FTX, Trust and Trustlessness

There is a paradox at the heart of the FTX saga: crypto has caused a huge wave of speculation, fraud and ponzi-nomics, but it also presents part of the solution to preventing these behaviours.

You might have noticed that something happened in crypto last week.

Sam Bankman-Fried was a 30 year old mythical crypto founder.  He was a leader in the crypto community and seemed to really care about the work he did.  Once worth $26bn, he pledged to give it all away to altruistic causes.  He was one of the good guys - or so everyone thought.

Actually, he was a criminal.

Sam was CEO of FTX, one of the biggest crypto trading exchanges in the world.  They held c.$10bn of customer funds within their system.  Without customer consent, FTX lent that $10bn to their sister company, a trading firm called Alameda Research.  Alameda then used this money for leveraged crypto speculation, using the FTX token ($FTT) as further collateral.  When the $FTT token started plummeting, customers got a whiff of what was going on and tried to withdraw their funds, but FTX didn't have it.  All customer funds were gone. FTX then declared bankruptcy and anyone with funds on the platform has lost them forever.

I'm really sad this happened.  It makes me question whether I want to keep spending time in the crypto space, when someone you think is the 'good guy' turns out to be a crook.

It's easy for those who aren't involved in crypto to say "ha I told you so, it was always a scam".  But actually this was not at all obvious.  Some of the biggest and most sophisticated investors in the world had invested in FTX or Alameda: Blackrock, Ontario Teachers' Pension Plan, Sequoia Capital etc. It’s hard to always protect against criminal executive behaviour - at some point you need to trust the team running the show.

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Unlike Terra Luna, the collapse of FTX was not a problem with crypto infrastructure.  It was a problem of 1. Executive fraud, enabled by shady opaque company structures, and 2. Crypto culture.

On 1 - a traditional centralised exchange was the product, the ability to exchange crypto was one of its features.  It was a traditional company structure, not a crypto protocol - this could have happened with a stock-broker account, or a bank (this did happen in 2008).  It's a problem of real world fraud and highlights how easy it is to hide inner workings and misappropriation of funds through opaque company structures.

On 2 - I love parts of crypto culture because its ambitious, bold and energetic.  But it’s also full of hype, unprofessional and born out of gamer-bro culture.  It's the hype and feeling of immortality that allowed Sam to fly so close to the sun, and surprise surprise his wings melted.  He believed his own hype, as did the markets, which encouraged him to take more and more risk with money that didn’t belong to him.

The collapse of FTX is a lesson in trust. People trusted Sam, just like people trust that their bank isn’t mishandling their deposits. And that’s not really anyone’s fault - at some point you just have to trust the companies you engage with, or else you can’t take part in the system we live in.

Crypto can also eradicate the need for trust. As I've written before, true decentralisation eliminates the needs for middle men in any form.  You don't have to trust anyone.  You don't need to trust the platform you are investing through, because there is no centralised processing, it's just smart contracts. 

There is a paradox at the heart of this saga: crypto has caused a huge wave of speculation, fraud and ponzi-nomics, but it also presents part of the solution to preventing these behaviours. 

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Clearly crypto has a communication problem.  Most don't see the difference between a traditional company that holds or uses crypto (rife for abuse, like any company is) and a truly decentralised protocol which runs entirely on smart contracts.  The former relies on trust, the latter eradicates the need for trust.  The latter is where the true potential of crypto lies, but unfortunately you need the former to build the latter.  To prevent these types of collapses in the future, we need more transparency and more decentralisation, and hence more crypto innovation, not less.

Let's compare FTX with a decentralised alternative, like Uniswap:

FTX was a Centralised Exchange (CEX) which acted like a traditional trading platform: you deposit money, swap $ for BTC, or BTC for ETH etc.  There is a centralised order book enabling the trades, and customer funds remain on the platform until they are withdrawn.

By comparison, Uniswap is a Decentralised Exchange (DEX).  Like with FTX, you can swap BTC for ETH, or any other types of crypto.  But Uniswap is not a company.  It's a Decentralised App created by the Uniswap Foundation.  Using Uniswap consists entirely of interacting with smart contracts. 

In using Uniswap to exchange BTC for ETH, I don't need to interact with a company or any people.  I only interact with smart contracts.  My money is not being held by a company on my behalf, like with FTX or a bank. I hold it in my own wallet and own it myself.  I don't need to trust that Uniswap isn't mishandling my funds.  I can see for myself exactly where my money is at all times and what is happening to it.

Any time a transaction occurs with Uniswap, there is a record which appears on the public blockchain for everyone to see.

If FTX operated like Uniswap, on a decentralised basis, this event could not have happened.  Sam could not have used customer funds without people's knowledge.  Every penny is accounted for, in real time, for anyone to see. 

The beauty of decentralisation is that it eradicates the need for trust.  With no intermediary involved, there's no need for trust.  It's trustless. 

One of the reasons I like crypto is that it dares ask the question "could we do this differently?".  It is founded on the philosophy of questioning the status quo, of pushing the boundaries.  In that process, things will break, and people will scam.  It's sad, but it's just human nature.  If we keep asking the question though, just maybe, over time, we will see the system change.