in matches locally and around the country. She graduated from Stanford University in 2016 with a bachelor’s degree in mathematics. While at Stanford, she joined the Effective Altruism club there and served as its vice president. During her student years at Stanford, she interned at Jane Street Capital and joined the firm after graduation, working in quantitative trading in a group led by SBF. They were apparently attracted to each other by their shared interest in Effective Altruism. They ended up becoming romantically involved and later lived together with a group of Alameda and FTX employees in the Bahamas. She is cooperating with the feds and has pleaded guilty to numerous charges.

Gary Wang grew up in New Jersey and also attended Canada/USA Mathcamp, where he met SBF. He, too, went to MIT where he studied mathematics and computer science, and was also a member of Epsilon Theta fraternity house. Upon graduation, he went to work at Google as a coder and software engineer. He left Google in 2019 to co–found FTX, which soon became one of the largest cryptocurrency exchanges in the world, handling as much as 10% of global crypto trading volumes; it apparently had around $15 billion of assets on its platform. He also came to own a small stake in Alameda Research. Unlike SBF, who admitted to being a poor coder of software, Gary Wang was apparently a brilliant coder. Some allege that he wrote codes that allowed Alameda traders to avoid being forced out of losing positions. Wang was one of nine roommates in the apartment complex in the Bahamas where the key members of SBF’s team lived. He has also pled guilty to numerous charges and is cooperating with prosecutors.

Like SBF, Nishad Singh went to Crystal Springs Uplands School in Hillsborough, California. In 2012, Singh set the world record for fastest 100–mile run by a 16–year–old. After high school, he went to the University of California at Berkeley. In 2017, he graduated summa cum laude with a degree in electrical engineering. He worked briefly at Facebook as a software engineer before SBF recruited him for Alameda Research, where he helped to build out much of the technical infrastructure. He became the Director of Engineering at FTX in 2019 and owned 7.8% of its stock. According to bankruptcy filings, he had also received a $543 million loan from Alameda Research. After becoming Director of Engineering, Singh became a steady donor to the Democratic Party, giving $8 million to federal campaigns of Democratic candidates in the 2022 election cycle. He was also one of the nine housemates who lived and worked together in the luxury penthouse apartment in the Bahamas, the operational headquarters of FTX and Alameda Research.

How did SBF and his cohort of 25–year–old millennials create a runway to riches in the billions of dollars? First of all, they were smart. Very smart, as can be seen from the brief biographies above. Next, they defied the conventional dress code and behavioral rules of the last century. They dressed down, like Mark Zuckerberg, in their cut–offs, T–shirts and flip–flops, showing their disdain as entrepreneurs for the rules by which many in the business world play. SBF took this kind of behavior to an even higher level. SBF played League of Legends during high–level meetings with investors, such as Sequoia Capital, who would go on to invest hundreds of millions into his companies. (League of Legends is a 2009 online team–based video game in which two teams of five powerful champions strategize on how to destroy the other’s base.) 

Furthermore, the business models of Alameda Research and FTX involved profiting from sophisticated quantitative strategies using algorithms to trade the more than 20,000 cryptocurrencies globally. Very few investors and clients could readily understand how they made their money. It was effectively the old “black box” strategy in which only the business owners and the creators of the algorithms understand how money is made or lost. Investment decisions are based entirely on investment results — as in the Madoff scandal. And this all took place during a huge bull market for financial assets of all kinds (including Bitcoin and other cryptocurrencies) caused, in large part, by the Federal Reserve’s maintaining rock–bottom interest rates. With the cost of capital nearly zero, many were encouraged to speculate and gamble on meme stocks and cryptocurrencies.

Finally, there was the halo effect. Many millions of dollars of profits, apparently effortlessly created out of thin air (trading cryptocurrencies), were channeled to politicians, political committees, and charities, because of SBF and his team’s belief in the cool philosophy of “Effective Altruism” — earning as much as possible and giving a great deal of it away. At the top in June 2022, Mad Money host Jim Cramer crowned SBF by tweeting, “Sam Bankman–Fried doles out credit lines to save crypto institutions. He’s the new JP Morgan.” Who doesn’t want to take part in this pathway to riches? Even Tom Brady and his former wife Gisele Bundchen were caught up in the hype, filming three ads encouraging people to trade cryptocurrencies on FTX. With all this adulation, SBF must have found it difficult not to believe all the praise and fawning. This is why the Greeks saw tragedy when hubris reigns. The timeline of SBF’s rise and fall is laid out on the following page.

2022 was the year of the perfect storm for SBF and his colleagues. During the previous four years, they had built a hugely profitable cryptocurrency trading operation. And while few facts are known, it appears that the successful market-making operations of Alameda Research, combined with FTX’s ability to issue their own tokens, FTT, for cash, was instrumental in their success. With success came suitors, and Binance, the world’s largest crypto exchange, invested in FTX. In 2021, it appears as if FTX had revenues of close to $1 billion and profits of over $300 million. As operations grew, it seems that Alameda Research had begun to borrow significant amounts of money and became highly leveraged. In May 2022, Alameda appears to have had large positions in the following cryptocurrencies: TerraUSD, Terra Luna, and Solana. During this month, the value of these currencies dropped over 95%. With these assets on their balance sheet nearly worthless, Alameda’s capital was likely wiped out. Even worse, there was apparently $10 billion more in liabilities than assets. At some point during the summer and fall of 2022, SBF, with the knowledge, it appears, of Caroline Ellison and Gary Wang, gave the go-ahead to funnel FTX’s client deposits to Alameda to fill the hole. In early November, Binance decided to sell its stash of FTT tokens, causing the value of FTT to drop 95%. With FTT tokens practically valueless, FTX’s issuance of FTT tokens could bring little or no proceeds. When FTX announced that they had a liquidity problem, Binance announced that they would buy FTX and solve the liquidity issue. However, when Binance examined FTX’s books, they backed out of the deal. On November 11, FTX, Alameda Research, and 130 affiliated companies filed for bankruptcy. SBF was arrested in December by Bahamian authorities and extradited to the U.S. He was released to his parents’ $4 million house in California after a $250 million bond had been posted.

John Ray, FTX’s new chief executive officer, asserted during bankruptcy proceedings that in his 40-year career, which included unwinding the mess at Enron, he had “…never seen such a complete failure of corporate controls and such a complete absence of trustworthy information.” SEC Chief Gary Gensler stated: “We allege that Sam Bankman-Fried built a house of cards on a foundation of deception while telling investors that it was one of the safest buildings in crypto.” It is unlikely that most clients and investors will recover much of their money.

What can investors learn from this cautionary tale? Unlike the Ponzi scheme, this was not a case of investors seeking to make extraordinary gains in a short period of time. This was a case where experienced venture capitalists, private equity firms, and investors were taken in by a band of young millennials who projected an image of being both well-intentioned and the smartest people in the room. And many of FTX’s clients were apparently willing to speculate on an emerging financial “asset class” which had neither the backing of assets nor an income stream. In the end, character and integrity are vitally important. Charm can be a dangerously seductive thing. Facts are what really matter. Ronald Reagan’s famous saying still rings true: “Trust but verify.” And finally, if something appears too good to be true, it probably is too good to be true.

In our January 2018 investment commentary, A Primer on Bitcoin: Bubble or Bonanza, our conclusion was: “For those whose imagination is captured by Bitcoin [or any other cryptocurrencies] and who want to have some of the action, we believe that investors should view any money used to purchase Bitcoin and similar vehicles in the same way as money used to gamble in Las Vegas. One should be prepared to lose every penny of it.” We have not changed our thinking since we wrote this.