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A BitBase cryptocurrency exchange in Barcelona, Spain, on 16 May 2022. (Photo: Angel Garcia / Bloomberg)
© Steven Boykey Sidley
Last week I wrote about the $32bn implosion of the 3rd largest crypto exchange, FTX and the likely criminal activities of its founder Sam Bankman-Fried (SBF). I predicted contagion, other horrors emerging, which happened within days and continues to grow, even accelerate.
And then I suggested that many cryptoverse builders had ignored the lessons that traditional finance has learnt over the last 1000 years. Which had some people yelling at me. I am going to try again through a different lens.
Firstly, know that the FTX affair has continued to spread, scalding everything in its path. It is far from over, and every day brings new misery to mostly innocent people. I suspect that we haven’t seen the half of it. Probably less.
It was perpetrated by one bad actor, with the connivance of a few close associates (all of whom have now fled the US, trying to find their way to Dubai, which does not have an extradition treaty). SBF was charming, articulate, young and reasonably modest in a loud and brash space. And yet he fooled everyone. Supposedly wise investors and VC elders gave him billions. Celebrities and politicians wanted to be seen with him. Billionaire Anthony Scaramucci, ex-White House Communication Director, even described him as the ‘the next JP Morgan’.
And over a hundred thousand small players were seduced into trusting him with their money. They have lost every cent they invested. There is no government insurance in this world.
What has now been uncovered beggars belief. Over 100 companies had been set up part of his empire. Depositors’ funds (supposedly safely lodged on a blockchain) were freely loaned and intermingled with entirely unrelated projects (this is absolutely verboten under law; jail awaits anyone in traditional finance who tries this). Risk management at his companies, as described by the young CEO of Alameda Research, (SBF’s trading company) in a truly appalling 54 second video clip https://www.youtube.com/watch?v=YpkgjLFBuDY, is almost too shocking to be believed.
Amphetamine usage was encouraged. Software security was, well, paper-thin (it has even emerged that he had a ‘back-door’ into the software that allowed him to move cryptocurrency around, one which no-one else at FTX may even have known about).
It was, as one pundit described it, an out-of-control junior frat house party with no adults in sight.
This scenario was exactly zone of the core problems that the original blockchain techno-philosophers sought to solve. They wanted to build a system which could be ‘trustless’, meaning that no individuals, corporations, or state actors could interfere with or debase the system. The intent was that there should be no one to trust, and therefore no one who could breach that trust. And it is humans who breach trust, as in the case of SBF. Take humans out of the loop, and you don’t need trust.
Only you can’t. Not always.
There are exceptions though. The largest on-chain Defi crypto exchange is called Uniswap. It has processed $1 trillion in transactions in its short life, moving various cryptotokens between buyers and sellers. There are no humans anywhere. No legal entity, no CEO, no brokers, no board of directors, no call centers. Just hardened code. This is the way it is supposed to work.
But humans are generally a part of economic and transactional ecosystems; to imagine a world in which this is not true is to lean into science fiction. And because of this, the utopia of trustlessness often fails to materialise.
Consider the borders of the cryptoverse, that liminal space between the real world and the blockchain. It is where there is a necessary handshake between real-world money and cryptocurrency, or real-world title deeds and NFTs, or real-world justice systems and smart contracts. There are always humans at these borders. Banks, centralized exchange managers, state attestors, judges and attorneys, software developers. All of these humans may have human flaws. Mistakes, incompetence, predilections to illogic, bias, even transparent malfeasance, as in the case of SBF.
Where there are humans there is risk.
I’m probably swimming upstream here, but I do not think that SBF from FTX or Zhu from Three Arrows Capital (another spectacular crash) or Do Kwon from Terra Luna (another spectacular crash) got into crypto to steal money. I am confident that was no original criminal intent. They failed to understand the complex world of financial risk, things that grey, quiet and anonymous back-office banking technocrats and regulation bureaucrats understand well.
And so these well-intentioned crypto entrepreneurs found themselves tumbling into an unfamiliar hole at the first arrival of a macro bear market. And then lost sight of everything as they took greater and greater risks to try and ‘make good’ again.
What happened last week has little to do with the technology of blockchain and everything to do with the necessary of presence of humans scattered around the growing crypto ecosystem. And yet trustlessness remains a beguiling prospect.
Flawed humans and flawless code. That bridge has not been built yet.
Steven Boykey Sidley is a Professor of Practice at JBS, University of Johannesburg and co-author of Beyond Bitcoin: Decentralised Finance and The End of Banks.
This article was first printed in Daily Maverick
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