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The case that foreshadowed the lessons of the FTX collapse

So how did our self-proclaimed modern day Robin Hood, who accepted extradition in the US earlier this week, to end up in chains?

The answer is foreshadowed by another “ethical crusader” who, just over a decade ago, experimented with his own philanthropic fantasy on the other side of the globe: Vikram Akula and his microfinance initiative. Microfinance refers to institutions that provide financial services, particularly small (“micro”) loans, to people normally unable to access credit from conventional banks, typically poor women, often in rural areas. The concept of microfinance, and the first microfinance institution, Grameen Bank, had been founded in the 1970s by economist Muhammad Yunus in Bangladesh and had gradually grown to boast millions of borrowers in the country and around the world: winning Yunus and his non-profit bank i Nobel Peace Prize in 2006 for contributions to the eradication of global poverty.

Akula, who grew up in the US, wanted to bring the business acumen he’d acquired as a management consultant at McKinsey – his equivalent of Robin Hood’s archery – into the microfinance model in his ancestral homeland of India : in particular, accelerating the process to bring into play the logic of rapidly scaling consumer brands, such as Coca-Cola or McDonald’s. He founded his own company, SKS Microfinance, in 1997 to do this. Driven by the notion that the faster Akula’s company expanded, the more good it could do, SKS quickly became one of the fastest growing institutions in the history of the industry, and Akula the bold new global face of microfinance, making, for example, the Time magazine list of the 100 Most Influential People of 2006. By 2010, an IPO of SKS, as apparent proof of the profit-with-a-purpose pudding, was oversubscribed 14 times.

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The similarities between FTX and SKS go beyond their founders’ personal trajectories of rebel with a cause. Like Robin Hood and his followers’ noble cat-and-mouse game with the tyrannical sheriff, both men operated on the fringes of the law in the extralegal liminal space between the legal and the unlawful, with SBF working in the unregulated cryptocurrency industry and Akula in the mostly unregulated South Asian microfinance sector. (In 2010, Akula also had an arrest warrant issued against him, though the “sheriffs” in India that they are, he was never arrested.) And both were motivated, theoretically, just like “the ‘man of the people’ Robin Hood, with a democratizing zeal to empower the people.

In fact, the original cryptocurrency and microfinance models had a lot in common. Crypto is a decentralized digital currency (Included, for example, Bitcoin, Ethereum, Tether, Binance Coin and Dogecoin) traded on cryptocurrency exchanges (such as Coinbase, Kraken, Gemini and, until recently, FTX, as well as some brokerage platforms such as Robinhood, Webull and eToro). Unlike traditional government-issued “fiat currencies,” cryptocurrency is not backed by any physical assets: its value is evoked entirely by common consensus. Because transactions (“blocks”) are verified and recorded (in a continuous link, or “chain”) in a code known as the blockchain, the equivalent of a checkbook spread across countless computers around the world, is viewed as open, pervasive, and consensus-driven: people’s ultimate ledger, or an opportunity for millions of ordinary people to collaborate in creating their own collective financial history.

The microfinance model, on the other hand, is notable for providing loans without contracts or guarantees, but rather through “group lending” or by organizing borrowers into supportive peer groups, usually of five, significantly expanding the funding radius. allowing virtually anyone (even those without legal or financial assets) to access credit, making it the people’s bank par excellence. Despite the absence of the usual punitive mechanisms and, again, collateral-backed lending, microfinance institutions achieve and remarkably maintain extremely high repayment rates—regularly in excess of 95%, reportedly—by consensus or common consent among borrowers. At the core of both are peer-to-peer relationships and dynamics that supersede the traditional hierarchies of finance, akin to Robin Hood’s commitment to redistribution as financial justice.

