Last week, I kicked off the first of five (and counting) articles about FTX and Sam Bankman-Fried by emphasizing that I didn’t want to write about FTX and Sam Bankman-Fried.
In my opinion, crypto, Web3 and decentralized finance aren’t appropriate for consideration by serious investors and thereby aren’t worth my time or yours. That opinion is informed by first-hand experience. The events of the past week spoke loudly to the notion that institutional investors should avoid crypto and DeFi like the plague, something Sequoia, SoftBank and the Ontario Teachers’ Pension Plan Board, among others, are in the process of learning the hard way.
But there was another reason I didn’t want to go down the FTX rabbit hole — namely, it’s a rabbit hole. And unlike rabbit holes in story books, there’s nothing fun at the bottom of crypto rabbit holes, just circular reasoning and a hopeless tangle of rehypothecation, all booby-trapped, Home Alone-style, with explosives.
Attempting to sort out that tangle will drive you crazy. Literally. Which means you’ll fit right in down there. (“We’re all a little mad here,” said the cat.)
Unlike traditional markets where the more you know and the more experience you have, the easier it becomes to editorialize, in crypto and DeFi, the more experience you gain through participating in the casino, the more challenging it becomes to explain the scope of the cross-holdings to people who haven’t seen it first-hand. Everything is related. Including, as we now know, centralized exchanges. There’s overlap there too, and it took center stage with the FTX blowup courtesy of the exchange’s Serum holdings, which I mentioned here in brief on Sunday.
The day before (so, Saturday), I took a fun trip down memory lane by way of two lengthy podcast interviews Bloomberg conducted with Bankman-Fried. Odd Lots (the podcast) actually interviewed Bankman-Fried three times, but only two were chaperoned by Matt Levine, who I suggested should’ve been more combative with Bankman-Fried following the latter’s characterization of yield farming as akin to a magic box. On Monday, Levine described that episode as “now-infamous.”
If Levine read my Saturday piece (I can assure you he didn’t), he’d have taken note of my contention that, contrary to Bloomberg’s (totally unbiased) assessment of Matt as the best writer in all of finance, I am in fact that writer. Only not when it comes to Serum and FTX, apparently, because in the Monday piece mentioned above, Matt delivered what’ll probably be considered the definitive accounting of Bankman-Fried’s Serum… errr… accounting.
Those of you who hang on my every word likely picked up on my allusion Sunday to the Serum story being worth telling. I started to go there (“FT Alphaville’s description of Serum as ‘obscure’ betrayed a lack of hands-on familiarity with the market about which they were pontificating. It’s obscure to the masses. But it’s not obscure to anyone familiar with Solana…”) and then I stopped myself (“The fact that I just inadvertently slipped down the Bankman-Fried rabbit hole speaks to how easy it is to get sidetracked by the spectacle of a five-alarm blaze at a casino that doubled as a fireworks warehouse and tripled as a storage facility for high explosives. With that, let me steer us back onto the highway.”) I thought I was being prudent. Now, having read Matt’s piece, I wish I’d indulged, because he certainly did.
The problem with FTX’s carrying value for its Serum holdings ($2.2 billion) wasn’t the disparity with the market cap of the publicly held Serum (which I and plenty of others on social media immediately flagged as… well, a red flag), but rather what would’ve happened to the price of Serum had FTX sold its holdings. None of this is news (let alone new) to crypto aficionados (whatever that even means), but it’s probably news (and new) to everyone else, so here’s Matt (abridged):
One thing that is really really really really really important to mention about the Serum protocol is that it was created and promoted by FTX and Alameda Research. FTX is a centralized crypto exchange, but a lot of people in crypto do not trust centralized exchanges (for reasons!) and prefer to trade on decentralized exchanges. Serum is, in a loose but meaningful way, the decentralized exchange of FTX. Something like 3% of the total value of Serum is held by the public and trading on exchanges. The other 97% is not. Something like two-thirds of that 97% is held by FTX and Alameda. One simple point here is that FTX’s Serum holdings — $2.2 billion last week, $5.4 billion before that — could not have been sold for anything like $2.2 billion. FTX’s Serum holdings were vastly larger than the entire circulating supply of Serum. If FTX had attempted to sell them into the market over the course of a week or month or year, it would have swamped the market and crashed the price. Perhaps it could have gotten a few hundred million dollars for them. But I think a realistic valuation of that huge stash of Serum would be closer to zero. That is not a comment on Serum; it’s a comment on the size of the stash. But I do want to comment on Serum, because Serum is not some weird token that FTX cornered for some reason; Serum is a token that FTX made up. To use a loose but reasonable analogy, Serum (the protocol) is sort of FTX’s decentralized exchange subsidiary, and SRM (the token) is sort of the stock in that subsidiary. A little of the stock trades publicly, but it is mostly held by FTX, its corporate parent, as it were. The public market price of the small free float might give a reasonable estimate of the value of the subsidiary. But in the real world, the value of the subsidiary is incredibly tightly linked to the value of FTX’s overall business. If everyone is like “ah yes FTX is a good exchange operator and a leader in safe crypto trading,” then its decentralized exchange protocol has a good chance of being popular and profitable. If everyone is like “ah yes FTX is a careless fraud,” then Serum is going to have a hard time.
