SBF’s dangerous decision-making philosophy that brought down FTX

The vast majority of us would not even take the risk of playing this game. After all, it seems morally atrocious to trade a 49 percent chance of all human civilization disappearing for a 51 percent chance of doubling the value of our civilization—essentially a coin toss.

But when Sam Bankman-Fried (SBF) was asked exactly that on a podcast with Tyler Cowen in March 2022, he was perfectly willing to play that game — and play it over and over again. Cowen asked SBF about the high probability of destroying everything by making double from nothing on a series of coin tosses. SBF responded that he was willing to make that trade-off for the possibility of “an enormously valuable existence” with a coin toss.

As I listened to this podcast, I realized that this philosophy of high-risk, high-reward decision-making made his wealth possible — but also fragile. In fact, he was worth $26 billion at the peak of his fortune. He was crypto’s golden boy: lobbying and donating to prominent government figures, high-profile interviewing, and bailing out failed crypto projects. In fact, he went by the nickname of Crypto’s JP Morgan.

His decision-making philosophy worked for him—until it didn’t.

FTX filed for bankruptcy on November 11 along with 130 other related companies. This filing resulted from the disclosure of some very shady bets and deals that led to a run on the stock market and federal investigations into fraud.

SBF resigned as CEO as part of the bankruptcy filing. His net worth – all tied up in FTX and related companies – dwindled to near zero. His coin toss luck finally ran out.

When his financial empire collapsed, SBF tweeted: “I screwed up… poor internal labeling of bank-related accounts meant I was way off with my sense of user margin.”

Certainly, given the circumstances, we shouldn’t just take SBF’s word for it. Yet at least the gruesome accounting part of the statement and the overly optimistic view of user funds are backed by the only external investigation into the matter to date.

Binance, the world’s largest cryptocurrency exchange, was initially offering to buy FTX when it collapsed. However, after looking through FTX’s books, Binance realized the problem was too big to solve. Binance pulled on citing revelations of “mishandled client funds” and describing “the books” as “a nightmare” and “a black hole,” according to a person familiar with the matter.

Playing around with customer funds is a big no-go. The Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Department of Justice (DOJ) are all investigating FTX’s handling of client funds. In particular, they are investigating whether FTX has complied with securities laws regarding segregation of client assets and dealing with clients.

Reuters has reported that SBF built what two senior executives at FTX described as a “back door” into FTX’s accounting system, which was built using bespoke software. This backdoor allowed SBF to execute commands that would not alert others, whether at FTX or outside auditors. The two sources told Reuters that SBF allegedly “secretly transferred $10 billion in customer funds” from FTX to SBF’s own trading company called Alameda Research.

In discussions with investors, SBF reportedly described its decision to lend Alameda $10 billion as a “bad decision.” This coin toss landed on the wrong side. Double or nothing became nothing.

The underlying story here is a fundamental compliance and risk management failure. The inner circle of executives at FTX and related companies like Alameda lived together in a luxurious penthouse and had very strong personal and romantic ties. Fortune spoke to several former and current employees of FTX, who described the inner circle as “a place fraught with conflicts of interest, nepotism and a lack of oversight.” Of course, this context of personal loyalty at the top makes monitoring and risk management difficult. It allows things like secret software backdoors, shady accounting, and misuse of customer funds to thrive.

This nonchalance towards risk management stems essentially from SBF’s decision-making philosophy of high-risk, high-reward bets. SBF is undoubtedly a visionary and financial genius. One of the world’s best-known venture capital firms, Sequoia Capital, invested $210 million in his company, and a partner at the firm said SBF had a “real chance” of becoming the world’s first trillionaire. However, she ignored the serious dangers of SBF’s decision-making philosophy.

SBF isn’t the only multi-billionaire ignoring risk management and oversight. Consider Elon Musk’s approach to Twitter.

After taking over the company, he fired the vast majority of the existing leadership team and board of directors, replacing them with a select inner circle who remained loyal to him. He then began experimenting with various Twitter features, most notably selling blue tick verification badges for $8 a month with no mechanism to confirm a user’s true identity.

Previously, Twitter only offered verification – free of charge – to those who had some public status and could prove it. After Musk’s offer, thousands of new accounts appeared with a blue tick impersonating real people and companies, such as an account that looked like Eli Lilly claiming insulin was now free. Musk seemed very surprised by this result and paused the paid blue tick program in response.

The outcome of the introduction of paid Blue Badges was clearly predictable. Still, there was no meaningful risk management and oversight over Musk’s actions, just as there was none at SBF.

The result of Musk’s risk-taking on Twitter could be bankruptcy, which would be a loss for some big banks and investors, most importantly. The outcome of SBF’s risk taking on FTX is definitely bankruptcy. This bankruptcy is not only hurting big investors, it is also destroying the savings of many thousands of ordinary people who have kept their money in FTX.

SBF’s misdeeds also harm the many charities he has donated to, such as: B. pandemic preparedness. As a committed philanthropist who has given away tens of millions and focused on evidence-based charities, SBF raised hopes of inspiring billionaires to give away their fortunes quickly, just like MacKenzie Scott. However, many charity projects that he has pledged funding for are now in limbo, having had their funding withdrawn. Staff at SBF’s grant organization, the FTX Future Fund, resigned over revelations of wrongdoing at FTX, saying they were concerned about the “legitimacy and integrity” of SBF’s operations, which funded the grants.

Such harmful consequences that result from a lack of oversight and risk management highlight why it is so important for founders to have someone to help them make good decisions, manage risk and fix blind spots.

Risk managers need to be in a strong position and be able to go to the board — which needs to have real control over the CEO, not the CEO being able to fire the board like Musk did. When serving clients in this capacity, I insist on having access to a supervisory authority as part of my consultancy contract. I almost never have to use this option – but having it available helps me curb the double-or-nothing impulses from brilliant founders like SBF or Musk, since they know I have this option.

If you decide to make an investment with what appears to be a brilliant entrepreneur, do your risk management and oversight due diligence. If it seems like the entrepreneur has no one to curb his impulses, be careful. You take excessive risks and you gamble rather than invest your money wisely.

Gleb Tsipursky, PhD, is CEO of boutique consultancy for the future of work Disaster Avoidance Experts. He is the bestselling author of seven books including Never Go With Your Gut: How Pioneering Leaders Make the Best Decisions and Avoid Business Disasters and Leading Hybrid and Remote Teams: A Guide to Benchmarking with Best Practices for Competitive Advantage. His expertise comes from over 20 years consulting for Fortune 500 companies from Aflac to Xerox and over 15 years in the academic world as a behavioral scientist at UNC-Chapel Hill and Ohio State.

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