November 11, 2022
Happy long weekend, to those of you who have Veterans Day off.
- With FTX filing for bankruptcy protection this morning, I'm dedicating most of this newsletter to Sam Bankman-Fried, its failed founder and CEO. I also look at how well Paul Allen's art investing paid off. It's 1,408 words, a 5-minute read.
1 big thing: When genius fails
Sam Bankman-Fried knew exactly what risks he was taking; he explained them in some detail in a podcast last year. From his point of view, they were risks worth taking. From the point of view of other crypto-market participants now surveying the rubble, however, they most certainly were not.
Why it matters: FTX and Alameda Research were both fully controlled by a single man with a highly idiosyncratic risk appetite. The final result: Ignominious bankruptcy.
- His personal philosophy of wealth meant that, in contrast to most billionaires, there was no point at which he took his foot off the growth pedal in order to start dialing back on risk.
The big picture: SBF, as he's universally known, was in many ways the public face of crypto.
- No other industry player had so much credibility — and money — that Tony Blair and Bill Clinton would fly to the Bahamas to make a joint appearance at his crypto conference.
- That credibility is now shot to smithereens, and there's no one who can take his place. It's a safe bet that neither Clinton nor Blair will ever appear at a crypto conference again.
SBF was hyperaware of the risks involved when an exchange allows its clients, and especially its biggest clients, to lever up. He was also gaining edge in an incredibly risky way: By borrowing money against his own token, FTT.
- The idea: He was a big enough whale, especially when it came to FTT, that he could effectively set its price, and therefore ensure he would never face a margin call.
- That was a +EV trade, to use one of SBF's favorite terms — it had (or was supposed to have) positive expected value. On the other hand, in the low-probability event that it didn't work out, it could wipe him out — and take much of the rest of the crypto market with it.
The bottom line: In SBF's utilitarian calculations, that was a risk worth taking. In theory, a bet can be a smart bet even if it doesn't always work out. In practice, however, that's generally not the case when you're risking absolutely everything.
2. When altruism fails
One of the main ways that SBF gained credibility was by finding a way to take the famous "greed is good" line from "Wall Street" and try to make it literally true.
How it works: As a recent glowing profile of him from one of his investors put it, SBF adopted a philosophy, EA, whereby "he was going to get filthy rich, for charity’s sake." (Annoyingly, the profile has now been taken down, but you can read it here or just ask me for the PDF.)
- By pledging to give away all his wealth and ostensibly abnegating any material luxuries, SBF created a world where he had no real fear of losing money.
- Or, as the same profile put it: "If the amount won multiplied by the probability of winning a bet is greater than the amount lost multiplied by the probability of losing a bet, then you go for it."
The catch: SBF seems to have been bad at actually giving his billions away, beyond a few relatively small political donations.
- His philanthropy, the FTX Future Fund, claims it has "committed over $160 million" in grants — but it's unclear how much of that was actually paid out.
- The fund's entire staff has now resigned.
Between the lines: SBF was a hedge-funder at heart — someone who turns money into more money. In his mind, the opportunity cost of giving away money today was enormous, since he could turn it into much more money tomorrow.
- When SBF did spend real money, on things like arena naming rights, SuperBowl ads, or speaking fees for former heads of state, it was aimed at generating growth for FTX. That helped to create a $32 billion valuation for his exchange — paper wealth that was effectively impossible to donate to good causes.
- Weirdly, SBF also seems to have invested hundreds of millions of dollars in external VC funds over which he had no control.
The bottom line: If your purpose in making lots of money is to give it away, then it makes sense to find a job with a high disposable income.
- If giving away your money hurts your ability to make more money, that raises huge ethical and philosophical conflicts.
3. When ethics fail
SBF did try to retain moral clarity in his dealings with investors and the public. But even that fell through when crisis hit.
- The tweets are consistent with SBF's earlier letter to shareholders in FTX, where he said that "Our first priority is to protect customers and the industry" and that it was "non-negotiable."
The catch: SBF's tweet on Thursday came only after an earlier tweet thread, on Monday, where he said that “FTX has enough to cover all client holdings. We don’t invest client assets (even in treasuries).”
- That tweet has been deleted, probably because it's simply not true. The WSJ has reported that FTX lent more than half of its customer funds to its sister company Alameda, and Reuters earlier reported that FTX had transferred at least $4 billion of its funds to Alameda.
- That would explain why FTX had to pause withdrawals on Tuesday morning — it simply didn't have client assets on hand.
The big picture: SBF's moral priorities don't actually matter here. With FTX in bankruptcy, customers will have to fight for recovery against all of the company's other creditors.
The bottom line: As SBF tweeted on Thursday, "I f*cked up, and should have done better."
4. Paul Allen's art profits
You might have heard that art is a fantastic alternative asset class that has outperformed the S&P 500. Microsoft co-founder Paul Allen, from beyond the grave, is here to say: Not so much.
Driving the news: In the biggest and most blockbuster art sale of all time, a selection of paintings and sculptures from Allen's collection was auctioned at Christie's in New York this week. In total, the art sold for more than $1.6 billion.
How it works: Allen, a prolific collector, bought many works at auction — which means we know exactly how much he paid for them. The Cézanne that sold on Wednesday for $137.8 million, for instance, was bought in 2001 for just $38.5 million. By looking at the resale values, it's possible to see how much the art rose in value.
Between the lines: There are many reasons why these numbers massively overstate the broader returns to art investment.
- Paul Allen was, as the title of the auction says, a visionary. Most collectors don't have his unique combination of a great eye and deep pockets in the 1990s, when first-rate art was particularly cheap.
- Collectors coveted Allen's art in particular: Because of the quality of the collection as a whole, Allen provenance has real value.
- Allen's estate has the luxury of being able to time the market. The collector died in 2018, but this art is only being sold now, at a time of extraordinary demand.
- The resale price includes "seller's premium" — the amount the Allen estate paid to Christie's and its guarantors. So the cash-on-cash return will be lower than the numbers on this chart.*
- Christie's and the estate both had every incentive to sell those works — and only those works — for which demand is currently hot. The paintings the estate didn't sell will have seen much less appreciation.
By the numbers: Even with all those tailwinds, the average annualized growth rate on the 11 lots with public entry prices was just 6.2%. On average, Allen held them for 18 years before selling them.
- By contrast, even after its fall this year, the S&P 500 still boasts a compound growth rate of 8.9% over the past 18 years.
The bottom line: Allen would have made more money just buying an S&P 500 index fund.
*For the chart nerds: We used a log scale for the art chart, so that the steeper the gradient of a line, the higher the CAGR. While a normal scale shows up as a straight line when you rise by the same dollar amount every year, a log scale shows up as a straight line when you rise by the same percentage amount every year.
Thanks to Kate Marino for editing and Elizabeth Black for copy editing today's newsletter.