Why investors keep falling for child prodigies

Time and again, investors are duped by charismatic founders, most recently in the case of the crypto exchange FTX. Why does this scam work again and again? An attempt to explain.

It has been a really exciting economic drama that has unfolded in the crypto world over the past few days. FTX, one of the largest crypto exchanges in the world, collapsed in a very short space of time. Reports quickly made the rounds about the free-handed handling of customer deposits, about an overburdened management team consisting mainly of friends of the company's CEO Sam Bankman-Fried. There were also allegations of fraud. It can be assumed that Netflix is already lining up a documentary crew to shed light on the disaster in its entirety. 10 episodes of 45 minutes each, probably coming soon.

As amusing as the whole thing is to watch, the FTX collapse also points to a fundamental problem that manifests itself particularly in the tech industry. This is not about the dark side of the crypto market, which is once again evident here. It's about the tendency to be blinded by supposed child prodigies and geniuses - and that does enormous damage to the entire scene.

Few industries practice such a cult of personality around company founders. Sometimes this is justified. Steve Jobs, Mark Zuckerberg or Elon Musk may be (or have been) controversial, but their success usually proved them right. But time and again it also becomes apparent that there is little substance behind the big show and messianic posturing.

Take Theranos: the young founder Elizabeth Holmes posed as a female biotech Steve Jobs, right down to the black turtleneck sweater. She was paid 700 million US dollars for her start-up, which allegedly developed revolutionary blood tests. None of it was true, Holmes was convicted earlier this year.

Keyword Wework: The charismatic Adam Neumann promised to turn the coworking company into a kind of comprehensive lifestyle brand. At the beginning of 2019, investors thought this was a 47 billion dollar idea. Less than a year later, the main investor Softbank paid Neumann 1.7 billion US dollars to withdraw as completely as possible from his own company. The founder's behavior, both in the company and in his private life, had become so problematic that the continued existence of Wework was in jeopardy. After all, unlike Theranos, the company still exists, but it is still not making any money.

So now Sam Bankman-Fried, or SBF for short, because apparently there are no names in the crypto scene, only acronyms. There was great enthusiasm for the son of a lawyer from Stanford, who had not only built up a huge platform, but also appeared altruistic and modest. Despite his 20 billion dollar fortune, he allegedly continued to drive an old Toyota Corolla. It has become clear in recent days that this image was not at all true. SBF will now go down in history at the very least as an overstretched frothing-at-the-mouth, if some of the allegations are substantiated, and probably even as the crypto Bernie Madoff.

Why do people who manage and invest money professionally fall for what appears to be the same scam time and time again? Research provides a clear answer here: we humans tend not to look for the best leaders, but the most charismatic, superheroes so to speak. The female Steve Jobs, the co-working Jesus, the big-hearted crypto-bro: they all fit this pattern. But unfortunately, charisma often comes with a dark side. It is often narcissists and sociopaths who appear particularly charismatic due to their self-confident demeanor and daring moves. However, these people often have little interest in what happens when they are wrong. This pattern has worked for centuries, in politics, in entertainment, in business.

It is by no means surprising that the tech industry, of all sectors, has a concentration of such cases. The answer here is probably even simpler: many people simply don't understand the subject matter. Biotechnology is complex, the blockchain and crypto world is a jungle full of terms and technologies that hardly anyone understands. And coworking may not be complicated, but when a long-haired, charming Israeli blathered on about We Company, which is supposed to encompass all areas of life, some people preferred to nod knowingly instead of admitting that they had no idea what the gibberish meant. This applies not only to amateurs and private investors, but frighteningly often also to professional investors, VCs and so on.

Incidentally, nobody should be fooled by the fact that these examples all come from the USA. We Germans also like to fall for such types. Markus Braun and his company Wirecard are a perfect example of this. A supposed guru - who also liked to pull out the black Jobs turtleneck - a technology that hardly anyone understood and, in the end, billions of euros burned and a lot of supposedly smart professional investors looking pretty stupid.

So what to do? Investors need to take a closer look. In all the cases described, irregularities could be seen long before the big bang if you looked closely enough. With a little due diligence, you can avoid these kinds of bumps in the road. However, it is at least as important to resist the herd instinct from time to time. If the large herd of cattle once again runs stampede-like in one direction, in a dynamic that in retrospect it often cannot explain itself, it is worth simply not going along.

Will the latest case lead to this rethink? Perhaps yes. Probably not. Wework founder Adam Neumann, for example, recently received another 350 million US dollars for a new start-up. The extent to which this can be reconciled with a learning effect for investors is highly questionable.