SBF’s lack of risk aversion led to FTXDM implosion

Victor Haghani, one of the founding partners of LTCM, applied the economic theory of choice under uncertainty to try and explain how FTXDM crumbled to the ground. 

In layman’s terms, “choice under uncertainty” means that you have to make a decision, but you’re not sure what will happen as a result of your choice. The theory posits that, in that instance, you will choose the option that maximizes the expected utility rather than the expected wealth.

Going against the sane

Here is a good example of choice under uncertainty:

Let’s say you discover an investment with a 98% chance of going to zero and a 2% chance of 10,000x ROI. Most wealthy people would choose to invest between 0.1% – 1% of their wealth in this investment because it is a reasonable thing to do. Not SBF, though.

“Yeah. I think the way I saw it was like, let’s maximize EV: whatever is the highest net expected value thing is what we should do. As opposed to some super sublinear utility function, which is like, make sure that you continue on a moderately good path above all else, and then anything beyond that is gravy.”

Victor Haghani, LTCM founder. 

Haghani relates this theory to SBF’s appetite for risk. He says Bankman-Fried made his investment decisions “as though he had no risk aversion.” In the example above, SBF would choose to invest 100% of his wealth in that investment because it maximizes the expected wealth.