Last week’s Blood Moon lunar eclipse presaged two financial events that had nothing but everything to do with one another. Christie’s auctioned Paul Allen’s art collection in New York City for more than $1.6 billion, the largest haul ever from a single-owner collection. The late Microsoft cofounder’s will dictated that all proceeds go to philanthropic causes.[1] Meanwhile, 125 miles away in Delaware federal bankruptcy court, crypto asset exchange FTX filed Chapter 11.[2] FTX’s Q1 2022 funding round valued the company at $32 billion, just three years after its founding. Hailed as a Millennial generation genius committed to serving humanity, FTX founder Sam Bankman-Fried gambled his and his co-investors’ entire stake and rolled snake eyes.

In its meteoric rise, FTX attracted eight and nine figure investments from superstar venture capital firms, including Sequoia, Blackrock, Softbank and Tiger Global. Other investors included the Ontario Teachers’ Pension Plan, the Alaska Permanent Fund and the Washington State Investment Board.[3] The Alaska and Washington investments were via Sequoia’s Global Growth Fund III, which bought into FTX.

Sequoia hyped FTX, publishing on its website in mid-September an article titled “Sam Bankman-Fried Has a Savior Complex—Maybe You Should Too.” The article recounts the Sequoia investment committee’s Zoom call due diligence interview of Bankman-Fried.[4] “[He] told Sequoia about the so-called super app: ‘I want FTX to be a place where you can do anything you want with your next dollar. You can buy bitcoin. You can send money in whatever currency to a friend anywhere in the world. You can buy a banana. You can do anything you want with your money from inside FTX.’ Suddenly, the chat window on Sequoia’s side of the Zoom lights up with partners freaking out. ‘I LOVE THIS FOUNDER,’ typed one partner. ‘I am a 10 out of 10,’ pinged another. ‘YES!!!’ exclaimed a third.”

Last week, Sequoia wrote off its investment in FTX and removed the article from its website.

FTX’s bankruptcy is ironic. The premise on which crypto assets have been created, bought, and sold is that market participants can regulate themselves and their assets solely by means of so-called “smart contracts” among themselves. No other legal framework is needed. Blockchain technology makes the contracts self-executing. Once a market participant presses “enter” on her computer everything else is automatic.[5]

FTX initially operated from Hong Kong but moved to Barbados during Covid. There, like other crypto asset businesses, it operated outside U.S. jurisdiction in a world of its own making. No federal or state securities law registration of crypto asset offerings. No federally chartered banks to be third-party custodians of crypto assets. No legislatures or courts to set behavioral boundaries for market participants. No rules except its own—until FTX overleveraged its balance sheet, made speculative bets on companies that faltered, and drastically overweighted investment in its own cryptocurrency. When the roof fell in, Bankman-Fried and his team grabbed what they had steadfastly avoided—protection of U.S. federal law.

Beyond irony, the FTX case in our opinion is a benchmark event in the evolution of our global financial system. FTX will be dissected and analyzed as more than 100 nations now contemplate creating their own digital central bank currencies. China leads the pack, having debuted its digital yuan during the recent Olympic Games there. Chinese citizens are now being told to use digital yuan every day. Transaction data collected by the government gives it more control over citizens’ lives. The government also hopes digital yuan will help that currency attain parity with the U.S. dollar as an internationally-accepted reserve currency.[6]

The U.S. is taking a more measured approach. Beyond legal complexities, creating a digital dollar presents a thicket of technical issues, summarized in a report released by the White House in September.[7]

The signal difference of digital central bank currencies from crypto currencies is the involvement of an issuing central bank and the financial and legal regimes that follow. What exactly a central bank’s role should be is a hot topic. Commercial bankers fear central banks issuing and administering digital currencies will make commercial banks irrelevant. That outcome is theoretically possible, but politically unlikely. Non-bank payment system participants all have their own interests to protect—VISA, Mastercard, P-to-P payment systems, Western Union and even the U.S. Postal Service. So do big tech and telecom companies, e.g., Apple, Google, AT&T and Verizon. They see themselves as rightfully occupying the center of the financial transactions hourglass. Multiple federal agencies also have a stake in the outcome. Also to be reckoned with are New York and California financial regulators, who always impose rules of their own on parties operating in their jurisdictions. The resulting battle royale will likely take years if not decades to resolve.

In the best of all worlds, the FTX bankruptcy case will point up needs that must be met to arrive at a safe and sound system for digital currencies that serves everyone well enough. Too, a stronger legal regime among nations will be needed if digital currencies are to have transnational utility. Amid those realities, tech entrepreneurs and those who fund them will need to overcome their perennial habit of getting drunk on their own wine, as they did when they threw money at FTX.

Adam Fisher, the author of “Sam Bankman-Fried Has a Savior Complex,” writes of his visit to FTX’s picture-perfect Barbados residential compound: “As I fry up an omelet for myself . . . my thoughts drift until they shoal in the lee of The Great Gatsby. . . . [D]amend if [Bankman-Fried’s Barbados campus] is not West Egg. But is crypto the new jazz? And, if it is, does that make Sam Bankman-Fried the new Jay Gatsby?”

Trying to answer his own question, Fisher contrasts the two men but overlooks their essential commonality. Gatsby and Bankman-Fried both use cold-blooded rationality to become wealthy. Yet psychic gratification is what animates them. Gatsby craves Daisy’s love and so throws lavish parties at the big house with the blue lawn and the green light at the end of the dock. Bankman-Fried craves “effective altruism” on a grand scale, scheming to build a trillion-dollar personal fortune he can give away, eclipsing Paul Allen’s and his peers’ achievements. For both Gatsby and Bankman-Fried and his co-investors, the constructed reality is an illusion. That it ends badly is no surprise really; rather, it is inevitable.

[1] https://www.cnn.com/style/article/paul-allen-collection-christies-auction-record/index.html

[2] https://www.nytimes.com/2022/11/11/business/ftx-bankruptcy.html

[3] https://decrypt.co/114235/ontario-teachers-95m-ftx-pension-fund-limited-impact

[4] https://web.archive.org/web/20221109230422/https://www.sequoiacap.com/article/sam-bankman-fried-spotlight/

[5] I first encountered “smart contracts” eight years ago when attending a law school reunion. A very able classmate then working for Silicon Valley companies described his work on smart contracts. It seemed far-fetched to me at the time. I now better understand where he and others were going.

[6] https://www.wired.com/story/chinas-digital-yuan-ecny-works-just-like-cash-surveillance/

[7] https://www.whitehouse.gov/wp-content/uploads/2022/09/09-2022-Technical-Design-Choices-US-CBDC-System.pdf