Thoughts on a crypto crisis
If you’ve never seen the movie “There Will Be Blood” starring Daniel Day Lewis, then now might be a good time. Based loosely on an Upton Sinclair novel that satirizes the early days of the oil industry, it portrays the life of an independent oil man who rises to great wealth and power at the expense of his humanity. While that character’s arc is predictable, what makes the movie is his back and forth interaction with a young pastor whose own lust for power turns out to be just as great, and just as corrupting. Lewis’ character, while evil, is at least self-aware about his greed and selfishness. The pastor is not, and in some ways turns out the more pathetic character.
Welcome to the state of crypto in its thirteenth year, except that in our story the greedy entrepreneur and the morally bankrupt spiritual leader have turned out to be the same person. FTX founder Sam Bankman-Fried, but also Do Kwon (of Terra), Su Zhu (of Three Arrows Capital), Alex Mashinsky (of Celsius) and a few others. All claimed to be working towards the greater good. All ended up obscenely wealthy in the process. All turned out to be frauds.
Tempting as it might be to focus all of our energy into anger towards these men, this is a time for self reflection. As an industry, but also a community. Crypto has attracted millions of people from all over the world and the vast majority are good people who believe in this new way of building trust. But we are terrible at picking leaders (with a few exceptions) and have only ourselves to blame when they let us down.
The great irony of the collapses we’ve experienced lately is that nobody has to use these firms. Unlike Wall Street, where consumer choices are always limited (by design) the censorship resistance of crypto often means nobody has to use any service. Most of FTX’s clients could have custodied their own coins and used DeFi, in the same way that people who wanted a more decentralized stablecoin could have used Dai.
And yet, countless users who came to crypto to get away from traditional authorities ended up running into the arms of services offered by inexperienced leaders who act like they are running a cult. But why?
The simplest answer is greed. The KwonZhuMashFried’s of the world all promised their followers a faster road to riches. Greed has an exponential function. The more money people make, the more they (paradoxically) want, despite the marginal utility of the next dollar declining quickly. Crypto has made a lot of people rich, but for every user who cashes out there seems to be two who double down. This compulsion for always making more drives some people to suspend disbelief and to seek out the quacks who make the most grandiose promises.
But blaming everything on greed is too simple. There has to be more to this story, and true self reflection requires going deeper.
Another explanation is the messy birthing process of a new industry. Director Paul Thomas Anderson chose the early days of the oil industry as the setting for his tale of human corruption for a good reason. There is something about transformative technologies and their early boom-bust cycles that pulls in certain kinds of people, and those people often end up hurting many others. There is a good amount of historical precedence to what is happening in crypto today in other industries. The early days of the railroad industry had the Crédit Mobilier scandal, the early days of the web had Worldcom, and the early days of securitization had Lehman.
Ironically, even the early days of central banking included a spectacular bubble that led to a major collapse, as orchestrated by a cult-like figure who turned out to be a fraud.
In each example, early adopters who believed that the world could be a better place — a place where central banking could work, railroads could crisscross the land, or electronic communication could be ubiquitous — had to suspend some level of disbelief. They also had to have faith in the face of great skepticism, for each new idea had its naysayers. But their open-mindedness also paved the way for grifters with a messiah complex to come in, take over, and almost ruin everything.
Almost, because good ideas transcend the bad people who hijack them. This is a point that the crypto skeptics now basking in their schadenfreude tend to miss. Crypto didn’t become important because some mountebank mouthed off about it on twitter or because some charlatan testified about it to congress. It became important because it can solve important problems, and that importance enabled the rise of people like SBF. The collapse of FTX does not change that promise, in the same way that the collapse of countless railroad companies in the 1870s did not change the utility of trains.
Blockchain is a technology invented to transform trust. In that sense, it is even more fundamental than oil, railroads or telecommunication, for trust is the alpha and omega of civilization. This transformation was always going to be messy and have many ups and downs, great moments of triumph followed by equally hard periods of despair.
The fact that history is repeating itself doesn’t let the rest of us off the hook. We can and should do better. For me, I at least owe that much to my students and readers. For you, it might be something that you owe to your investors or customers. Governments owe it to their citizens and we all owe it to future generations.
Here’s a short (but by no means definitive) list of how:
First, we need to stop with the cults of personality. Even after everything that has happened we still have too many charlatans. The Michael Saylors and Max Keisers of the world only hurt the cause. Part of me is ashamed to work in an industry where people behave like this. (Side note: Bitcoin has lost half of its value since the time Keiser declared “we are not selling.” Not only are these people scummy grifters, they are also terrible investors).
Second, success in this domain was, is and will always be about the tech, not the money, and certainly not the hype. Capital deployment, economic incentives and money legos are intricately involved with that tech, but doing well should only come to those who do good, and doing good means building something sustainable. The biggest tell of the impending doom of the KwonZhuMashFrieds of our world was their tendency to focus on flowery bullshit like super cycles and altruism, as opposed to the technology.
How sad that the lineup for the next major Bitcoin conference consists almost entirely of hype people, even after everything that’s happened. For contrast, this is what real leaders like to talk about.
Second, we need to stop the endless tribalism. Competition is healthy, believing your preferred project can only succeed if others fail is not. Tellingly, some of the industry insiders who just read my preceding paragraph have already jumped to false conclusions about my feelings towards Bitcoin and Ethereum, and will now filter the rest of my comments through that lens. This is not how serious people behave.
Our tribalism is a direct result of our insecurity. If you are actually certain that your project is the best then you should welcome the competition.
