Talking to the Stranger, SBF
Special Thanks for @0xThorol and @Ansen0x for reviews.
Unless you live under a bedrock, you have probably heard of the fallout of Sam Bankman-Fried (or SBF) and his crypto exchange FTX. At its peak, FTX raised $400 million at a $32 billion valuation; almost every well-known institutional investor was trying to get in the funding rounds.
Fast forward to now, FTX filed for Chapter 11 bankruptcy and SBF, the biggest fraud in the crypto space, is on the run. The magnitude of institutional exposure to the FTX fallout can be summarized in the table below.
And here is Sequoia’s letter to its LPs explaining why they invested in FTX and what it is worth now: $0.
Why did VC and institutional investors’ failed to discern SBF’s true character? Malcolm Gladwell’s book, Talking to Strangers, might offer some insights.
Lesson 1: “Default to Truth” is in human nature.
In episode 104 of the All-in Podcast, Coinbase CEO Brian Armstrong spoke about his impression of SBF:
“So again, I’m speculating here. I’ve spent time with [SBF]. Met [SBF] a bunch of times. I have to say I did not see this coming. [SBF] appeared to be a very bright, credible, competent person, perhaps a bit young, perhaps you know a bit reckless at times, but not unethical and not committing fraud. I definitely did not see that.” (Brian Armstrong, All-in Podcast E104)
When SBF pitched to Sequoia about FTX, FTX’s potential blew their GPs away. Sequoia partners’ reaction is probably representative of how most institutional players on the yellow list above view SBF and FTX.
As human beings, we tend to think the best of everyone. Similar things happened throughout history, and the worst it could be is to trust a psychopath who would start a genocide and a World War. In Talking to Strangers, Gladwell uses the example of Neville Chamberlain meeting with Adolf Hitler to demonstrate why statesmen like Chamberlain trusted the psychopath. Chamberlain wrote to his sister about his impression on Adolf Hitler when they met in-person.
“In short I had established a certain confidence which was my aim, and on my in side in spite of the hardness and ruthlessness I thought I saw in his face got the impression that here was a man who could be relied upon when he had given his word.” (Chamberlain, 1938)
Yet Winston Churchill who never knew Adolf Hitler personally had the clarity. Why? Churchill simply read about what Hitler wrote and did. Similarly, Elon Musk also had the clarity on SBF:
“[SBF] set off my bs detector, which is why I did not think [SBF] had $3B.” (Elon Musk, 2022)
In hindsight, FTX’s liquidity condition does not add up. Brian recalls some red-flag moment of SBF:
“You know if I look back and see were there any warning signs that I should’ve thought twice about it, one of the things that I noticed was that in 2021 Coinbase had a good year: we did $7 billion in revenue, $4 billion in positive EBITDA, and we became public as a company. At that time, FTX did about $1 billion in revenue. And I know how much money we had for our venture budget and just like different investments we wanted to make. And I knew their revenue. I had to scratch my head a bunch of times: where did this guy getting all this liquidity? Because he was buying 9% of Robinhood. He was like putting a billion dollar into this. He was donating to all these politicians. And it did not make sense to me where he get all his cash. People just kept telling: oh his market maker Alameda was just printing cash.” (Brian Armstrong, All-in Podcast E104)
The FTX fiasco brings out the worst in everyone. From now on, are institutional players capable of trusting founders (not guilty till proven)? Should these players continue to lazily copy what others are investing? On an even broader level, how are crypto/web3 founders and VCs trying to onboard the masses if the owner of a top-tier exchange individual was such a fraud? What due diligence/research did the VCs conduct that ended themselves and FTX retail investors in such a sh*t show?
Lesson 2: It is difficult to understand strangers when their intents and behaviors mismatch.
Gladwell defines “transparency” as when “people’s behavior and demeanor — the way they represent themselves on the outside — provides an authentic and reliable window in to the way they feel on the inside.” Yet, strangers rarely are transparent.
In general, there are two types of mismatch:
- A liar acts like an honest person. ← our focus
- An honest person acts like a liar.
Hitler’s behavior and intent mismatched and Chamberlain fell for the trap. The double handshake that Hitler performed gave Chamberlain a false image of a warm and enthusiastic version of Hitler, blinding Chamberlain’s judgment on the mismatched psychopath in front of him.
In SBF’s case, he is a philanthropist, effective altruism (or EA) believer & practitioner, and industry leader/educator on the outside.
Yet under all such facade, SBF is the biggest fraud in the crypto space. He borrowed customer funds for risky bets. He embezzled $1 billion customer funds for personal use. There’s also the over-leveraged FTX, FTT token, and Alameda Research trilogy. In simple terms, what they did is equivalent to:
Furthermore, he built a “backdoor” in FTX’s book-keeping system so that external auditors would not notice the changes on FTX’s financial records. The list goes on… Yet, at the same time, he was teaching the web3/crypto space about regulations, transparency, and how things should be done.
Lesson 3: Context matters for understanding strangers.
On top of default to truth and mismatch, Gladwell adds a third layer: a lack of contextual understanding in which the stranger is operating. As he observes, how individuals behave under situations is often coupled with their surrounding environment.
Gladwell picks the example of people who committed suicide. A survey was conducted for 515 individuals who tried to jump from the Golden Gate Bridge between 1937–1971 but has been unexpectedly restrained, and it found that about 5% of those persisted in killing themselves. If you take the bridge out of the equation, 95% of them survived. To people who want to commit suicide, physical environment matters.
For SBF’s case, we simply don’t know what context SBF is coupled with. Maybe it’s his attachment to Effective Altruism? In a March 2021 interview with Vox, when the interviewer asked: “Is your objective when you’re thinking about the company, or thinking about just your work in general, still just to maximize net worth?” SBF said the following:
“I think the answer is closer to yes than no. The core plan is still, ultimately, donate as much as I can, and then most of what I’m going to do now that matters is maximizing the amount that I can make that will lead to that.” (SBF, March 2021)
In fact, Vitalik points out EA’s fundamental weakness: a lack of theory on social capital allocation that causes a mismatch in one’s intention and behavior.
“… you’re not just giving out money, but also reallocating public attention, inspiring the next generation… be willing to make big crazy bets, and keep accumulating wealth because you tell yourself you’ll donate it later.” (Vitalik Buterin, 2022)
Or was it his affinity to the Dem party being one of President Biden’s biggest donors?
Whatever the context might be, if one were to take that out of the equation, maybe SBF would not screw up so big.
