There will be no bailout as this fairytale revolution deserves its unhappy ending
Well, at least some good will come out of the FTX debacle and the latest crypto collapso. Michael Lewis, the author of The Big Short, Liar’s Poker and Flash Boys, has been shadowing Sam Bankman-fried, the now humbled founder of the collapsed crypto exchange, for the past six months. The resultant book may now have a different ending, but it will no doubt be a better read for the drama of the last week.
Just a few short days ago, Bankmanfried was being talked about as a modern-day JP Morgan and the king of cryptoland. FTX had stepped in to prop up a whole raft of tottering crypto-projects. As recently as June, The Economist described Bankmanfried as “crypto’s last man standing”.
Now he’s on his knees. The exact details behind the subsequent fall from grace are still emerging, but it has been precipitous. The unravelling started when Changpeng Zhao tweeted that Binance, his own crypto exchange, would be selling its holdings of FTX’S FTT tokens “due to recent revelations”.
This prompted what was effectively a run on FTX with a stampede of investors following Binance’s lead.
The result was a massive liquidity crunch. At one point it looked like Zhao would step in as a white knight. However, Binance took one look at FTX’S books and backed away from a deal.
FTX filed for Chapter 11 bankruptcy at the end of last week with a reported $8bn (£6.7bn) black hole in its finances. There have been suggestions that Bankman-fried, who by now sounded like he had been named by Charles Dickens, borrowed customer funds to make investments through his crypto trading firm Alameda Research. FTX also appears to have made some large and ill-advised loans backed by its own Monopoly money.
Lewis hasn’t started the book yet, but an email sent by his agent promoting the project to Hollywood studios that has been obtained by the Ankler, an American news outlet, suggests it will highlight the rivalry between Bankman-fried and Zhao. Lewis describes them as the Luke Skywalker and Darth Vader of crypto, according to the email. His assessment of which is which may have altered in recent days.
The book will no doubt be a best-seller and provide a timely reminder of the fact that investors perpetually underestimate the importance of narratives in the valuation of assets. Morgan Housel, a fund manager who also writes brilliantly about finance, once said: “There are always two sides to every investment: the number and the story. Every investment price, every market valuation, is just a number from today multiplied by a story about tomorrow.”
This is true of every asset. For example, the value of something as boring as a government bond is partially a product of the stories economists and investors tell each other about a country’s creditworthiness and the path of future interest rates.
When it comes to equities, the numbers become a little less important and stories more so.
Indeed, if the management team is unable to spin a credible yarn the value of a company may tread water despite pumping out reasonable numbers. Such investments often get branded “value traps”. The multiples may suggest they’re cheap, but without a new story to prompt a rerating, there’s no telling how long they may remain so.
The more speculative the asset, the more important the story. For example, Made.com, the online furniture retailer was able to float on the stock market 17 months ago with a valuation of £775m despite never having made a profit because it convinced investors that a pandemic-trigger boom in online sales was the “new normal” and it had set up a “flexible, asset-light” supply chain. Both claims turned out to be works of fiction.
The collapse of FTX – following the downfall of Luna, the Three Arrows hedge fund, the broker Voyager, lender Celsius, among others – has highlighted that crypto assets are almost all story without any (meaningful) numbers. Some crypto assets give investors rights over their underlying technology, but many do not. Dogecoin was literally set up as a joke.
Indeed, there have been at least three twists in the prevailing narratives about crypto assets.
The first was that they could be used as a way of making practically frictionless payments. This tale was, however, somewhat undermined by the huge volatility in their value. A computer programmer called Laszlo Hanyecz famously paid for two pizzas with 10,000 bitcoins a few years ago. Despite bitcoin’s recent fall in value, that means those pizzas cost Hanyecz the equivalent of more than $166m today.
The second tale suggested crypto assets could be used to disintermediate traditional banks and the broader financial system. But it turns out that banks, though widely disliked, and regulation have evolved over time to deal with pretty fundamental problems around trust and cleaning up the mess if something does go wrong.
One of the more amusing aspects of the FTX debacle has been the sight of anarcho-libertarian cryptoevangelicals bleating about the need for some kind of bailout.
That’s not going to happen. Turns out disintermediation works both ways.
The latest story crypto investors tell themselves is that these assets can act as a store of value and a kind of alternative to gold. In a way this does make some sense.
Gold has very few practical uses, no yield and doesn’t provide investors with access to any future cash flows. Ultimately the precious metal appeals to humans because it is rare and shiny. Most crypto assets are also resilient and reasonably scarce: there will only ever be 21m bitcoins, for example.
But even here I have my doubts. Bitcoins may be finite but the ability of plausible-sounding tech bros to dream up revolutionary new crypto-assets is surely limitless. As yet, there is no scalable use for any of them. Instead we are beginning to see this is another story unlikely to have a happy ending.