One key aspect of the FTX debacle is that it undermines the idea of DeFi as the uncorrupted alternative to centralized crypto exchanges (always an oxymoron given crypto’s decentralized promise). In reality, they’re intermingled. And look what happened.
This is the sort of thing that drove me away from Web3, crypto and particularly DeFi, earlier this year, a divorce I documented so often that one reader became exhausted enough to exclaim, “I’m getting a little tired of these [articles] to be honest.”
As tired as that reader was, I was even more tired — of the sort of doomsday dynamics detailed in the excerpted passage (above) from Levine who, in the same Monday piece, went on to note that (again, abridged),
[FTX’s] third-biggest asset, incidentally, was SOL, the token of the Solana blockchain. Solana is not something that FTX made up, and has an existence independent of FTX. But it is certainly associated with Alameda, FTX and Sam Bankman-Fried; they have been big backers of the Solana ecosystem. It’s not that Solana is “the blockchain of FTX,” but it’s a little bit like that. There is wrong-way risk there too. I am not saying that all of FTX’s assets were made up. Still it is striking that the balance sheet that FTX circulated to potential rescuers consisted mostly of stuff it made up. Its balance sheet consisted mostly of stuff it made up! Stuff it made up! You can’t do that! That’s not how balance sheets work! That’s not how anything works!
Not true! It’s how DeFi works. Which is why I left the casino. But it’s also how FTX worked, which is disconcerting because, as noted above, it suggests incestuous commingling between DeFi and a centralized exchange operator. Basically, the whole damn thing (Web3) works like that. Or doesn’t work like that. Matt jokingly conceded as much: “Oh, fine: It is how crypto works.”
Indeed it is. And, as documented here over the weekend, nobody knows that better than Levine. And here’s where I’ll do my best Matt impression: Ok, fine: Somebody does know it better than Levine. That person is Bankman-Fried. But Levine knows it the second best of anybody, because Bankman-Fried literally gave him the blueprint to the box three months ago!
I’ve never had a magic box, but if I ever decide to build one (I have a blueprint!) someone I won’t tell is a former securities lawyer, appeals court clerk and Goldman banker. Ok, I may tell a Goldman banker. But only if he wants to put money in the box!
Matt acknowledged on Monday that, “The box, it turns out, was FTX (and Serum).” He used the farming quote from the third (and, I assume, the last) Odd Lots interview with Bankman-Fried.
As I was writing this on Monday afternoon, a reader was kind enough to remind me that, on June 18, while regaling readers with tales of Celsius, Lido and Three Arrows, I warned on the perils of sundry DeFi “boxes.” To wit:
It’s just a matter of time before this box explodes. The self-referential dynamics are a feature of DeFi, not a bug. It’s a labyrinth of leverage built on nothing. Imagine a totally opaque, global rehypothecation scheme where the vast majority of the collateral is worthless, not because the assets went bad, but rather because they were never assets in the first place.
The title of that piece was “Crypto End Game Goes Through DeFi’s Black Box.”
And to think: I didn’t need to be a lawyer or hear it from Bankman-Fried.
Matt Levine was pretty thorough today. You have been concise with your opinion and have tried to keep this out of your writing. Your foot work to understand this and come back out of it and tell the tale was somewhat noble. You have every right to say “I told you so”
Pyramid scheme dressed in the emperors new clothes
Who brings this to film first? HBO or Netflix?
