The FTX Saga: Lessons We Knew but Didn’t Learn
Months after Terra, Three Arrows Capital, and a host of other industry-leading firms imploded, the crypto space has been hit by another major wipeout. What can we learn from the crisis?
- The collapse of Sam Bankman-Fried's empire has shocked the crypto industry—and set it back by several years.
- The industry overlooked too many red flags, which allowed Bankman-Fried to rise to prominence.
- The FTX debacle could have been avoided if crypto had stuck to its core tenets: don't trust, verify; and always self-custody your assets.
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After Do Kwon, Three Arrows Capital, and Alex Mashinsky set the standard for outrageous misbehavior in the crypto space this year, Sam Bankman-Fried’s spectacular fall from grace has recalled one of the Internet’s most popular memes: “Hold my beer.”
This week, it was revealed that SBF, as he’s known in crypto circles, blew a $10 billion hole in the balance sheet of one of the once-largest and most trusted centralized cryptocurrency exchanges, FTX. It will take months until the dust has settled and the full extent of the damage becomes clear.
The lessons this industry will have to (re)learn to unearth itself from this crisis, however, will be the same ones it has always preached. Rule 1: not your keys, not your coins; and Rule 2: don’t trust, verify.
Trusted Third Parties are Security Holes
Almost 14 years after Satoshi Nakamoto published the Bitcoin whitepaper, where they outlined the blueprint for “a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution,” crypto pulled a full circle and most of its trading volume happened on centralized exchanges, i.e. financial institutions.
Satoshi stated their motivation for creating Bitcoin clearly, saying that they wanted to eliminate the financial system’s dependence on third parties. And while whoever stood behind the Satoshi pseudonym was a genius, this idea wasn’t theirs. In 2001, polymath and godfather of smart contracts, Nick Szabo, published a blog post titled “Trusted Third Parties are Security Holes.” In it, he outlined the dangers of building systems that rely on trusted third parties and the essential need to build ones that aren’t.
Then Satoshi arrived and created an alternative; Bitcoiners—especially “those pesky toxic maxis” crypto followers love to hate on—intuitively understood the underlying idea, latched onto it, and prophesized it to the masses. “Not your keys, not your coins” became a mantra for the space, aiming to highlight the need to self-custody crypto instead of relying on centralized intermediaries. Still, many overlooked this advice. Despite numerous warnings, including the Mt.Gox and QuadrigaCX blowups in 2014 and 2019, this year thousands of crypto enthusiasts, including some industry veterans, have had their fortunes wiped out because they used centralized crypto exchanges or lending platforms.
Not only did people choose not to “verify,” but they also blindly trusted completely untransparent and inherently risky businesses. Billions of dollars were plunged into black boxes and custodied by self-serving egomaniacs, while the industry stood back and did nothing. Then we acted shocked when the risks played out—as if Satoshi didn’t clearly lay them out in the whitepaper.
The worst part about the FTX crisis is the red flags were clear all along.
Red Flags Surrounding FTX
Sam Bankman-Fried made his name in crypto after founding FTX in 2019. He quickly became a prominent industry figure and a mainstream media darling without showcasing any proof of work demonstrating prior competency, becoming the world’s richest under 30-year-old as FTX hit a $32 billion in 2022. Bankman-Fried became known for his geeky persona and plans to give his staggering wealth away through effective altruism—wealth he accrued from rent-seeking and selling wholesale hopium to venture capitalists who resold it to crypto tourists looking to make a quick buck flipping the latest buzzy coins on the market.
The predatory practices of Alameda Research, the trading firm Bankman-Fried founded in 2017, are no secret to the industry. The firm farmed the governance tokens of dozens of promising DeFi projects then dumped them to oblivion, in many cases irreparably hurting retail investors and the projects themselves. Bankman-Fried also became an ardent supporter of Solana—the Layer 1 network whose total value locked was largely inflated by two brothers impersonating a team of DeFi developers. Solana has gone down on several occasions since it exploded in 2021 and its ecosystem has taken a big hit due to FTX’s collapse.
Bankman-Fried spent this year plastering his face on billboards advertising FTX, mingling with politicians and regulators, and lobbying for the Digital Commodities Consumer Protection Act (DCCPA) bill that, if enacted, would effectively kill decentralized finance. In other words, he weaseled his way to the top and then tried to pull the ladder beneath him to sabotage everyone else.
Bankman-Fried oversaw FTX, while Alameda Research was led by Caroline Ellison, a 28-year-old with only 19 months of prior experience as a junior trader at Jane Street. In 2021, she sparked controversy when she revealed on Twitter that she used amphetamines. “Nothing like regular amphetamine use to make you appreciate how dumb a lot of normal, non-medicated human experience is,” she wrote. Fast forward a year, Ellison has found herself at the epicenter of the FTX scandal after it emerged that Bankman-Fried moved around $10 billion of FTX customers’ money to help the firm battle an insolvency crisis.
While many more shenanigans were likely going on behind closed doors, some of which may surface and some we may never find out, the red flags with Bankman-Fried and Ellison were there for everyone to see. Yet very few did—and no one predicted the pair’s fraudulent antics. We fell for their spiel despite watching several similar episodes of the same soap opera this year.
Sadly, there are still many red flags across the industry.
We Never Learn
Last week’s happenings in crypto are nothing new. History is rife with abuse of trust, money, and power. This is why Satoshi invented Bitcoin—to create a sound money system that eliminates the need for trust and cannot be abused. But it seems that we can’t help ourselves. Jeremy Irons’ ending monologue in the movie Margin Call sums it up perfectly:
“It’s just money; it’s made up. Pieces of paper with pictures on it, so we don’t have to kill each other just to get something to eat. It’s not wrong. And it’s certainly no different today 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 whatever we want to call this. It’s all just the same thing over and over; we can’t help ourselves.”
Change the years of the financial crises with crypto blowups, i.e., Mt. Gox, QuadrigaCX, Voyager Digital, Celsius, FTX, BlockFi, and the parallels are clear. It’s all just the same cycle repeating itself. It seems that we never learn.
In some weird cosmic irony, the crypto industry had done a full circle, cherry-picking and reproducing the worst aspects of the traditional finance world it initially sought to overthrow. Reliance on trusted third parties, shady off-chain dealings, overleveraged, uncollateralized borrowing for unabated risk-taking—we did it all and did so unapologetically, in typical cypherpunk fashion. Only this time, the government and the central bank’s infinite balance sheet won’t be there to cushion the blow, privatize the gains, and socialize the losses, as for some time has been the tradition in the real world.
And for the nocoiners cocked and ready to shout, “we told you so”—relax. This didn’t happen because “crypto is a scam,” or because “crypto is unregulated.” FTX was a regulated businesses under the full laws and regulations of the same off-shore jurisdictions your politicians that promote these nonsense mantras leverage to hide their wealth. In other words, a regulated business did something illegal without the regulators catching them in the act. What a shocker, right?
We screwed it up royally this time, not because our goals were ignoble, but because we failed to learn the lessons we already knew: don’t ignore red flags; don’t trust, verify; and always self-custody your assets.
Disclosure: At the time of writing, the author of this feature held ETH and several other cryptocurrencies.