Tech Won't Save Us - (Un)Stablecoins and the Crypto Crash w/ Bennett Tomlin

Episode Date: May 19, 2022

Paris Marx is joined by Bennett Tomlin to discuss last week’s crash of Terra and Luna, the problems with stablecoins, and whether this collapse will finally force regulators to take action on cryptocurrency.Bennett Tomlin is a co-host of Crypto Critics’ Corner and writer of the FUD Letter. Follow Bennett on Twitter at @BennettTomlin.Tech Won’t Save Us offers a critical perspective on tech, its worldview, and wider society with the goal of inspiring people to demand better tech and a better world. Follow the podcast (@techwontsaveus) and host Paris Marx (@parismarx) on Twitter, and support the show on Patreon.Find out more about Harbinger Media Network at harbingermedianetwork.com.Also mentioned in this episode:Paris wrote about the Terra/Luna collapse and why we can’t let those who promoted crypto scams escape blame for their actions.Bennett references George Soros’ attack on the British pound in 1992, also known as Black Wednesday.Do Kwan was behind the failed Basis Cash stablecoin.Vitalik Buterin backed a proposal for an FDIC-like response to rescue “small holders” who lost money in the Luna collapse.Investors recently pulled $7 billion out of Tether, which still won’t be open about its reserves. It was hacked in 2017.FTX CEO Sam Bankman-Fried described yield farming as a Ponzi scheme.Justin Sun has already launched a copycat of the failed Terra algorithmic stablecoin. The Verge did a deep dive on him in March.a16z says the crypto winter is here.Support the show

The issue with stablecoins in general, and the issue with crypto building so much around stablecoins, is that when they fail, they devastate everything that depends on them. Hello and welcome to Tech Won't Save Us. I'm your host, Paris Marks, and this week my guest is Bennett Tomlin. Bennett is the co-host of the Crypto Critics Corner podcast and the writer of The FUD Letter, a newsletter that digs into the crypto industry. Now, you might have noticed that over the past six months, the crypto industry has been headed on a downward slope with the prices of major cryptocurrencies like Bitcoin and Ethereum tanking about half, even more than that possibly. And last week, a particularly devastating event where UST or Terra, one of the major stable coins,

used to be the third largest, collapsing to effectively zero. It was around 12 cents the last time I looked. And it's connected governance token, Luna, crashing to a fraction of a penny from about $60 or $80 and a high of over $110 last month. This caused a lot of pain for a lot of people, but it also showed the fundamental fragility and problems that are built into the foundational aspects of the crypto ecosystem. And so in this conversation, Bennett and I talk about the roots of that problem and the vulnerabilities that stablecoins introduce into the system, while also making it more accessible for people to get into the crypto ecosystem,

which in itself is still difficult and confusing for a lot of people. This is an industry ripe with scams and fraud. And as it declines once again from its biggest level so far, there are going to be consequences. Coins and projects are going to fail. People are going to lose a lot of money. But it's also a time to gain an even greater understanding of what goes on in this industry to hopefully ensure that

there's regulations to stop the worst aspects of it from being able to operate or if not shutting down the whole industry altogether, which unfortunately, I don't think we're going to see any governments in the West try to do. On that front, I would just love to see them copy China and kick it all out of their country. But unfortunately, I don't think we're going to see that. So this was a fantastic conversation with Bennett, who is so knowledgeable and insightful on these topics. I was so happy to have him on the podcast and to chat with him about this. And just one thing to mention as we get into the conversation, Bennett does use the term DeFi, and I'm not sure that we define that. So that's just decentralized finance. These projects or businesses trying to create like a decentralized finance system

separate from, you know, the traditional finance system that we have right now effectively. So if you like this conversation, make sure to leave a five-star review on Apple Podcasts or Spotify and share it on social media or with any friends or colleagues who you think would enjoy it. If you find these conversations informative and you enjoy listening to the podcast every week, consider supporting the work that goes into making it by joining supporters like Greta from Hanover in Germany, Tatiana in Los Angeles, and Mahendra in Ireland by going to patreon.com slash tech won't save us and becoming a supporter. Thanks so much and enjoy this week's conversation. Bennett, welcome to Tech Won't Save Us. Glad to be here. I'm really glad to speak with you. Your podcast, Crypto Critics Corner, is one that I always turn to to learn about what's

happening in the crypto space. So it's great to be able to speak with you and get your insights on what actually happened last week with the crash of UST and Luna, learn a bit more about that. So if you could give us an introduction as to what is UST and what's its relationship to Luna, and what did we actually see happen last week when these two coins imploded? In cryptocurrency, there's a group of assets called stablecoins, which are just tokens that are meant to mimic the price of another asset. The most common variation of these are pegged to the dollar, though there are other ones. Some are pegged to the euro, a few are pegged to gold, et cetera, et cetera, et cetera.

