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Weekly Report: November 13, 2022

Observations

This week was one of those “weeks where decades happen”. It’s been endlessly fascinating and entertaining. Let’s get into it.

FTX!

You can read about what happened in all the articles linked below, but here are a few things that struck me about the situation.

FTX hit a $32 billion valuation within 3 years and dealt with tens of billions of dollars. It all vaporized in the space of a little more than 3 days. Typically when an organization gets to that scale, the founders bring on seasoned execs. That didn’t happen at FTX. (This is in part a failure of FTX’s investors, who felt so much FOMO that they were satisfied with whatever surface-level diligence they performed and willing to overlook the fact they had no board seats or other protective rights that VCs typically have.) Not only did it remain an underweight organization (apparently with only about 400 people, compared to Binance with almost 20x that), but if you look at the key players, including of their sister trading shop, Aladema Research, they are almost all inexperienced. Reports are that a bunch of them lived out of a shared $30+ million penthouse in the Bahamas and dated each other.

  • Caroline Ellison was the CEO of Alameda and, at 28 years old, mostly managed SBF’s money and reportedly dated him “at times”. She graduated from Stanford with a math degree in 2016 and had only one job prior to Alameda — 19 months at storied firm Jane Street as a quant trader. In a now infamous video, she mentions that “being comfortable with risk” in the job is “very important” and that they “tend not to have things like stop losses”. Risk management was clearly not her forte and she seemed to confuse being comfortable with risk with being reckless with risk.

  • Constance Wang was COO of FTX. She graduated from NUS in 2016 with 2:1 honors and took an entry-level job at Credit Suisse working as an analyst doing AML/KYC checks and risk controls. She was there for barely 2 years, jumped over to another crypto exchange (Huobi) for 8 months and then took the COO role at FTX. This site mentions that “Wang clearly wasn’t responsible for the misfortune that’s befallen FTX,” but she took the title and in any other firm managing that amount of money in a position with that title, you pretty much are responsible in some capacity.

  • Gary Wang (Zixiao Wang) co-founded FTX but appeared to avoid the limelight, unlike SBF. He attended MIT (like SBF) and apparently met SBF at a math camp in Canada.

  • Dan Friedberg was Chief Regulatory Officer at FTX. Apparently, Friedberg was embroiled in an online poker cheating scandal and cover up in the past — a period of time that reportedly appeared as a big gap in his now-deleted LinkedIn profile. Friedberg was either a partner or counsel at Fenwick & West running their blockchain practice from Seattle. He took the job after the poker scandal, so one wonders what kind of due diligence both Fenwick and FTX did on a pretty darn senior legal hire (and if they knew about it, why didn’t they care?). It appears that Friedberg joined as General Counsel but then transitioned over into the regulatory role after Can Sun joined.

  • Can Sun joined as General Counsel in mid-2021. He was a colleague of Friedberg in Seattle and co-chaired Fenwick’s blockchain practice with Friedberg. Sun certainly has pedigree (Yale Law, PhD from Princeton, a year at David Polk followed by almost 7 years at Fenwick as an associate), but no in-house experience prior to FTX. Sun abruptly resigned (as did most of his legal team, it was reported) a couple days after the news broke.

  • Sam Bankman-Fried is the son of two tenured Stanford Law professors — Professor Bankman (who teaches tax law at SLS) and Professor Fried (now emerita). According to his LinkedIn profile, he graduated in 2014 from MIT and was at Jane Street for a little over 3 years. He founded FTX after reportedly making a shit-ton exploiting the many crypto arbitrage opportunities that opened up around 2017 via Alameda Research. (Me and a couple friends got in on this action at the end of 2017, but our scale was many orders of magnitude smaller than what SBF achieved.)

  • I looked at Alameda Research’s site before it was taken down. It had the team’s photos on there and they all looked young.

From these profiles, you can see one main theme emerge: inexperience. There’s also nepotism, but that happens all the time in tech startups, and it’s not necessarily a bad thing as long as the person being hired is a good fit for the job.

Inexperience, though, is far more dangerous — particularly in a field where you’re dealing with other people’s money. This is people’s lives, we’re talking about. The fallout will be felt in the coming weeks and months, but some people have now lost a huge amount of their life’s savings, and suicide risk is real. There are also signs in the news that the reason for the gaping $8 billion hole in FTX’s finances extends beyond manifest incompetence to some sort of criminal malfeasance. At the least, the abuse of client funds in the manner reported in the media would likely be criminal in TradFi.

Which brings me to my thoughts on the crypto space as a whole. I believe there are two types of people: (1) principled “believers” who are genuinely invested in the technology and the promise of building something actually useful with it, and (2) people who see an opportunity to make money. There are a lot more of type 2 than type 1. And there are a lot of people who claim to be type 1 but are really type 2.

Crypto is a modern day gold rush — people see fortunes to be made and flock out to the wild west.

There’s nothing wrong with that, of course. But when you’re there to make money, it doesn’t matter whether it’s crypto or DeFi or TradFi… it’s just finance. The difference is that TradFi is build up on centuries of experience, and the regulatory framework is developed.

There’s a lot about crypto that’s new, but that’s often confused with what’s not, and the crypto world is “rediscovering” learnings that are already well-trodden in TradFi — such as basic risk management and the dangers of leverage. (This reminds me of a time back when Netflix was still mailing out DVDs, I saw a post online asking “Why isn’t there a startup where we can borrow books, like a Netflix for books?” only to receive a disgruntled reply, “Yeah, it’s called a library.”)

The wild west metaphor is apt because crypto is relatively unregulated. That is just fine for the many crypto enthusiasts with libertarian leanings, but in the real world that means people lose their figurative shirts as a result.

