The Lies We Believe
This post is a continuation of last week’s “Built for Traders by Traders” post, but with a different headline. The current CEO of FTX John J Ray III (the same gentleman who cleaned up the Enron mess after its accounting fraud in 2001) said this about the FTX situation – “The situation is unprecedented. Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information.”
The key words to remember here are absence of trustworthy financial information. Park this thought with you as I will return to this shortly.
But first let’s figure out what exactly happened. Well, this is the subject matter of an entire book (and you can expect one from Michael Lewis sometime in the future), but I will attempt to explain in as few words as possible.
The operating words here are Greed, Lies, and Leverage.
Once a trader starts making money…all he wants to do is make more money. To do this, he first leverages. But then how about leveraging on more and more money. Isn’t this smarter? Why stop if you think (even if you are hallucinating) you have cracked the formula.
So, raise as much money as possible. Spend money (like there is an unlimited supply of it) on media coverage, popular sports celebrities (and teams) and every other influencer (whether podcasters, bloggers, entrepreneurs, prominent confident bullshitters) who can be your spokesperson. Talk about Climate Change. Donate to political causes. Talk about World Issues and Voila you have established trust at scale.
This is exactly what Samuel did.
But greed has no limits or boundaries. You need more. So, tell people you will give them free stuff (no fees) and VIP access. Show them how they can save money by coming to you and be treated like a rock star at the same time.
Thus, FTX creates $FTT. Initially $FTT has practically no value.
So, Alameda buys or premines (in crypto parlance premines means allocating the tokens to yourself for free or at super low prices. Similar to sweat equity/ESOPs of the start-up world).
The next step is to increase the value of $FTT (artificially inflating the value). Now comes the magic step.
Alameda posts $FTT back to FTX as collateral, borrowing real assets from FTX’s customer deposits.
Voila, you now have access to real money.
What will a greedy trader do with all of this? Try to make more. Continue the leverage game.
The honeymoon party in Bahamas (the location of the FTX team) was going very well till November 2021, at which time crypto prices peaked and started their southward journey. This year we witnessed the fall of many crypto lenders and hedge funds. And the contagion led to FTX. But Samuel didn’t stop. He now positioned himself as the saviour of the crypto industry by bailing out many of these companies or at least promising them with his magic money. All of this was a front to hide the real fraud that he had committed.
So how did this break? Well, that is the story for the third part but let me now get back to John J Ray III.
Mr. Ray wrote in the filing in the U.S. Bankruptcy Court for the District of Delaware – “The FTX Group did not keep appropriate books and records, or security controls, with respect to its digital assets.” He said FTX’s human resources department was so disorganized that his team has been unable to prepare a complete list of people who even worked at FTX. Corporate Funds have been used to buy personal homes for employees and advisers without proper documentation. Can you believe FTX had no cash management or employee record system. Employees would make payment requests over a chat portal and supervisors would approve disbursements using personalized emojis.
This story is just mind blowing which brings me to the headline “The Lies We Believe” and the “absence of trustworthy financial information”.
But why only blame Samuel and his coterie of members for this?
What about the venture capitalists who doled out billions of dollars to him without any due diligence? What about the influencers who portrayed him as the God of the Crypto world? What about the media who made him a hero overnight? What about the investors who believed in his bullshit of free, low cost, discounts, and high returns?
Will this all end with Samuel?
While we might certainly not see (or we might) another fraud of this scale anytime soon, the key point I want to make here is that day in and day out we see people in our industry lying about their special products, risk, performance and returns. Firms bullshit about their products and performance. They get investors to believe that they have cracked the formula for high returns no/low risk. And people lap these stories up.
Some prominent lies we hear all the time, and I am sure you do too:
• We beat the stock market on its way up, and we go down less than the stock market during a downturn.
• We will get you out before the market tanks and we will get you back in right before the market goes up.
• We always beat the markets. Our portfolio manager is a genius.
• We have a huge research team and a proprietary QXLP formula that exactly identifies the wealth creators of all times (Sellers of this wisdom know that people want to hear such shit.)
The truth is nobody knows what is going to happen tomorrow. We live in an uncertain world and the only certainty here is uncertainty. To be successful in a world like this, we don’t need to get stuff exactly right. We need to get stuff less wrong. And to do that we need to stop believing the lies we believe.