Amongst stable coins, there's a few different variations. There's the like asset backed model, which is kind of like a tokenized money market fund, right? It's cash, treasuries, bonds, all stored in one account and with enough reserves for every token in circulation. Terra is not like that. Terra is what's called an algorithmic stablecoin. Algorithmic stablecoins are very different because they don't have any backing or they back themselves, depending on how you look at it. So in the case of Terra, there are two tokens involved here. There is the Luna token, which is the quote unquote governance token for the protocol that allows people to vote on changes to it and allows them to stake it and collect their portion of the fees paid from people using the protocol. Then there's the Terra assets, which are the stable assets that are meant to be

pegged to currencies, with the only one that really mattered being Terra USD, which was pegged to the dollar. And I'll probably just call Terra for the rest of this episode. So the way these protocols are supposed to work is once you have a governance token that people think is valuable for whatever reason, you can use it as kind of a pseudo collateral for the stable token. And so you're able to, through the protocol generally, exchange one teradollar for a dollar worth of Luna or a dollar worth of Luna for one teradollar. And the assumption is that is what will keep it stable. Because if, for example, the price of the Terra dollar falls to 90 cents, you can buy one for 90 cents, go back to the protocol, and get a dollar worth of Luna, and now you've made 10 cents.

Or if for some reason Terra started trading above a dollar, say a dollar and 10 cents, you could burn a dollar's worth of Luna, get a Terra dollar, and then sell it for a dollar and 10 cents and make that difference. And so the entire idea behind the protocol is that you can incentivize people to try to keep it at this certain value. But the problem is the entire time it's dependent on the assumption that Luna is valuable. And so what ended up happening is people started to no longer want to hold UST. The exact reasons of this are related to the anchor protocol, which I'm sure we'll get into in a little bit. But the important part is people no longer wanted to hold UST. So they started selling it, people started redeeming it through the protocol. And as they started to redeem it through the protocol, more Luna was

minted. Because when you exchange your Terra dollar through the protocol, it mints a new dollar's worth of Luna, and that's what you get. And so as people started to exit Terra, you started seeing more and more Luna issued, which decreased the value of every existing Luna as they were dil swap it, which caused the issuance of more Luna, which caused the price of Luna to decrease, which decreased confidence in the system, which made people sell their Terra, which caused the issuance of more Luna. And this is what's called the algorithmic stablecoin death spiral, is once this system starts to destabilize, loses its kind of metastable positioning, it is extraordinarily challenging to bring it back to stable because you're effectively trying to restore faith in a failed fiat currency.

Yeah, it's very complicated, as I think many people can surmise from your description. But I thought it was fascinating, right? Because what you saw was effectively Terra or UST dropped to around 80 cents and then come back up a little bit. And then what the people behind it, Do Kwon, who is the co-founder and CEO of Terraform Labs, were saying, like, we're going to bring it back up to peg. We're going to make sure that, you know, what we saw was Luna start to plummet in value. And so that made it effectively impossible, much more difficult to restore the peg of UST and the confidence in Luna itself. So now you have Luna basically worthless, worth less than a penny. And UST, I believe I checked earlier, was around 12 cents. And so I'm assuming that means it's not going to be able to be re-pegged ever. Yeah, I don't think so. Do Kwon has proposed his own recovery plan involving forking the chain into two, one which still keeps the stablecoins and one which eliminates the stablecoins. I am deeply skeptical that this will ever have a functioning

stablecoin return to peg. And I expect it'll end like Doquan's last algorithmic stablecoin project, abandoned and pegged to zero. Yeah, he did that under a pseudonym. So we didn't know until I believe just in the past week. Is that right? That's exactly right. So in February of 2019, they did their ICO for Terra, and he started working at Terraform Labs to run Terra. In 2020, apparently, he got bored and decided to fork an earlier failed algorithmic stablecoin called Basis to create his own version he called Basis Cash under the pseudonym Rick Sanchez.

Very creative name. Yes. And eventually, like the famous scene when Rick goes to the Galactic Federation, he set the value of the currency from one to zero and the system collapsed. Oh, my God. It's wild, though. Like, just the stories that happen in this industry of scams and fraud are just absolutely wild. Now, you mentioned the Anchor Protocol, which is part of this as well. And I'll admit, this is part of the story that I don't understand as well. So what is the importance of the Anchor Protocol and how

does that fit into this broader picture when we're talking about Terra and Luna? Fundamentally, Anchor was just supposed to be a lending protocol, making it easy for people to lend out or borrow certain assets on the Terra chain. However, the wrinkle there is Anchor's defining feature is that it was supposed to have a stable yield. They were supposed to be collecting certain fees and using those to create a yield reserve, which would allow the yield rather than fluctuating at a very rapid basis like many other lending protocols, it would be more stable. Now, what actually happened is the yield reserve was almost entirely subsidized by Terraform Labs and was used to pay out a much higher rate to lenders than the borrowing market could support.

