What I'm reading: SBF edition: Understanding the FTX scandal

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Sam Bankman-Fried, the disgraced founder of the cryptocurrency exchange FTX, is having a very rough week.

On Monday, he was arrested in the Bahamas after prosecutors from the U.S. Department of Justice indicted him on a variety of criminal charges. Yesterday morning, the department’s indictment was unsealed, revealing that Bankman-Fried, who often goes by the initials SBF, is being charged with eight different crimes, including wire fraud and conspiracy to defraud the United States. The Securities and Exchange Commission also filed a civil case against him. And then, yesterday evening, a judge in the Bahamas denied him bail, ruling that he must remain in jail while awaiting extradition proceedings.

The aspect of this story that I find most fascinating is the way that Bankman-Fried managed to embody a character that a lot of people seemed to be looking for: a lovable, virtuous, but still ultrasuccessful capitalist.

The book “The Confidence Game,” by Maria Konnikova, explores how trust is a crucial element of every successful fraud and Ponzi scheme. (Bankman-Fried has only been accused, not convicted, of fraud.) Fraudsters usually build trust, she shows, by identifying what their marks are yearning for and then promising to fill that vacuum.

Frauds, in other words, can be a kind of mirror for their marks’ desires, showing what they are so desperate to find that they will overlook obvious red flags to pursue it.

Bankman-Fried carefully branded himself as part of the “effective altruism” movement, and claimed that his large fortune was actually just a way to do more good in the world. In interviews, he often mentioned his upbringing by legal ethicist parents and his modest lifestyle. The message was not just that investing with him was almost akin to giving to charity, but also that his pure motives meant he was a trustworthy person to do business with.

Perhaps he genuinely held those beliefs. Perhaps they were just a cynical ploy to build trust. Either way, he seems to have tapped into people’s desire to obtain the financial benefits of capitalism without guilt about its social drawbacks. And investors were so eager to jump on that bandwagon that they missed what now seem to be fairly obvious warning signs. According to John Jay Ray III, FTX’s new chief executive, the company suffered from an “unprecedented failure” of corporate controls. And a number of people have sounded the alarm about the risks of the entire cryptocurrency ecosystem: Charlie Warzel had an interesting interview in The Atlantic this week with the author of a prominent crypto-skeptic newsletter about the problems he had observed at FTX before its meltdown in November.

Bankman-Fried’s story is in some ways a microcosm of the broader promises and pitfalls of cryptocurrency. Last year, for instance, President Nayib Bukele of El Salvador made Bitcoin a national currency, a move that he claimed would make the tiny Central American country a hub of financial innovation and bring banking services to the poor. But the price of Bitcoin then fell sharply, cratering the savings of citizens who had invested in it. Foreign investment has been slow to appear. And just as Bankman-Fried’s altruistic persona hid a darker truth about his financial dealings, Bukele’s image as a modernizer has helped to distract from his authoritarian crackdown on civil liberties.

If you want to understand more about the specifics of the FTX scandal, you can start with the work of my Times colleague David Yaffe-Bellany, who has been covering the story closely. And Andrew Ross Sorkin interviewed Bankman-Fried via a video link live onstage at the DealBook summit two weeks ago.

But my personal favorite resource on this is Matt Levine’s “Money Stuff” newsletter for Bloomberg Opinion, because it is also often very funny. I particularly recommend the Nov. 14 edition, in which he walked through the mysteries of FTX’s leaked “balance sheet,” a vaguely labeled spreadsheet that included a mysterious entry described only as “Hidden, poorly internally labeled ‘fiat@’ account”:

“But then there is the “Hidden, poorly internally labeled ‘fiat@’ account,” with a balance of negative $8 billion. I don’t actually think that you’re supposed to subtract that number from net equity — though I do not know how this balance sheet is supposed to work! — but it doesn’t matter. If you try to calculate the equity of a balance sheet with an entry for HIDDEN POORLY INTERNALLY LABELED ACCOUNT, Microsoft Clippy will appear before you in the flesh, bloodshot and staggering, with a knife in his little paper-clip hand, saying “just what do you think you’re doing Dave?” You cannot apply ordinary arithmetic to numbers in a cell labeled “HIDDEN POORLY INTERNALLY LABELED ACCOUNT.” The result of adding or subtracting those numbers with ordinary numbers is not a number; it is prison.”

So it would appear.