Happy Wednesday from Puck, and thanks for reading Dry Powder, my biweekly email about what’s really happening on Wall Street.

As you know, I’ve spent the past weeks chronicling some of the people in finance and media who first saw the failure of FTX coming. (Part 1, in conversation with Anthony Scaramucci is here; Part 2, featuring former broker Laura Goldman, is here; and Part 3, with short-seller Marc Cohodes, is here.) For tonight’s installment, I sat down with James Block, the amateur financial sleuth who was one of the first to get his hands around Alameda Research’s balance sheet—and helped to bring to light Sam Bankman-Fried’s house of cards.

As always, keep the tips and feedback coming. Your responses to these private emails go directly to my inbox.

Bill

As everyone knows by now, after weeks of verbal diarrhea, S.B.F. was arrested in the Bahamas on December 12 and extradited to the United States before Christmas. He pleaded not guilty to the numerous fraud charges filed against him by the Justice Department and the Securities and Exchange Commission. After pledging some $250 million of assets, he was released on bail to his parents’ home, where he continues to defy legal advice and has met with my friend and former colleague, Michael Lewis, and my friend and partner, Teddy Schleifer. His trial begins in October. (You can read Teddy’s fabulous piece from inside the brain and home of S.B.F. here.)

Meanwhile, in early November, Block got his hands on the now infamous one-page unaudited balance sheet that purported to show the assets and liabilities of Alameda Research, S.B.F.’s now defunct hedge fund that put to work (read: lost) many billions of dollars that he allegedly siphoned off from FTX’s many customers. Block received the information at about the same time as Coindesk, the cryptocurrency news site. Like Coindesk, Block knew pretty much immediately once he saw the document that, if it was close to accurate, then Alameda and FTX were built on a house of cards and would surely collapse. He had seen it all before, with Celsius Network, a multi-billion crypto lending firm with close ties to S.B.F. that had filed for bankruptcy last July after using its own spun-up crypto token to make it look like it had more assets than it actually did.

Once he saw the purported Alameda balance sheet, Block thought he recognized the same phenomenon going on at Alameda and FTX. It was stuffed full of spun-up crypto tokens, including FTT, FTX’s crypto token. “I knew that they were in very serious trouble if those financials were real,” Block explained. “Because none of that stuff was realizable, as we’ve obviously seen since. That’s how all these schemes work: they basically create a bunch of assets on paper that are totally fictitious, essentially. So pretty easy once you’ve delved into a few of these things. So it was easy. Once you’ve seen it at once, it’s easy to recognize it.”

On November 4, Block wrote a blog post asking the provocative, and at the time shocking, question: “Is Alameda Research Insolvent?” Few had genuinely contemplated that notion before Block, and almost no one had articulated it out loud. As a result, Block’s financial heroism has earned him a spot in this mini-series about early S.B.F. bullshit callers. Not bad for a biology major.

Block was incredulous. The Alameda balance sheet once again confirmed his “dirty shit” thesis after all. “S.B.F. has a reputation for being the smartest guy in the room,” Block wrote in his post. “The crypto billionaire controls both one of the largest crypto hedge funds, Alameda Research, and one of the largest crypto exchanges, FTX. He has appeared in the thick of multiple crypto company failures, bailing out crypto lender Blockfi and acquiring most of the assets of Voyager Digital after their respective failures. Some have even compared his role during the recent crypto rout to J.P. Morgan during the crisis of 1907. However, a recent leak”—of the Alameda balance sheet—“suggests that S.B.F.’s crypto empire rests on some questionable foundations.”

He described Alameda and FTX as a “flywheel scheme,” similar to the one Celsius Network had created before its bankruptcy, wherein you create a bullshit crypto token, pump it up by making it illiquid and then convert it into an actual currency—dollars—and use the real money to convince investors to invest, to buy real estate, stadium naming rights, Lambos, etcetera. “FTT token is another stupid flywheel,” Block continued. Worse, he realized, the FTT tokens were utterly illiquid and the increase in their valuation was basically phony; any attempt to sell the FTT tokens into a market that barely wanted them would result in a death spiral.

“All this to say that Alameda will never be able to cash in a significant portion of FTT to pay back its debts,” he concluded. “There are few buyers, and the largest buyer appears to be the very company Alameda is most closely tied to. The reality of this situation is that the vast majority of the value Alameda accrues to FTT token is unrealizable, and the fair market value of their FTT in the event of large sales would rapidly approach $0.” (Block’s emphasis.)

