The House That Sam Built: Part I
The mindset, upbringing & famous trade of crypto's most interesting man
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Since John D. Rockefeller first became one in 1916, humans have always held an intense fascination with billionaires. This fascination is not without merit - the average billionaire has a net worth more than 1,000x what the average American citizen will earn in their entire life. It becomes difficult to truly fathom that amount of personal wealth. How did they do it? How do they live? How can we be like them? Should we be like them?
Humans have even greater interest in young billionaires. Not only did someone make more money than most people can fathom, they did it really fast. How can this be anywhere near humanly possible?
When we filter the fascinating topics of immense wealth & youth against an equally fascinating topic - cryptocurrency - we arrive at a very selective club of individuals. Most don't speak publicly about their wealth or daily lives.
One does. His name is Sam Bankman-Fried (SBF for short). With an estimated wealth north of $16 billion, SBF is considered to be the richest person in crypto. At 29 years old, SBF may also be the most interesting person in crypto. And he talks - a lot.
I've spent the last number of months reading, watching, listening to & compiling as many interviews with SBF as are public. The result is a detailed picture of his life, his businesses, his worldview, and his plans for the future.
This post, split into two parts, is a summary of what I’ve learned.
The Goal
The first sign of Sam Bankman-Fried’s driving principles surfaced while in school at MIT. SBF excelled at math & science and majored in physics, but like most college students did not know what career to pursue after graduating.
How do most students pick a career when the time comes? They choose a job that pays the most, or is in the city they want to live, or lines up with their passion & can lead to a life they think would be the most enjoyable.
How did SBF pick a career? In his own words: “I want to maximize every cent I can and aggregate net happiness in the world.”
That’s… a unique thing for a 22 year old college student to say. Maybe the underlying message isn’t unique - most people would likely say they want to make the world a better place if asked the question. Treating happiness as a variable in a mental life algorithm, on the other hand, is not what I believe most people consciously do when deciding on a career path.
SBF’s quote is two ideals in one - first, his goal is to maximize aggregate net happiness in the world, otherwise known as effective altruism. Second, the way to be the best altruist is via wealth maximization - make as much money as possible only to give it all away over time.
We should examine this ideal with a healthy amount of skepticism. Plenty of young graduates pursue wealth with charity as a convenient enabler of greed. Charlie Sheen’s character Bud Fox in the classic movie Wall Street portrays this best: “You gotta make it to the big time first, then you can be a pillar and do good things.” (Fox would go on to make it to the big time and do bad things, missing jail time only because he cooperated with the Feds to incriminate his boss, Gordon Gekko). Should we trust SBF when he says he’s getting rich to make the world a better place?
With what I’ve seen from Bankman-Fried so far, I am choosing to believe his altruistic goals. First, he puts his time & money where his mouth is. Before becoming a crypto billionaire SBF spent time working at the Centre for Effective Altruism, a non-profit focused on encouraging young professionals to embrace charitable ideals. He left the job a few months after starting because he felt his skills could be used elsewhere for greater impact - mainly that donating to the charity would do more good than working for the charity. Today he and his businesses donate a non-trivial portion of revenue to various foundations every year. SBF’s actions back up his words enough for me to believe them.
Second, Bankman-Fried doesn’t look to be enjoying his wealth, at least publicly. SBF doesn’t drive around Hong Kong in expensive Lamborghinis. He isn’t buying NFL teams. He’s not taking lavish vacations & frequenting rich celebrity parties. He’s working, around the clock. As most people have seen by now, he regularly sleeps on a bean-bag chair next to his desk:
This doesn’t give me the impression Bankman-Fried is working for the money. SBF may have an unhealthy obsession with work, but he likely doesn’t have an unhealthy obsession with wealth, at least as far as I can tell. Take this evidence and make your own conclusions about SBF’s driving principles. I have no reason to believe he’s lying about his focus on effective altruism through maximizing wealth.
The Training
So we have a very smart MIT graduate looking to leverage his knack for math & science to make as much money as possible for a better world. What kind of career path suits this kind of skillset? In SBF’s mind, the choice was clear - quantitative finance. In June 2014 SBF signed on to work with Jane Street, a high-speed trading firm specializing in global ETF arbitrage.
Jane Street was founded in the late 1990s after a few Susquehanna options traders left to explore ETFs, a new, complex & fast-growing financial instrument. The expertise these traders developed at Susquehanna ported incredibly well to the ETF market. One skillset in particular worked well across both options & ETFs - arbitrage, the art & science of keeping related financial products in line with each other and making risk-less profits in the process.
Bankman-Fried traded with Jane Street during a golden era for the ETF industry - passive investing was surpassing active management in AUM, more complex ETF products were hitting the market, and global volatility in 2015 & 2016 gave Jane Street plenty of opportunities to put their arb expertise to work:
While at Jane Street SBF learned how to arbitrage global markets from the best teachers on the planet. He learned how to trade fixed income ETFs against a basket of thousands of illiquid, hard to price underlying bonds. He learned how to trade emerging market ETFs where the underlying stocks didn’t all trade in the same time zone. He learned how to navigate extreme market shocks & how to squeeze money out of a quiet, calm, uneventful trading season. And he made a lot of money doing it.
The knowledge Jane Street had obtained & improved upon from Susquehanna can be considered a treasure, giving recipients the ability to mint extreme amounts of wealth in a short period of time. For three years Bankman-Fried had access to this treasure & absorbed its contents to the best of his ability.
On the surface, Jane Street had everything SBF could want. A good team of like-minded math & science savants. A way to leverage his skills to make money. A compensation package likely in the millions of dollars, fulfilling his altruistic goals. Despite these attractive features, SBF left Jane Street in late 2017.
Why?
