Chris Clearfield is the co-founder and managing director of Clearfield Group. Andras Tilcsik is a professor at the Rotman School of Management at the University of Toronto. They are the authors of Meltdown: What plane crashes, oil spills and stupid business decisions can teach us about how to be successful at work and at home.
The failure of Sam Bankman-Fried’s FTX exchange exhibits the classic elements of the failure of what is called a “complex” system. It’s like the remake of a famous movie franchise: a story with the same plot and the same basic characters, played only by different actors.
The same factors that underlie the collapse of FTX are behind the financial crisis, the bankruptcy of Enron, and frauds such as Bernie Madoff’s Ponzi scheme and Elizabeth Holmes’ Theranos. These factors also drive plane crashes, industrial accidents, including the Deepwater Horizon oil spill, and failed responses to public health crises.
As business leaders, we must recognize that the growing prevalence of such catastrophic collapses calls for a new approach to managing organizations – one that eschews control and focuses on building the capacity for change and resilience.
A complex system is not simply a system that contains many parts. It is a network whose many parts are interconnected, more like a web than an assembly line. A disturbance in one part of the system can affect another in unexpected ways, so connections tend to matter more than isolated parts. The dynamics of the system are difficult for any individual to understand or control.
Also at work in these failures is what engineers call “tight coupling”. A tightly coupled system has little buffer to absorb shock; a relatively minor disruption can bring the system down before operators can react to what is happening.
The crypto ecosystem displays both of these characteristics. It is strongly interconnected. Smart contracts – tokens with embedded code – can automatically trade between different currencies. And leveraged bets, when clients borrow against assets to increase their size, can go awry as the value of the underlying collateral changes.
Through its collateral practices, FTX has explicitly positioned itself as a nexus between different cryptocurrencies. And Mr. Bankman-Fried’s Alameda Research, the FTX-affiliated crypto hedge fund, had deep ties to the crypto world.
Over the summer, for example, when crypto firms BlockFi and Voyager failed, Mr. Bankman-Fried stepped in as a white knight.
Whether it was because of those liabilities, other investments, or ongoing losses, Alameda needed assets — and Mr. Bankman-Fried and senior FTX officials loaned FTX clients money to the fund.
Many of these loans appear to be backed by dodgy collateral, including FTT, a token created by FTX that has lost value as confidence in FTX wanes.
The complexity of crypto (and FTX’s ability to mark crypto assets at fantastic valuations) has created opacity and the possibility of wrongdoing. Result: bankruptcy.
Mr Bankman-Fried’s ability to dazzle investors such as Sequoia Capital by telling a visionary tale of a future unbound by existing constraints makes him a peer of Theranos’ Ms Holmes – sentenced last week to more than 11 years in prison.
The FTX implosion is an important story, even if you are not a crypto enthusiast. The world beyond finance is also becoming more complex and intertwined. We live in an ongoing polycrisis, fueled by everything from climate change and market shocks to changing employee expectations.
So what can we do?
Begin by being curious about how these factors manifest in your world. From the pandemic and strained supply chains to the increasing regulatory demands businesses face, complexity and tight coupling affect us all.
When you encounter a complex system, approach it with skepticism. Executives, regulators, banks and high-level gatekeepers often fail to recognize the warning signs until it’s too late.
We need to admit that we don’t know the answer (in a complex system no one does) and focus on leadership with curiosity to unleash the creativity and ideas of our teams. Role-modeling the answer to which we don’t know — and instead relying on curiosity — helps us create psychological safety, what researcher Amy Edmondson calls a “felt sense of openness.”
If we want to depend on the ideas of others, we must create conditions where others are willing to share.
We need to hone our ability to drive change. Many leaders are promoted because of their technical expertise, but the answers have limited value in a complex system. As leaders, our job is not to impose answers; it’s about engaging others and taking them on a journey.
We rarely have the potential to redesign and simplify our systems, so we must learn to navigate them in order to avoid producing endless sequels of the same type of failure.
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