(Bloomberg) — Few could have predicted the sudden collapse of Sam Bankman-Fried’s billion-dollar crypto empire.
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But for all the twists, revelations, and haunted Twitter threads, it’s a fall from favor with an undeniable ring of familiarity.
A week that started with two crypto CEOs tweeting barbs ended with the bankruptcy of FTX, one of the largest and most prominent crypto exchanges, along with about 130 other companies it owned. The company had attempted to cover a whopping $8 billion shortfall, with the details of the failure — now subject to multiple investigations — yet to be revealed.
That much is clear: an intoxicating concoction of easy money, wishful thinking and hyped innovation contributed to an implosion that, while spectacular, was nothing new, aside from scandals like Enron, WorldCom and Lehman Brothers before it. The details differ, but they all had in common that they had hubris, weak regulation and the reality of an economic cycle with many precedents.
“We’ve had an industry that was primarily based on FOMO and easy money, and now that governments around the world are raising interest rates and that limits easy money, you just survive on FOMO,” said Hilary Allen, a law professor at American University. in Washington. “It’s not so attractive anymore.”
While there is no shortage of debt, the arc of the FTX’s fortunes can also be seen as a result of a garden variation of Federal Reserve policies. FTX, along with crypto itself and a host of other market gimmicks, from meme stocks to stay-at-home tech fads and special-purpose acquisitions, flourished as the Covid-19 pandemic prompted the Federal Reserve to cut interest rates to zero and leave them. there for two years.
Now, despite the Fed’s most aggressive tightening cycle in four decades, shaky empires are evaporating just as quickly as the liquidity that propped them up. The demise of FTX is certainly a disaster, unique in many ways, with billions of dollars in paper wealth and trading profits likely to be set on fire. But FTX’s failure is far less extraordinary when we consider 11 months of tech stock wreckage and centuries of asset bubble history.
The FTX scandal shows remarkable parallels to what happened to Enron. Both were led by messianic figures in Bankman-Fried and Jeff Skilling who dazzled the faithful with engineering feats. Both enjoyed near-universal adoration from the press and financial establishment. Both also seem to have made basic financial mistakes to keep the party going. The crypto empire reportedly allowed its balance sheet to rest precariously on a token tied to its own fortunes, listening to Enron’s use of its own shares to support its funding structures.
Ultimately, a doomed hope that rising markets would hide mismanagement or outright fraud became the epitaph of a once-thriving business. When Bankman-Fried resigned from his position as CEO of FTX.com on Friday, John J. Ray III was replaced — the former chairman and president of Enron left in the early 2000s to pick up the pieces of his bust.
The boom-overbuild-bust cycle is familiar to Bokeh Capital Partners’ Chief Investment Officer Kim Forrest. It’s happening across the economy right now, but the tech industry is the poster child, she said. Where is crypto in that metaphor? “Ground Zero.”
“I was a software engineer in the late ’90s, I saw the excesses, ‘wow, they’re hiring way too many people,'” Forrest said. “These companies hadn’t been productive by taking on too much, not getting enough output, and not showing the return on capital.”
For its part, FTX had raised approximately $4 billion in funding through its network of affiliates, including Alameda Research, a trading house co-founded by Bankman-Fried, FTX Ventures and a separate exchange for US investors.
Though more spectacular, the collapse of FTX shares storylines with much of what went wrong in the markets and tech space in the pandemic era. In addition to its obvious resemblance to other crypto victims Three Arrows Capital, the Terra Ecosystem and Celsius Network, its demise was fueled by complacency and belief in its own genius that characterizes the crises Meta Inc. and Twitter Inc. currently afflicting.
As for bubbles, few were predicted as enthusiastically as this one. Along with meme stocks, the crypto craze has been ridiculed by securities industry veterans almost from the beginning, with the pitch of criticism growing along with the price of Bitcoin in 2020. Charlie Munger once said he admired the Chinese for it. ban it, while Black Swan author Nassim Nicholas Taleb likened Bitcoin to a “tumor.”
They came out as insane then. Now those predictions are coming true as the Fed tightens the screws. Meme stock is little more than an afterthought, aside from the occasional pop in AMC Entertainment Holdings and GameStop Corp. Highly speculative growth stocks have collapsed, pushing Cathie Wood’s Ark Innovation exchange-traded fund — one of the highest flyers of the pandemic era — to its lowest level since 2020.
A bull market masks many sins, but is exposed by a turn of the cycle. History is littered with such examples, perhaps no more famous than the demise of Bernard Madoff’s massive Ponzi scheme, which lasted for at least 15 years before stock markets plummeted in 2008, leaving clients seeking more withdrawals than he could accommodate.
“You have to have a certain amount of volatility in the financial markets because that will prevent surrender and abuse of the system,” said Michael O’Rourke, chief market strategist at Jonestrading. “Madoff was only exposed because of the global financial crisis.”
Even with regulations seemingly on the horizon for the crypto industry, the off-shore location of many crypto companies (including FTX) has authorities like the Securities and Exchange Commission tied with their hands. Hester M. Peirce, an SEC commissioner, said questions about the lack of jurisdictional clarity are “partly our fault” as investors and companies have asked the watchdog again and again to provide greater clarity about where our jurisdiction lies and we didn’t do that.”
As a result, the financial playground that is crypto has been allowed to thrive with limited oversight. “There is no holistic digital asset regime that is globally accepted, and that creates huge opportunities,” said Jay Wilson, investment director at London-based venture capital firm AlbionVC.
The costs are clear to Bokeh’s Forrest: this is going to happen again. The players and details will be different, she said, but the human psychology will be the same.
“People don’t change. People just don’t change,” Forrest says. “As much as we’d like to think we’re learning from the past — we can learn not to invest in WorldCom, but we don’t know not to look for another.”
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