Learning Lessons in Crypto

I’ve been reflecting on the FTX news this week and came away with one overwhelming feeling – sadness. I’m sad for all the millions of mostly crypto-curious people who lost their money and trust in “crypto” as a whole. I’m sad for all the smart, hard-working builders out there who will get lumped into the same category as the teams behind, like Celsius, Luna, and FTX.

The FTX collapse feels like the lowest moment in crypto, where millions of people probably lost their life savings. Even though I was not personally affected financially (except for the capitulation of Solana), it felt like the shittiest of sucker punches.

I say this despite experiencing my share of crypto setbacks, and losing a material amount of money in the process.

  • In 2014 I lost ALL my Bitcoins in the Mt. Gox Bankruptcy (Centralized Exchange, or CEX like FTX), but it was all so early that we just accepted the collapse and mismanagement as “early adopter risk”.
  • In 2021, Iron Finance (an algorithmic stablecoin), a promising experiment, lost its peg to the USD and collapsed in just a few hours. I clearly had not learned my lesson about algo stablecoins, and chose to invest in Anchor/Luna on the Terra ecosystem as well (powered by UST, another USD pegged stablecoin). Many smart friends were investing and wrote thoughtful, credible analyses of the protocol (example, example 2) which also lost its peg and collapsed in a few days. Fool me twice, shame on me because these were both decentralized, and I could have made better decisions.
  • In 2022, I was affected, again, by the collapse of Celsius (centralized and I had no opportunity to withdraw funds), which had exposure to Luna and is now insolvent. I luckily pulled all my remaining funds out of BlockFi, which is also now insolvent given exposure to FTX.
  • And again last week I was affected by the hack on DFX Finance which was a “safe” decentralized pool for me, given it was FX stables (CADC-USDC, EURC-USDC) and I was farming yield on the token. I took protocol security risk and got burned.

What’s happened?

This has been covered by a number of smart and credible folks but the quick summary is that Alameda Research, which was a hedge fund also run by Sam Bankman Fried (known as SBF, founder of FTX) likely had a bunch of losses driven by falling token prices in the first half of 2022 that they could not cover. They were unable to raise money from other backers (equity/debt) and so SBF likely used customer funds from FTX to prop Alameada in the “short term” while they recovered funds which is illegal, unethical, and has no guarantee of success.

FTX was the third largest crypto exchange in the world, and crypto is much more mainstream now than when Mt. Gox collapsed. Many retail investors dip their toe into crypto through centralized exchanges, and this event will set back the industry for a very long time, particularly for the crypto curious.

Here are a few of the best Tweet Threads I’ve come across to summarize what happened with different perspectives:

This is a good long form summary by Trung Phan, shared with me by my friend Ahmed Hussein.

What lessons can we learn?

There are so many lessons to be learned from this event both as individuals and as an industry. Here are a few that I took away:

  • Centralization: Centralization does not work in crypto especially without regulation and government support. There is no FDIC insurance and no government bail outs. We need to put a lot of our faith in the people who are running these platforms and trust in their integrity and risk practices, which has not panned out.
  • House of Cards: When one part of the system fails, it can create a knock on effect across the industry. Luna’s demise triggered the destruction of Three Arrows Capital and Celsius, and FTX’s demise triggered the destruction of BlockFi (and many more to come out of the woodwork).
  • Compounded risk: When investing in crypto (and DeFi in particular) you are taking a lot of compounded risk – risk that the protocol is safe from hackers, risk that there are no material bugs in the code, risk that the underlying assets are safe (e.g. Wrapped ETH on Solana). The more protocols you use (e.g. providing liquidity, staking, auto-compounding) the more you are layering on risk that something in that chain is broken or exploitable.
  • DYOR (Do your own research): When I had the time and the headspace (summer of 2021), I spent a lot of time researching projects before investing. When I got busier, I got lazier and relied on thin articles or recommendations from friends and invested without spending the time to understand what I was doing (e.g. DeFi 2.0 stuff like DopEx and OHM) and got burned.

What comes next?

I’ve been a believer in crypto for a long time and have chosen to build the next phase of my career in crypto (I work for OpenSea) but these events caused me to question my resolve and the people we celebrate in our industry. I think everyone who is building in crypto should take a moment to reflect and make sure that the first principles reasons that drove them to crypto still hold true.

I care deeply about building tools that help creators and entrepreneurs find audiences and trade/transact globally without friction regardless of where they live. The technology behind crypto (digitally native currency) and NFTs (digitally native property) still has a shot of powering digitally native trade. This is still true, regardless of what happened at FTX.

I used to think that decentralization was just for the crypto maxis, but now I realize that decentralization will power the future of crypto, However, the UX for decentralization sucks; key management is scary and hard, and it’s easy to get phished/scammed. We need to build better tools for users (and maybe even as part of our mobile hardware/operating systems) before we see any mainstream adoption of crypto.

These events will also most certainly result in increased regulation and government involvement which may not be a bad thing. As a resident of the US, I do hope that the US government has a proactive stance and chooses to work with developers to build out these frameworks to both protect users and foster innovation.

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