The Trade
In mid-2017 Sam Bankman-Fried saw something that made him stop his career path dead in its tracks. It caused him to quit his satisfying, high-paying job and take big personal risk. What did he see? The price of Bitcoin denominated in Japanese Yen was trading a whopping +20% higher than its USD-denominated counterpart:
Why is this such a big deal? In Jane Street’s world of ETFs, differences between similar assets means an opportunity to make money. If an ETF is trading 0.5% higher than its underlying basket, you can buy the basket, redeem it for shares of the ETF, sell the ETF, and make a free 0.5% return. Do this thousands of times per day and you have yourself a mutli-billion dollar quant trading operation.
In 2017 the crypto markets offered a similar kind of operation, but instead of 0.5% returns, it offered 20%+ returns. That is unheard of in modern finance. When SBF saw what was happening in the above chart, his first thought was ”That’s fake. I don’t know why yet, but that’s fake. That can’t be real.” Upon closer analysis of the price difference, not only did he confirm it was in fact real, but it was potentially a trade he could execute.
On the surface the trade seemed straight forward:
Step 1: Buy Bitcoin on a USD-denominated exchange.
Step 2: Transfer position to a Yen-denominated exchange.
Step 3: Sell Bitcoin on JPY exchange for a higher price.
Step 4: Send the money back to the USD exchange and repeat until the spread is gone.
But if it’s so easy to make this 20% profit, why hadn’t anyone done it yet? SBF was about to find out.
After Bankman-Fried left Jane Street he and a few of his friends set out to capitalize on this trade. Although the 20%+ opportunity had come and gone during the summer, SBF wanted to be prepared if another such situation presented itself. First they tried to get a bank & prime brokerage relationship set up in the US and immediately ran into problems. It was mid-2017, the early stages of crypto market structure, and no regulated US bank wanted to have exposure to the asset class, let alone to a newly-formed group of mid-20s prospective crypto traders. To get around this obstacle SBF and team gave their firm a traditional sounding name - Alameda Research - and hired a team of lawyers to help them understand the legal rules & how to navigate through them with traditional banks.
Next came the challenge of buying Bitcoin & transferring it where they wanted quickly & in large quantities. Most crypto exchanges have daily withdrawal limits to mitigate fraudulent activity. Which exchanges have the highest limits? How fast can crypto be pulled out? Where can it go? What wallets can support multi-million dollar transfers at a time without crashing & losing all the money inside? Tedious work was required to research & organize the best answers to these questions.
On to Step 2: getting US Bitcoin into a Japanese bank & exchange. Just like in the US, most Japanese banks either weren’t allowed to or didn’t want exposure to crypto in 2017. Additionally, in order to have a banking relationship in Japan residency & in many cases citizenship is required, not to mention fluency in Japanese. Alameda overcame this challenge by again finding lawyers & residents to establish relationships with mostly rural Japanese banks to get access to the country. Relationships with multiple banks were required for the best chance at success - if one bank flagged or froze Alameda’s account mid-trade, they wouldn’t be able to maximize their profit & may face sizable losses.
Step 3 began to deal with the question of liquidity. Sure there may have been one or two out-of-line Bitcoin/Yen trades, but was there enough demand at those high prices to justify the trade? How much Bitcoin could Alameda sell in Japan before the opportunity was gone? Was it worth all the work & risk? In mid-May when the first arbitrage window was open BTC/JPY volume averaged ~$30 million USD notional per day, with large spikes in activity during periods of high volatility. The liquidity was certainly there in high enough amounts to realize the profit Alameda was after.
Lastly, Step 4 - sending the money back to the US for restarting the trade - continued to pressure Alameda’s banking relationships in both Japan and the US. If this trade were to occur as planned, Alameda’s accounts would show massive one-way flows of money out of Japan and into the US, which would be sure to raise suspicions of money laundering or illegal activity. How could these banks understand what Alameda was trying to do?
Hopefully the loose summary of the BTC/JPY trade above gives you an idea of the massive amount of work & skill it took to make money in crypto arbitrage in 2017. SBF and his new Alameda team worked tirelessly for months to get all the infrastructure set up perfectly in the US and Japan, waiting for their time to strike.
As late 2017 turned into early 2018, Alameda finally saw their chance. Just like in mid 2017, the price of Bitcoin in JPY terms spiked well above its US equivalent, offering similar 15%-20% arbitrage returns for a little over one month:
This time, SBF was ready. During that now historic five week period Alameda funneled millions of dollars through their banking & exchange apparatus, capturing daily returns - daily returns - of between 5%-15% until the mispricing ended in late January 2018. Using conservative estimates, Alameda could have more than quadrupled their initial capital after taxes & fees from this five week mispricing. Everyone could see what was happening, but only SBF & his Alameda team had done the hard work to execute it, with generational wealth as the reward.
Just The Beginning
Fast forward three years, and Alameda is the largest quantitative firm in crypto. They regularly trade between $1 and $10 billion per day across the crypto spot & derivatives markets. They have a significant presence on every major exchange across the world, doing the hard work to watch markets for mispricings & then capitalizing on those mispricings. Given the early innings of crypto market structure, much of this trading is still a manual process. In 2019 Alameda released footage of SBF & his team noticing & trading on a multi-million dollar Bitcoin mispricing in real-time, giving you a sense of the work Alameda still does on a daily basis:
This resume would be impressive for any trader, let alone a 29 year old. The crazy part is, we haven’t touched on a major part of SBF’s current activity - FTX, now one of the top 5 largest crypto exchanges in the world with plans to expand massively in the US and developed countries around the globe. Part II of this series will focus specifically on FTX and its role in SBF’s vision to become a John D. Rockefeller in his own right - wrangling the crypto markets to meet his altruistic, larger than life aspirations.
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ, COIN and VIRT. I am also long Solana.