Third, we need a better approach to VC. I’ve worked in venture and have many friends who work in crypto VC, but something has gone wrong here, because the most sophisticated investors have somehow fallen for the biggest scams. I’m not sure what the solution is, but it probably starts with more diverse views within the venture community and more patience. Just because your fund can raise a billion dollars to deploy doesn’t mean that you should.
As a corollary, we also need to do something about the entrance of so much “biased capital” into our domain. Why do otherwise conservative institutions (such as pension funds) who would never invest a dollar into Bitcoin plow hundreds of millions of dollars into companies that promise to do stuff with Bitcoin like Celsius and FTX? Anyone who wants to get capital exposure to crypto should invest directly in crypto, as opposed to startups run by inexperienced boys with bad hygiene.
Fourth, we need better infrastructure. One reason major institutions prefer indirect equity exposure over directly owning the coins is custody. So we need better custody of all kinds, from safer self-custody to regulated centralized custodians. I find it telling that so many funds and protocols who obviously knew better still kept all their coins at FTX. They did that because it was easier.
The crypto-originalist vision of a world where every participant practices strict self-custody was never going to scale. Human beings have always wanted the help of a trusted institution to protect their valuables. This was true in ancient times when people used bearer assets like gold and will be true in future times when people use digital bearer assets like Bitcoin.
Fifth, we need better regulators. Naked ambition masquerading as “doing good” by people with a messiah complex doesn’t just infect the industry. It also infects some of the people who regulate it. Gary Gensler is a good example. He talks a big game, but his track record of actually preventing bad stuff from happening is abysmal. His agency directly looked at Terra & BlockFi, and dealt directly with Sam, but did nothing to protect their victims. This obsession with classifying tokens as securities is counterproductive.
The SEC’s refusal to allow a basic Bitcoin ETF, while simultaneously approving garbage like the BITI short Bitcoin fund, is the ultimate proof that this is more about Gary than investor protection. (BITI isn’t bad because it is shorting Bitcoin, it’s bad because it is bad at being short Bitcoin. BTC is down over 20% since it launched but the ETF is up less than half that amount.)
Gensler belongs to a family of regulators and government officials who seem to think industries exist to serve their needs, as opposed to the other way around. If they were in charge when YouTube came out they’d be fining kids who uploaded cartoon clips while demanding every YouTube channel get a federal broadcast license. Bad regulators are almost as harmful to a new industry as bad entrepreneurs.
That said, the crypto industry needs to get over its childish views on regulations. The parts of crypto that are fully centralized should be regulated like any other intermediary. The parts that sit in the middle (as FTX did) should be regulated by a mix of traditional rules and new ones that take advantage of the underlying tech, like proof of reserves. Only after we concede these points can we make a credible case for why things like DeFi should only be regulated by code and economic incentives.
Sixth, we need to start differentiating between good innovations and the inevitable get-rich-quick schemes that result. Ethereum (which only ever raised $16m) was a good innovation. The fifth smart contract platform based on the Move programming language (which has already raised a billion dollars) is not. Digital scarcity as applied to art and collectibles was a good innovation. Almost every BYAC clone is not.
As a corollary, we need to refocus tokenomics on building sustainable economic security and adoption. Bitcoin did this, but countless projects that have launched since have not. If your project gives more tokens to insiders and early investors than users will ever get then you have the wrong priorities. If your project needs a hundred million dollars to launch then you are in the wrong industry. There’s a high correlation in crypto between projects that have raised a lot of money and those that have failed spectacularly.
Seventh, decentralization is not binary and exists on a spectrum. So much time and energy is wasted on arguing the extremes in the abstract, but the real world is always gray. This is one of those areas where a bit of nuance goes a long way. Yes, Bitcoin is decentralized but no, mining and exchange are not. And that’s OK, because the underlying protocol is censorship-resistant so there will always be competition.
As a corollary, we need to be better at engaging with our skeptics, and that can only come from taking a balanced approach. For example, we need to concede the fact that hacks are a drawback of DeFi. Only then can we point out that one reason why DeFi gets hacked is because everything is transparent, so vulnerabilities are easy to spot. (Our legal system works much the same way, but we don’t try to end due process every time a criminal gets off on a technicality.)
Eight, we need to stop rushing to embrace the next hot thing. I love DeFi, but I would never put all my money into a brand new protocol with an unproven economic model, even if I believe in the model. Ours is an industry that likes to experiment in production, which is great. But we need to recognize that experiments can (and do) end badly.
Ninth, we need to stop relearning the hard lessons of history. Direct democracy doesn’t work, too much leverage is deadly, systems tend towards hierarchies, and financial institutions need to manage risk. Disrupting the old ways can only come from a place of awareness, not ignorance. If you haven’t studied the reasons why fiat currencies came to be, then you can’t have an informed opinion on Bitcoin. And if you aren’t an expert on banking, then you shouldn’t be building in DeFi.
Tenth, we are all going to make it. Well, most of us anyway. Next year will be my tenth in crypto and this is my fourth bear market. Each one has its low points, but none have shaken my belief that crypto will eventually re-architect the global economy because my thesis is based on history and a deep understanding of the technology, as opposed to prices and prophets.
While it’s true that debacles like FTX now happen on a bigger scale, that’s only because the industry has grown. It will continue to do so, even if at an uneven pace.
[UPDATE] A friend just pointed out something that was missing from my 10 bullet points, which is a need to diversify the talent pool. This is a very important point so I’m adding it here. Part of the problem with the crypto industry is the way it attracts a certain kind of person — young, male, risk-seeking and likely to buckle convention. This might have been beneficial in the early days but we need older people to take leadership roles, along with more women and more people with experience from other industries.