Cryptocurrency and microfinance – cousin experiments in decentralized and inclusive finance, respectively – challenge top-down institutions such as banks and governments by not only involving ordinary people but also, in theory, putting them behind the wheel (the community “verifies” the transactions in the crypto model and monitor lending via “peer monitoring” in microfinance). Despite their many detractors, they have managed to defy conventional wisdom to become multi-billion dollar industries, receiving the blessings and backing of some of the world’s most respected investors. Each, in turn, has been anointed by the benchmark venture capital firm Redwood Capitalfounded by the “godfather” of Silicon Valley Don Valentine.

And in both cases, the actors once considered its “golden boys” have almost single-handedly destabilized the prospects of the entire sector, proving their fragility. The hubris of FTX and SKS in developing highly simplified versions of their products was that they were working with a universal scaling formula, a mechanical substitute for trust, allowing for infinitely rapid growth. Indeed, Satoshi Nakamoto, in outlining the proposal for the first cryptocurrency, Bitcoin, hypothesized to be in part a response to the excesses of the 2008 financial crisis, explicitly described the technology as “based on cryptographic evidence instead of trust”. Similarly, Akula set out to develop what he called the “Starbucks version” of microfinance. FTX drew its confidence from the halo effect of blockchain code deemed incorruptible, while SKS operated under the assumption that the high repayment rates characteristic of microfinance were based on a cold economic cost-benefit analysis by borrowers.

They were wrong.

Like Nobel Prize-winning economist and high priestess of informality Elinor Ostrom established, the peer-to-peer mechanisms underlying both models can be highly resilient. But their success lies in their community calculation (relationships of trust and reciprocity between the participants and the institution), which makes the participants feel involved. Social identity has been a key part of what made both cryptocurrency and microfinance work. Women in India, like their roughly 15 million compatriots in Bangladesh, repaid their loans largely because it meant belonging. One in five Americans report that they have traded cryptocurrency, with 33% of those in crypto circles quoting “wanting to be part of a community” as at least a minor reason to invest. The secret ingredient that freezes any institution – but above all informal, like Robin Hood and his band – is solidarity within the group and faith in the morality of his mission: in these cases, correctives to the injustices of mainstream finance . SBF and Akula understood IT and business, but not the technology of trust.

In the early 2000s, Joseph Stiglitz (another Nobel Prize-winning economist) and I spotted the incipient “irrational exuberance” in the microfinance industry and predicted that the bubble would likely burst on the basis that SKS was undermining the same thing that had made microfinance work—trust—by “mass-producing” it at a rate and profit margin that crowded out the moral incentives of borrowers. In November 2010, anticipating events 12 years later at FTX, this unfolded: Soon after its explosive growth spurt, SKS was faced with a wave of defections in the form of mass delinquencies, a sad first in the history of the industry. Regulators, who had struggled to keep up with new developments in the industry, were quick to act, introducing draconian legislation. And so, after all, Akula’s experiment ended up in the “sheriff’s” chains. The lasting legacy of India’s microfinance crisis, barely reported by the international media, has been that 10 million women have been designated defaulters and denied access to credit in the future, potentially for the rest of their lives. Those footing the bill for Akula’s big gamble were the very people for whom he was acting: the common person. Meanwhile, this November, a tweet from Binance CEO Changpeng Zhao prompted a run on FTT, the FTX token, finally exposing the rot at the organization’s core and revealing an $8 billion hole in its balance sheet. potentially leaving 1 million of its customers, ordinary people, once again footing the bill.

SKS has irrevocably changed microfinance, shattering the fragile balance of goodwill that has long sustained it. FTX, for better or for worse, promises to do the same for the cryptocurrency industry. In light of corporate restructuring expert and Enron veteran John Jay Ray III testimony before the US House of Representatives on Bankman-Fried’s Bernie Madoff-style “old-fashioned embezzlement,” SBF is starting to look less like a heroic outlaw and more like a backyard highwayman. But from the FTX scandal, which is likely to join the ranks of “one of the largest frauds in American financial history,” to the SKS debacle, one of the largest mass defaults in history, the lesson is clear: the key thing about a l institution of the people is that you have to keep the trust of the people. Otherwise you go from being Robin Hood to, at best, the prince of thieves.