In Hindsight: Seeing the Next FTX and Theranos Coming

When people lose money, fingers start pointing.

Who shoulders the blame? Who should have seen this coming? Did the media miss the story?

With the collapse of FTX, one of the world’s largest cryptocurrency exchanges, many fingers are pointing at the media.

Elon Musk, with more than 116 million Twitter followers, fanned the flames last week.

In a Twitter exchange, Musk agreed with a crypto account that the mainstream media would be taken more seriously if it didn’t promote scammers like FTX Founder Sam Bankman-Fried (SBF) and disgraced Theranos founder (and now convicted fraudster) Elizabeth Holmes.

And those who aren’t blaming the media for its part in legitimising the likes of SBF and Holmes are relishing just how badly the puff pieces and magazine covers on the pair have aged.

‘Should have seen this coming’

Much of the ire directed at the media stems from the rebuke that it should have seen through the hype.

It should have seen the collapse of FTX and the unravelling of Theranos’s lies about the efficacy of its blood-testing machine coming.

But that implies there was something to see…and see with clarity.

The FTX disaster wasn’t just foreseeable…it was right there in front of the media’s eyes all along, glaring back.

If that’s the case, two possibilities stand out:

1. The media saw through FTX and Theranos and turned a blind eye; or
2. The downfall of FTX and Theranos was not as foreseeable as hindsight makes out.

Option 1 is nefarious.

Given that thousands entrusted their money with FTX, and hundreds of private investors pumped a billion dollars into Theranos, 1 implicates the media in helping FTX and Theranos mislead investors.

Smart money makes a dumb decision

But how influential was the media’s coverage? Did it fan the hype or spark it?

Investors often quip that if something is in the news, it’s already priced in. And once a story makes a splash on major magazine covers, it’s likely already peaked.

Hence the idea behind the magazine cover indicator theory. As The Economist put it in 2016 (emphasis added):

‘The premise behind the indicator is that when a journalist or editor finally devotes a cover to a market trend, company, country or person, the story or theme has been in vogue for some time and is likely past its peak. Positioning and sentiment should already fully reflect the story on the cover of the publication and the story should be fully priced in. In other words, by the time a journalist writes about the trend, a majority of the move has already happened.’

This would lessen the media’s portion of the blame in validating frauds like Theranos and disasters like FTX.

And clearly, many investors weren’t taking their cue from media coverage.

As The Wall Street Journal noted last week:

‘Dozens of the world’s lead­ing in­vest­ment firms, in­clud­ing Se­quoia Cap­i­tal, Sin­ga­pore’s state-owned in­vest­ment com­pany Temasek, the On­tario Teach­ers’ Pen­sion Plan, Soft­Bank Group Corp., and hedge funds Third Point and Tiger Global, show­ered SBF with money.’

Venture capital firms and hedge funds don’t fish for ideas in magazine covers. In fact, once something is on a front cover, chances are the hedge funds are already out.

So how did Sam Bankman-Fried and Elizabeth Holmes manage to hoodwink big investment firms like Sequoia and Tiger Global?

Reality distortion field

Steve Jobs was said to have possessed a ‘reality distortion field’ that made him and his ideas so persuasive.

Some argue both Sam Bankman-Fried and Elizabeth Holmes wielded a reality distortion field of their own.

Drawing lessons from the collapse of Theranos, the Financial Times wrote:

‘The third lesson is that charisma carries some bosses further than their capabilities merit. Holmes’s status as a rare female in a male-dominated world combined with her self-belief and charisma to create a “halo” effect that stifled disbelief. Her charm and plausibility have been compared to that of Bernard Madoff, the US financier who perpetrated the largest Ponzi scheme in history.’

And it’s true that you couldn’t get through an article on Bankman-Fried without a journalist mentioning his charisma.

Bankman-Fried’s reported genius was also mentioned regularly.

The most notorious example, of course, was the 13,000-word hagiography from Sequoia, now taken down but archived forever by the internet.

Instead of seeing SBF’s ‘scepticism’ of books as a red flag, the Sequoia profile saw it as a sign of superior intellect (emphasis added):

‘Wouldn’t someone with IQ points to spare realize that dismissing books—all books—as essentially worthless might rile a writer? Was he playing with me? Is this fun? Is this humor?

‘I’m satisfied with my meta-analysis until I realize that one can always increment the level of strategic play in this sort of game. It’s like poker. Level one is just thinking about how to strengthen your own hand. Level two is thinking about what your opponent’s hand is. Level three is thinking about what your opponent thinks your hand is. And so on. And, since SBF is obviously a genius, I should simply assume that, compared with me, SBF will always be playing at level N+1. Which makes my analysis of the intent behind SBF’s “books are for losers” idea spiral into infinity and crash, like a computer program stuck in a loop.’

Maybe there’s a lesson or two here:

1. People who don’t read books warrant scrutiny, not praise.
2. Geniuses can vaporise billions of dollars. In fact, their genius makes it more likely they’ll find spectacular ways of doing so on a grander scale than a non-genius.
3. Someone who is obviously a genius might not actually be a genius.

That geniuses can lose money suggests that investors shouldn’t bet on the person but on the business.

Great founders with vision and unwavering dedication are certainly important considerations. Steve Jobs, Jeff Bezos, and Mark Zuckerberg have all delivered massive shareholder value by pioneering businesses billions now use and enjoy.

But charisma and genius can only go so far. Steve Jobs can’t sell you a turd, no matter how much he polished it.

Appraising the underlying business a charismatic founder runs may be more productive than appraising the personality of the founder.

If you focus on the underlying business or technological proposition a founder is selling, you’re in a better position to root out the hype.

Take MedVenture, a medical technology venture capital firm that turned down Elizabeth Holmes in 2004.

How did they manage to avoid Holmes’s reality distortion field? By focusing on the nuts and bolts of Theranos’s blood-testing machine.

Here’s a snippet from John Carreyrou’s Bad Blood, the book on Theranos:

‘One morning in July 2004, Elizabeth met with MedVenture Associates, a venture capital firm that specialized in medical technology investments. Sitting across a conference room table from the firm’s five partners, she spoke quickly and in grand terms about the potential her technology had to change mankind. But when the MedVenture partners asked for more specifics about her microchip system and how it would differ from one that had already been developed and commercialized by a company called Abaxis, she got visibly flustered and the meeting grew tense. Unable to answer the partners’ probing technical questions, she got up after about an hour and left in a huff.’

Don’t get FOMO

When a theme gets popular (like all things crypto did in 2021), it picks up a momentum that can easily be mistaken for longevity.

This momentum can be irresistible. For a while, it can even sustain itself.

That’s when FOMO (fear of missing out) kicks in.

And FOMO can disturb our decision-making.

Don’t take it from me. Take it from Sam Bankman-Fried himself. In April, Bankman-Fried described how venture capital firms were approaching FTX as an investment (emphasis added):

‘You get a bizarre f-ing process that does not look like the paragon of efficient markets that you might expect. Venture capitalists] see what all their friends are chattering about, and their friends keep talking about this company….and they start FOMOing [feeling the fear of missing out] and then [they] find a way to get into that…

‘And all the while, you’re like, “How do we justify: Is this a good investment? Like, all the models are made up…. You’re valuing [companies] off a model built by a person who owns the thing that’s being sold. So, like, of course the number’s going to go up between now and 2025, right? It’s going to go up an arbitrary amount. And you can justify anything”.’

If you find yourself feeling FOMO, be careful. Take a step back and zoom out. Make sure your FOMO doesn’t get exploited.

Until next week,

Kiryll Prakapenka,
For Money Morning