Drew Angerer
Never trust a fat banker or a skinny cook.
-French proverb.
This week, a New York federal court sentenced disgraced crypto mogul Sam Bankman-Fried to 25 years in prison for his role in one of the largest frauds in U.S. financial history. Bankman-Fried co-founded FTX (FTT-USD), a now-defunct cryptocurrency exchange and hedge fund. He ran his empire from a $30-million Bahamas penthouse he shared with friends and ex-girlfriend Caroline Ellison. Ellison testified against Bankman-Fried (a.k.a. SBF) and helped clinch prosecutors’ case against him. The U.S. has stated that the total losses from SBF’s fraud are around $10 billion.
Despite this, Bitcoin (BTC-USD) has been as strong as ever. BTC hit an all-time high earlier this month and has since been hovering around the $70,000 level. To this point, Bankman-Fried and his lawyers argued that since the Bitcoin the government seized had increased in value and diminished his investors’ losses, he should have been given a more lenient prison term of 5-6 years. The argument didn’t quite work, but it might have spared him from a life sentence.
Bitcoin Hit All-Time High This Month As Bankman-Fried Awaited Sentencing
At first, it may seem like a contradiction that Bitcoin hit an all-time high as Sam Bankman-Fried awaited his sentencing earlier this month. But if you have a deeper understanding of Bitcoin and its history, it’s really not. Many early Bitcoin enthusiasts were quirky libertarians based in California. They were idealists working in fields like academia, if they weren’t already self-employed. Bitcoin had virtues like privacy, freedom from government regulation, and monetary independence. This caused Bitcoin’s popularity to explode. But as Bitcoin grew in popularity, these same characteristics that made Bitcoin valuable to quirky academics also quickly created a gold rush for all kinds of shady people.
Just as the discovery of gold in California in the 1800s drew crooks from all over the world, the rapid popularization of Bitcoin caused the community to be quickly invaded by scammers and criminals. Exchanges soon popped up for those not wanting the inconvenience of tracking their own keys to their digital coins, and almost as soon many of these exchanges were hacked and robbed–if they weren’t the ones stealing customers’ money themselves. If you look deeper– there’s no contradiction. I’d argue that Bitcoin is a brilliant invention. But anytime something or someone has massive success, there are bound to be people who come in to try and take advantage. This happened particularly in crypto.
I first heard about Bitcoin in high school, around 2012-2013. I didn’t really get Bitcoin at the time. The people I knew who were early Bitcoin enthusiasts more or less reflected the Bitcoin community in the very early days– quirky guys who read Aldous Huxley and George Orwell and leaned libertarian. My high school graduating class was 80 kids. We had parties and no one ever stole anything or got in fights. After that, I went to college in South Florida. There, you quickly learn that you can’t trust everyone and that rules exist for a reason.
Whereas early Bitcoin enthusiasts might have used it as a lever for freedom and privacy, these kinds of libertarian ideas quickly fail when translated to the broader world. In hindsight, some of the early Bitcoin enthusiasts may have needed to read some Kurt Vonnegut, whose Cat’s Cradle depicted “ice-nine” a military weapon designed to freeze large quantities of mud, but that accidentally freezes the entire world. Far from its libertarian roots, Bitcoin was soon being used by third-world politicians stealing public funds, arms dealers, fentanyl traffickers, and plenty of alleged fraudsters/Ponzi schemers. While criminal activity was never the majority of the use of Bitcoin, crypto’s attractiveness to criminals has been an enduring problem for regulators since BTC’s invention.
Sunny Places For Shady People
Once Bitcoin started to go viral, it quickly became clear that the government would need to step in with plenty of regulation around its use to safeguard the public. The proliferation of exchanges was meant to solve this, with popular exchanges like Coinbase (COIN) becoming the gatekeepers of crypto for millions of investors. However, many of the original Bitcoin enthusiasts hated the idea of exchanges, predicting that they would be vulnerable to fraud and theft. Their mantra was “not your keys, not your coins.” Around the time of the pandemic, a new crop of exchanges popped up that functioned like traditional banks and brokerages, offering investments, with crypto lending products, staking, and a slew of “innovations” that were conveniently timed for the massive influx of stimulus money to consumers and businesses. The crypto world also attracted its share of minor-league hustlers. You can’t make some of this stuff up. Acquaintances of mine would post fancy cars (most likely rented), along with invitations to invest in crypto products. 20-somethings who had no visible skills or sources of income constantly began posting on Instagram from Miami, Las Vegas, and Dubai, praising the virtues of altcoins and yield farming schemes. A crypto hedge fund even hired a former adult film star for its risk management department.
A bit more on the mainstream side, crypto brokerages quickly popped up, offering 6% or higher interest on Bitcoin deposits on advertisements on financial news sites. Bitcoin + interest was an irresistible combination. My friends collectively invested hundreds of thousands of dollars into these exchanges, and I followed them. It seemed like a great deal at the time. Of course, there was a three letter catch–SBF. Some of us got out in time (including me, thankfully), and others are still mired in bankruptcy proceedings with BlockFi, Celsius, and other exchanges. We discovered later on that much of the missing funds were tied back to FTX.
For a time, Sam Bankman-Fried was everywhere. With his trademark hair and hoodies, news articles about SBF appeared on a near-weekly basis in various financial news outlets. He traveled frequently from his home in the Bahamas to NYC and Washington D.C. and spent millions on lobbying and donations. The biggest irony in the story is that SBF may have been largely undone by his ex-girlfriend. SBF paid other key executives hundreds of millions of dollars, but only paid Caroline Ellison $6 million. He also allegedly leaked her private diary to the New York Times, which surely motivated her to help the government convict him with her testimony.
United States vs. Bankman-Fried (via Bloomberg)
Lessons From FTX and Sam Bankman-Fried
- SBF wasn’t the first large fraud in the financial markets, and he surely won’t be the last. Crypto and otherwise, we’re in an extremely powerful bull market right now, and I’d expect the next downturn to reveal others who are engaged in fraud. And the bigger the bull market, the greater the extent to which wrongdoing tends to be latent.
- If it seems too good to be true, it often is. While this doesn’t mean that every investment that appears good is in fact bad, a combination of heavy media coverage, political involvement, flashy spending, and celebrity endorsements have repeatedly proven to be a toxic mix for investors. Companies that sponsor sports stadiums in particular seem to be suspect!
- The best investment opportunities are often in close proximity to the worst. Themes like AI, crypto, and weight loss drugs are thought to offer the potential for huge upside for investors. And if I had to bet on what industry will produce the next major fraud, my guess is you’ll find it in one of these.
- Reputation and fame are a poor substitute for due diligence. We felt a sense of comfort that the founders of some of these crypto companies were billionaires and well-known. Regardless of our outcomes, my friends and I who had money in crypto exchanges shouldn’t have relied so much on reputation. Thankfully, the resurgent price of Bitcoin is helping recover investor principal with the bankruptcy cases ongoing, particularly in BlockFi.
Bottom Line
For those looking to invest in Bitcoin now, the path has been cleared for you with the past 10 years of crypto chaos. Thanks to January’s SEC decision on spot Bitcoin ETFs, there are now 10+ Bitcoin ETFs carrying fees of a fraction of 1%. The largest is the iShares Bitcoin Trust (IBIT), which carries an annual fee of between 0.12% and 0.25%, depending on parent company BlackRock’s fee waiver. While Bitcoin will continue to have volatility and price risk, the new class of ETFs now offer a safe and regulated alternative to putting Bitcoin on an exchange. If the history of BTC is any guide, you’re much safer in an ETF than you ever would have been with crypto exchanges.
