Poof of Work
“Virtue sometimes pretends. Vice is always sincere.” – Mason Cooley
Johan Palmstruch was a Latvian-born Dutch entrepreneur who once opened a bank in Sweden. After two unsuccessful attempts, Palmstruch finally convinced King Charles X Gustav to grant his permission to the venture, and Stockholms Banco swung its doors open for business in 1657. History would have long ago forgotten Palmstruch had he not introduced two innovations to the European banking sector: the use of customer deposits to make loans and the issuance of banknotes.
The latter innovation was made necessary by the former, as Palmstruch was soon confronted with the classic problem of maturity mismatch: his deposits were short-term liabilities while his loans were long-term assets. Since they effectively replaced awkward-to-use copper and silver coins, Palmstruch’s banknotes became quite popular with the public, demonstrating the role of simple utility in the evolution of money.
Once Palmstruch realized he could create money from nothing he pretty much did. Small shortfalls were “papered over” until they festered into big ones, and eventually the gangrenous rot began to stink. When word got out that his bank might not be money good, a stampede of panicked depositors rushed to redeem their paper. The bank collapsed and Palmstruch spent most of his remaining life in prison. The remnants of Stockholms Banco were reincarnated as Sveriges Riksbank, the namesake of Sweden’s current central bank.
Not much has changed in the 365 years since Palmstruch’s bank collapsed, except for the whole “jailing bankers” thing. As long as there have been custodians of money, maturity mismatches, and varying degrees of liquidity among asset classes, there have been confidence losses that catalyze runs. Fraud is almost always found in the ashes of collapse (although history shows that outright fraud is usually a mid- to late-stage event). At some point in the boom-bust cycle, enterprises engaging in a little bit of chicanery to skirt through an otherwise manageable crisis find that once the culture accepts having stolen a penny, ethical incrementalism makes stealing nickels, dimes, and quarters all but inevitable.
The immunity from prison that fraudsters have thus far enjoyed in the currently bursting market bubble seems set to expire. In the past week, a fraud so brazen collapsed so spectacularly that even today’s batch of feckless regulators will be forced to act. Although the shockwaves from the rapid implosion of Alameda Research and FTX are still emanating from the Bahamas, a tsunami of consequences will barrel towards financial and political shorelines the world over in the weeks and months ahead. Investors are suddenly reacquainting themselves with the concept of counterparty risk (again!), and schemes that need a steady stream of fresh fiat to prop themselves up will soon drown in the contagion. And while it was the traditional media that blindly paraded Sam Bankman-Fried (SBF) to celebrity investor status, a combination of new citizen journalism and old-school short sellers played pivotal roles in exposing the scam. Let’s dig in.