This is not to say that TradFi doesn’t have its Big Problems. The GFC in 2008 is clear evidence of that, and the fact that it led to bailouts was a travesty. But TradFi doesn’t see the speed and sheer frequency of damage that the crypto space has inflicted on consumers (and institutions). Pump and dump schemes, market manipulation, and fraud are commonplace. Literally billions of dollars have vanished this year alone due to hacks or coding flaws. Entire crypto exchanges fold. And it’s mostly unchecked — there are few consequences for perpetrators of some of these schemes, and it just attracts more scammers.

One blessing is that crypto is mostly separate from the mainstream economy, so we haven’t really seen much, if any, contagion. And that’s just the thing — it’s never going to be mainstream as long as it’s unregulated or weakly regulated. It’s never going to be a tool that a family uses (or should use) to buy a house, or keep their retirement savings in.

In the same way that communism sounds kind of OK in theory but is very different in practice due to human nature, I feel the same way about unregulated crypto.

There’s a common refrain used by crypto enthusiasts arising from the FTX disaster: “Not your keys, not your coins.” (This refers to how if you don’t have the private keys that signify ownership of cryptocurrency, you don’t actually own it at all. When you buy Bitcoin from an exchange like Coinbase, they are actually coins owned by the exchange (you hope), and they assign ownership of those coins to you on paper. But you have to withdraw the coins out to your own wallet if you actually want to ensure ownership. Better yet, keep them in cold storage.)

There’s a slight edge to that axiom: it’s your own damn fault if you decided to buy crypto through a centralized exchange — you assumed the risk. If you want to ensure that doesn’t happen to you, keep your coins under your own digital mattress. And that’s just it — it’s not practical. If I want to daytrade crypto, I can’t do that easily through my Ledger wallet. It’s just not convenient. I need an exchange. (I know there are decentralized exchanges, but they have their own issues and don’t solve the underlying problem of lack of regulation.)

So, until the various government agencies get with the program and start regulating things in a thoughtful manner, crypto is not going to replace TradFi in any meaningful capacity, and it’s just going to be a place where both really interesting innovation occurs, and where people get their faces ripped off by avarice.

A sidenote on NFTs: IP lawyers I’ve spoken to are confused why NFTs have any value, given there is a valid question about the worth of the intellectual property you actually own. Similar to how DeFi is still finance, NFTs to me are just luxury goods. Value is in the eye of the beholder, and luxury goods are the epitome of when intrinsic value diverges from perceived value. That’s all it is.

A Birkin bag, or the Mona Lisa, is only valuable because enough people think it is. The materials for a Birkin do not cost $30,000 and the bags do not provide utility that is worth $30,000. But a knock-off Birkin is considerably cheaper than a genuine one. NFTs are exactly the same. They are intangible luxury goods. It doesn’t really matter that from a legal perspective, it’s questionable what, exactly, you own. It doesn’t matter that your picture of a bored ape can be copied with a couple clicks of a mouse (I mean, that kind of sums up the whole software industry). All that is irrelevant. NFTs have value because people believe they have value. And, like the tulip bulbs of the 17th century, if the fad passes, that value will evaporate. The question is: will the value endure?

The glory days of inefficient global crypto markets when we could make 23% on a single trade!

Twitter

Damn the torpedoes, full speed ahead!

I feel for what Twitter employees are going through at the moment. The two weeks after the acquisition have been a case of doing everything that good management practices say you shouldn’t do. It sounds like a terrible working environment.

Yet, there is a certain fascination about whether this might actually turn out ok — or even well — in the end. This whole thing is a bit of an experiment. This is a unique situation, and no one’s had the ability, gall or gumption to try what Musk is trying at this speed and scale.

There is a difference between taking a huge but calculated risk and being reckless (see Alameda Research, above), but for the Twitter x Musk combination, this may only become clear in hindsight.

Can you cut 50% of the workforce within 2 weeks, push out features without much apparent thought or planning, send everyone back to the office on no notice, do all the other stuff that’s happened there, and still manage to pull a company out of a spiral? I am not hopeful, but if this is even possible to pull off, I suppose it can only be someone like Musk. CEOs around the world are watching.

Elections. Well, my prediction last week was wrong. With the Dems holding the Senate, I’m pleasantly surprised at the outcome of the mid-term elections. And Trump has been even more unmoored lately and it looks like it’s turning people off.

Meta layoffs. 11K+ people were laid off at Meta this week. The company is still a cash cow, but I think Zuck’s “bet the company” approach on the Metaverse is doomed.

Inflation. On Thursday, the inflation number printed lower than expected. The stock market ripped up and the U.S. dollar fell. However, we’re far from out of the woods.

Lunar eclipse. In the early hours of Tuesday morning, the last full lunar eclipse in 3 years occurred. Unfortunately, it was raining and overcast where I am.

Powerball. A single person won the $2.04 billion Powerball jackpot on Wednesday.

  • The headline $2.04 billion jackpot is based on taking payouts over 30 years. Paid as a lump sum, the cash prize is $929.1 million, which is based on discounting future cash flows back to present values (you could invest the $929.1 million into treasuries yourself and end up with the same ~$2 billion). This calculation is sensitive to interest rates, which are higher than they’ve been for almost 15 years, allowing Powerball to advertise such a large headline figure.

  • The prize is taxable, but because the winning ticket was bought in California, no state taxes apply.

  • Yeah, we bought ourselves 5 tickets. Out of the 30 numbers that we got, only 1 matched a drawn number.
The Powerball jackpot was so big that the display at our local supermarket ran out of numbers

Articles

Pretty much just FTX and Twitter articles this week…

Charts, Images & Videos

Source: r/TrueReddit

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