Oh, you haven’t heard? … https://gizmodo.com/ftx-michael-lewis-movie-rights-bitcoin-price-ether-sbf-1849778463
You told us so
I should’ve gone into the Serum thing over the weekend. The problem is that everybody cares but nobody cares. Like, everybody says they want the details, but what I learned earlier this year is that unlike traditional finance, people don’t even try to understand DeFi when you put the specifics out there. People want to read the story, scoff and then laugh at the implosion, which is fun, but it takes forever to walk through this stuff point by point, and nobody has any frame of reference. So, you know, you start talking about Serum, and then you have to tell people what Serum is, and then once you say “Serum is this” they say “Well what’s that?” and then it’s just this endless ordeal. But not going through it leaves you at risk of pointing out the obvious (in this case the disparity between the carrying value of Serum on FTX’s balance sheet and the market cap), but not pointing out the real story, which in this case is that FTX’s holdings were multiple times the size of the entire market and, even more importantly, gifted to itself. But then (to reiterate) you spend all this time walking through that and what do you get back if you’re me? Blank stares. Anyway, I’ll be glad when this casino is shuttered for good.
Yes. By and large that’s me. But I got the gist of your text and steered clear. If I don’t understand the business model (my stupidity sometimes) I don’t invest. No matter the “upside” proposition. Keep writing H. I am a faithful reader and have helped others join your readership.
“Anyway, I’ll be glad when this casino is shuttered for good.”
Oh, but think of all of the profits the best & brightest will be losing! First ESG, now FinTech & Defi are crumbling. Now these money trains are getting derailed. Food delivery and scooter rentals are so last decade. What is left for our friends in VC and private equity to profit from?
Just wait until they hear about this cool new idea called the metaverse
This is really key: https://twitter.com/heisenbergrpt/status/1592271933285888000
“I did not like him, so I intubated him”. I, too, hang on your every word, but sometimes I get distracted by the shiny beach glass.
I’m pretty sure that Helen Keller could see it more clearly than I can.
All the more reason, in my view, for the US govt to not go down the whack-a-mole-rabbit- hole-of-Alice-in-Quicksand of trying to write and enforce regulations for crypto. It’s too much of a mess to legitimize with a regulatory scheme.
It seems like what is more likely to be developed are e-currencies, backed by various governments.
China has banned cryptocurrencyies, but is working on the e-CNY to keep watch/control over everyone’s transactions and also to stop transfers of wealth outside of China.
I personally keep a stash of paper USD’s hidden- not sure I’d want to be told by elected/appointed officials to put everything in e-USDs.
Don’t lose faith in the fiat currency!
Back in the late 70s I wrote to my congressman and asked one question “How can the money supply be increased without somebody getting something for nothing?” I got pages of answers that simply served to obfuscate the real answer ie. you can’t. I work in cryptography and security. I understand the math behind crypto. The only value that I have found in cryptocurrencies is the Greater Fool Theory of Finance. Otherwise there is nothing there. It definitely does not conform to any definition of currency that I am aware of. There is nothing there except for some numbers that comply with an arbitrary set of mathematical characteristics.
The Dutch bought Tulips and raised the prices to astronomical levels, but ultimately, there was nothing there. Did some people get rich during that craze, sure. But that didn’t create value where there was none. Cryptocurrencies only value comes from the people who believe that they can sell them later to someone else for more than they paid for them. That’s it. All the sophistry on the planet won’t change that.
One can spend a lifetime as a scholar of Christian, Jewish, Islamic, Sanskrit, etc writings. But one does not need to read any of those writings to be an informed non-believer of the underlying religions.
Fine piece, but it would help if you didn’t confuse DeFi with a centralized exchange like FTX.
I’m not confusing it at all. Apparently you missed this part:
And also this part:
SBF put the utility token of a decentralized protocol he created on the balance sheet of his centralized exchange, and it was the most valuable asset he had left when he went bankrupt, only it wasn’t actually valuable.
What would “help” is if SBF didn’t “confuse” (where that means he wasn’t confused at all, he did it deliberately) the two.
Read a little closer next time, maybe.
I just want to get to the part where we find out how much SBF and his ??GF??/Alameda CEO squirreled away in a Swiss gold vault!