The Garrulous Jay – What The FTX?

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I am big fan of nominative determinism: the hypothesis that people tend to work in fields or, in my opinion, gravitate towards behaviours that fit their names. One of the best examples is Igor Judge: an eminent lawyer, he went on to become Lord Chief Justice. But the financial services industry has something of a Rogues’ Gallery when it comes to nominative determinism.

The demise of the cryptocurrency trading platform FTX gives us perhaps the best example of this since the fraudster Bernie Madoff made off with all his clients’ money in 2008, condemning Kevin Bacon to a life sentence making adverts for the EE mobile phone network.

Sam Bankman-Fried is the name of the man who built up and ultimately blew up FTX. Although the second part of his surname is pronounced “freed”, there is no doubt that this particular bank man’s business has been well and truly fried.

In hindsight the case of the rise and fall of FTX and its (ugly) sister company, Alameda Research, had all the ingredients of a potential problem that should have set off alarm bells long before the business filed for bankruptcy on the 11th November…

A poorly understood asset class – Cryptocurrencies are the raison d’etre of FTX. And yet the underlying value of the entire asset class, let alone individual cryptos, is still up for debate. Think tulip bulbs!

Regulatory absenteeism – The cryptocurrency terrain is the Wild West frontier of finance. Regulatory oversight is largely absent, with the financial Sheriffs seemingly thinking their job is done simply by saying, “Good luck to you if you head out that way, son”!

A charismatic leader – An MIT-educated son of Stanford Law School professors, with signature wild curly hair, Bankman-Fried had the credibility to build success at speed. He founded the Alameda Research hedge fund at the age of 25, became very publicly involved in Democrat politics in 2020, and even testified before the Committee on Financial Services about regulating the cryptocurrency industry in 2021.

Leverage – FTX lent to its customers to allow them to gear up their crypto bets by using the platform’s own funds. This allowed clients to magnify their returns, with the same then being true of the platform as well.

Opaque accounting – Only now FTX has imploded has it become clear that at different times Alameda and FTX lent large sums to each other to create the impression of financial strength. Furthermore, these loans were secured on crypto assets, the value of which was extremely volatile.

Inadequate risk management – Despite its public championing of its risk management, FTX allowed clients to make large bets on individual cryptocurrencies without having the failsafe systems in place to protect the company’s balance sheet if that particular asset or the market more widely experienced significant volatility.

Greedy investors – Without its clients FTX could never have become as big as it did.

None of these ingredients are new. It’s all happened before, and it’ll all happen again. Caveat emptor!