In our interview, Block described what S.B.F. was doing with Alameda and FTX as a “cargo cult,” a phrase I had never heard before. Apparently, a “cargo cult” refers to the observed behavior of some indigenous, isolated societies that came to believe that certain rituals, such as building fake airports, could facilitate the arrival of mysterious people bringing desirable goods and advanced technologies. They associated one with the other, without fully understanding the concept of jets or airports. “It’s a real thing,” Block instructed. “Look it up. “It is a perfect analogy.”

FTX used its tokens, he said, to create a “facsimile of a real economy,” like a cargo cult. “Essentially, what they do,” Block told me, “is they make this token up, which is literally just a few 100 lines of code running on a blockchain. They sell some of them off to the public. They retain a lot more of them for themselves and give them to insiders. And the rest of them end up sitting on the company’s balance sheet… They take advantage of the fact that a relatively small number of the tokens are actually in circulation and then they’re able to kind of capitalize on that lack of liquidity to drive the price up on these markets.”

As the lack of liquidity of the tokens drives their price up, the S.B.F.s of the world then mark the tokens to the higher market value and tell potential investors that, in addition to being this newfangled, cutting edge ‘change-the-world’ kind of company, they also have a huge and valuable set of assets. “But basically, any test of liquidity destroys the token and that’s essentially what happens [to S.B.F.],” Block said.

Investors and customers fell for it in droves. But Block, given his background in psychiatry, had other views. S.B.F. was “probably one of the least charismatic Ponzi schemers in history,” Block said, “but maybe that’s what worked in his favor.” He continued: “It feeds into itself, like as you become more successful, the more likely people are to kind of give you the benefit of the doubt, and be less willing to challenge you. Crypto relies entirely on obfuscation, and it makes things seem more complex than they really are. A lot of the time when I try to explain this stuff to my friends or family who aren’t familiar with it, and they go, I don’t understand, maybe I’m not smart enough, my response is always, No, you’re smart enough. It’s just that dumb. It’s so dumb that you have to really think about it to understand that because it just doesn’t it doesn’t make any sense because it’s not sustainable and it’s not real.”

Block thought that was really weird. “Normally when I write these things that are very negative about crypto, everyone circles the wagons,” Block continued. “It’s always, We’ve got to be positive. We have to support the community. It doesn't matter if it's true or not. We’ve got to make sure that we don't do damage to the community and the reputation of all of us. So the fact that this guy, who runs the largest exchange in the world, is liking my post about his competitor being insolvent was interesting.” After that came C.Z.’s tweet about dumping his FTT tokens, starting the proverbial “run on the bank” at FTX and Alamada. By swapping C.Z.’s equity stake in FTX for FTT tokens, S.B.F. handed C.Z. “the guillotine and said, ‘Whenever you want to chop my head off, go for it,’” Block said.

The rest, as they say, is history. The combination of the leaked balance sheet, the articles by Coindesk, and, as I reported earlier, S.B.F.’s unwise fundraising mission in Saudi Arabia, seemed to create a vulnerability for S.B.F. that no Larry David commercial, stadium naming, Gisele event, or congressional hearing could undo. Block’s post, plus S.B.F.’s shit-talking about C.Z. on the fundraising tour, as The Mooch recounted to me, seemingly helped facilitate C.Z.’s now famous tweet, which was all the motivation anyone needed to want to try to take their money out of FTX and Alameda. A classic bank run, although no bank was actually involved.

Three days later, FTX and Alameda were in bankruptcy, not unlike the same three days it took Bear Stearns to go down the tubes, back in March 2008. The difference? Bear Stearns had a savior, in the Federal Reserve and JPMorgan Chase. FTX, Alameda and S.B.F. had no one or no thing to save them. Kaboom!

For his part, Block can’t quite get over all that happened in a few short days in November and his not-insignificant role in it. “I knew that they were in trouble, obviously, because I wrote the article,” Block told me. “But I had no clue that it was as bad as it was. I did not think that they would go down in like three days. That blows my mind. It blows my mind. The fact that they had so little of the money that they were supposed to have is insane. And I can't wait to find out what the heck they were doing with it all because it's a lot of money to have gone missing over the course of just a couple of years.”

I asked him if he ever anticipated that his question about Alameda’s solvency would help lead to the rather extraordinary series of events, resulting in S.B.F.s demise. “No clue,” he said. “I wrote about Celsius for months before it went down. And I mean, did I contribute a little bit to that? Yes, but it wasn't like this. No, I never thought I would be in this position of having maybe accidentally helped kill one of the biggest companies in the space. I mean, oops. But it happens, I guess. You know, you never know what's gonna happen when you put something out in the world, anything can happen.”