The FTX Saga: Lessons We Knew But Didn’t Learn

After Do Kwon, Three Arrows Capital, and Alex Mashinsky set the usual for outrageous misbehavior within the crypto house this yr, Sam Bankman-Fried’s spectacular fall from grace has recalled one of many Web’s hottest memes: “Hold my beer.”

This week, it was revealed that SBF, as he’s identified in crypto circles, blew a $10 billion gap within the steadiness sheet of one of many once-largest and most trusted centralized cryptocurrency exchanges, FTX. It is going to take months till the mud has settled and the total extent of the injury turns into clear.

The teachings this trade must (re)study to unearth itself from this disaster, nonetheless, would be the similar ones it has at all times preached. Rule 1: not your keys, not your cash; and Rule 2: don’t belief, confirm.

Trusted Third Events are Safety Holes

Virtually 14 years after Satoshi Nakamoto printed the Bitcoin whitepaper, the place they outlined the blueprint for “a purely peer-to-peer model of digital money would permit on-line funds to be despatched immediately from one get together to a different with out going via a monetary establishment,” crypto pulled a full circle and most of its buying and selling quantity occurred on centralized exchanges, i.e. monetary establishments.

Satoshi acknowledged their motivation for creating Bitcoin clearly, saying that they needed to remove the monetary system’s dependence on third events. And whereas whoever stood behind the Satoshi pseudonym was a genius, this concept wasn’t theirs. In 2001, polymath and godfather of good contracts, Nick Szabo, printed a weblog submit titled “Trusted Third Parties are Security Holes.” In it, he outlined the hazards of constructing programs that depend on trusted third events and the important must construct ones that aren’t. 

Then Satoshi arrived and created an alternate; Bitcoiners—particularly “these pesky poisonous maxis” crypto followers like to hate on—intuitively understood the underlying concept, latched onto it, and prophesized it to the plenty. “Not your keys, not your cash” grew to become a mantra for the house, aiming to focus on the necessity to self-custody crypto as an alternative of counting on centralized intermediaries. Nonetheless, many ignored this recommendation. Regardless of quite a few warnings, together with the Mt.Gox and QuadrigaCX blowups in 2014 and 2019, this yr 1000’s of crypto fanatics, together with some trade veterans, have had their fortunes worn out as a result of they used centralized crypto exchanges or lending platforms. 

Not solely did folks select to not “confirm,” however in addition they blindly trusted fully untransparent and inherently dangerous companies. Billions of {dollars} have been plunged into black containers and custodied by self-serving egomaniacs, whereas the trade stood again and did nothing. Then we acted shocked when the dangers performed out—as if Satoshi didn’t clearly lay them out within the whitepaper.

The worst half in regards to the FTX disaster is the pink flags have been clear all alongside.

Crimson Flags Surrounding FTX 

Sam Bankman-Fried made his identify in crypto after founding FTX in 2019. He shortly grew to become a distinguished trade determine and a mainstream media darling with out showcasing any proof of labor demonstrating prior competency, changing into the world’s richest beneath 30-year-old as FTX hit a $32 billion in 2022. Bankman-Fried grew to become identified for his geeky persona and plans to present his staggering wealth away via efficient altruism—wealth he accrued from rent-seeking and promoting wholesale hopium to enterprise capitalists who resold it to crypto vacationers trying to make a fast buck flipping the most recent buzzy cash in the marketplace.

The predatory practices of Alameda Analysis, the buying and selling agency Bankman-Fried based in 2017, aren’t any secret to the trade. The agency farmed the governance tokens of dozens of promising DeFi tasks then dumped them to oblivion, in lots of instances irreparably hurting retail buyers and the tasks themselves. Bankman-Fried additionally grew to become an ardent supporter of Solana—the Layer 1 community whose complete worth locked was largely inflated by two brothers impersonating a workforce of DeFi builders. Solana has gone down on a number of events because it exploded in 2021 and its ecosystem has taken a giant hit as a result of FTX’s collapse. 

Bankman-Fried spent this yr plastering his face on billboards promoting FTX, mingling with politicians and regulators, and lobbying for the Digital Commodities Client Safety Act (DCCPA) invoice that, if enacted, would successfully kill decentralized finance. In different phrases, he weaseled his strategy to the highest after which tried to drag the ladder beneath him to sabotage everybody else.

Bankman-Fried oversaw FTX, whereas Alameda Analysis was led by Caroline Ellison, a 28-year-old with solely 19 months of prior expertise as a junior dealer at Jane Road. In 2021, she sparked controversy when she revealed on Twitter that she used amphetamines. “Nothing like common amphetamine use to make you respect how dumb numerous regular, non-medicated human expertise is,” she wrote. Quick ahead a yr, Ellison has discovered herself on the epicenter of the FTX scandal after it emerged that Bankman-Fried moved round $10 billion of FTX clients’ cash to assist the agency battle an insolvency disaster. 

Whereas many extra shenanigans have been seemingly happening behind closed doorways, a few of which can floor and a few we could by no means discover out, the pink flags with Bankman-Fried and Ellison have been there for everybody to see. But only a few did—and nobody predicted the pair’s fraudulent antics. We fell for his or her spiel regardless of watching a number of related episodes of the identical cleaning soap opera this yr. 

Sadly, there are nonetheless many pink flags throughout the trade. 

We By no means Study

Final week’s happenings in crypto are nothing new. Historical past is rife with abuse of belief, cash, and energy. For this reason Satoshi invented Bitcoin—to create a sound cash system that eliminates the necessity for belief and can’t be abused. However evidently we are able to’t assist ourselves. Jeremy Irons’ ending monologue within the film Margin Name sums it up completely:

“It’s simply cash; it’s made up. Items of paper with footage on it, so we don’t need to kill one another simply to get one thing to eat. It’s not improper. And it’s definitely no completely different in the present day than it’s ever been. 1,637, 1,797, 1,819, 37, 57, 84, 1,901, 07, 29, 1,937, 1,974, 1,987—Jesus, didn’t that fuck me up good—92, 97, 2,000, and no matter we need to name this. It’s all simply the identical factor time and again; we are able to’t assist ourselves.”

Change the years of the monetary crises with crypto blowups, i.e., Mt. Gox, QuadrigaCX, Voyager Digital, Celsius, FTX, BlockFi, and the parallels are clear. It’s all simply the identical cycle repeating itself. It appears that evidently we by no means study. 

In some bizarre cosmic irony, the crypto trade had executed a full circle, cherry-picking and reproducing the worst features of the standard finance world it initially sought to overthrow. Reliance on trusted third events, shady off-chain dealings, overleveraged, uncollateralized borrowing for unabated risk-taking—we did all of it and did so unapologetically, in typical cypherpunk vogue. Solely this time, the federal government and the central financial institution’s infinite steadiness sheet received’t be there to cushion the blow, privatize the beneficial properties, and socialize the losses, as for a while has been the custom in the true world.

And for the nocoiners cocked and able to shout, “we informed you so”—calm down. This didn’t occur as a result of “crypto is a rip-off,” or as a result of “crypto is unregulated.” FTX was a regulated companies beneath the total legal guidelines and rules of the identical off-shore jurisdictions your politicians that promote these nonsense mantras leverage to cover their wealth. In different phrases, a regulated enterprise did one thing unlawful with out the regulators catching them within the act. What a shocker, proper?

We screwed it up royally this time, not as a result of our objectives have been ignoble, however as a result of we did not study the teachings we already knew: don’t ignore pink flags; don’t belief, confirm; and at all times self-custody your belongings. 

Disclosure: On the time of writing, the writer of this characteristic held ETH and several other different cryptocurrencies.