And so if you were willing to deposit your Terra into Anchor Protocol, you could for a long time get 20% yield. And then for a while it was like 19%. And so you could get this really high yield and what's effectively supposed to be like a dollar you're lending out, right? And so because of that, we ended up with like 50% of the total value locked in the Terra ecosystem, all being in this 20% yield gain being subsidized by Terraform Labs. And so almost the entire demand for new Terra tokens was being driven by Terraform Labs effectively paying people to create new tokens so they could earn this yield. Sounds a little bit like a scam. You know, when I think of like a 20% interest rate, especially in a moment where like interest

rates are still incredibly low, like maybe I'm talking about what I would pay like a 20% interest rate, especially in a moment where like interest rates are still incredibly low. Like maybe I'm talking about what I would pay like a credit card company if I let something like rack up on my credit card, you know, the debt there. But it's not something that you would typically see like a company or investment paying you back. And so, you know, you were talking about there how Terraform Labs was effectively subsidizing this interest rate. Is this based on the belief that the value of these tokens would continue to appreciate kind of indefinitely? Or was it just using like venture capital and funding in a way that we see with many of these tech companies to kind of subsidize the entry into their coin with the assumption that eventually it would be a major coin and then they could like reduce it later do you get an idea of what the approach was

the good faith version the steel man version of what they were trying to do if i want to give them the maximum benefit of the doubt is that it was a kind of growth hack like you're talking about where they wanted to really try to juice the growth so that eventually and more quickly, Terra would be able to get to this point where it would become integrated and used by certain payments companies. And because of that, because of its use through these swaps as these payments for all these things, you would end up with enough demand for the Terra token and enough demand for Luna that it would eventually no longer need the unsustainable yield.

Apparently, that was not true. Well, apparently that was not effective because as soon as they turned the yields to dynamic, like four days later, we started to see billions of dollars get withdrawn from Anchor. And then we started to see a bunch of Terra get redeemed. And then we saw the entire system collapse. Do we know how the actual decline in Terra began? What actually kicked that off? We don't exactly.

So several days before, we really saw it break. As I mentioned, it might have even been a week before, Anchor changed from this guaranteed rate to more of a dynamic one, where it was adjusting. It was still subsidized, but it dropped it from, say, 19% to 14 or 15%. And so it was a little bit less appealing. At that point, we started to see billions of dollars get withdrawn from the Anchor protocol. And then a few days after that, I think we started to see a bunch of sales of UST and swaps of UST back into Luna. So when this gets into the Luna and Terra community have been big on suggesting that they were the victims of some unfair attack or

something like that, and that that is the reason the system collapsed. And so the warring narratives here are kind of, was it just the loss of interest as the yields went down caused the unsustainable scheme to prove out as unsustainable. It was there an attack. And I don't really particularly think it matters because the entire history of pegged financial assets has shown that if you construct them poorly and make them an attractive target for attack, like the pound sterling, it's going to be attacked and make someone a lot of money like George Soros. And so the idea that there was some malicious attacker and without that, Terra would still be functioning fine is unconvincing to me.

Because eventually, if that flaw existed that allowed this attack, there would have been a well-capitalized individual who was going to exploit it. No, it makes perfect sense. There was another piece of this as well that was really interesting to me. And that, again, I didn't completely understand. And that is that Terraform Labs had a lot of Bitcoin that it started to sell off in order to try to defend the peg on Terra. And I believe it came out a few days ago that a lot of this Bitcoin was sold at a rate that was really favorable. And a lot of people would have made a lot of money in the way that it was sold at a rate that was really favorable. And a lot of people would have made a lot of money in the way that it was sold because it assumed a parity was still there that no longer was.

Can you explain what was going on there? What the importance of that detail is? Yeah, I've seen some of the analyses you're talking about, and I think they're not entirely there. What we do know, so zooming back out, Terraform Labs used a bunch of their ICO funds to buy several billion dollars worth of Bitcoin, with the goal being that if the peg was under attack, they'd be able to use the Bitcoin, prevent minting of Luna, and therefore delay the death spiral. On May 10th, the Luna peg broke below 75 cents, and so at that point, Luna Foundation Guard, the other entity set up to manage these Bitcoin, transfer them out, and supposedly started doing operations to save the peg. The ambiguity and issue here is we don't know exactly how those transactions were structured or what was going on. People saw the Bitcoin hit a couple different exchanges, but the implied exchange rate based on the price of Bitcoin

during this period and the number of they were ended up able to purchase with it. It seemed that they were purchasing it. I think the peg I calculated came out to like 89 or 90 cents. So it was not quite at parity, but it was well above the 75 cents that it was at when they deployed the capital. And so either they had structured this as some kind of over-the-counter deal to basically purchase back a bunch of Terra from some market maker or something who had accumulated it previously trying to arbitrage, and so that they'd been able to effectively get out above peg. Or the alternative is, that gives them the benefit of the doubt, is they deployed it,

temporarily brought the peg back up, because it did spike up for a while back there, never getting fully back to parity. But it's plausible that what we saw there was them doing the operations, recovering the peg. And so it was closer to parity than when they deployed the capital because they had brought it back up closer to parity. However, eventually the reserves ran out either because they had been used in just this single deal will be able to restore the peg on this. And he's talking about starting a new chain or whatnot. I was interested in your take on what he has been saying throughout this process. Because I remember in the beginning, he was kind of very, very positive about this, talking about the lunatic community and how it was so supportive and he was so into this community.

And then everything really broke down and he basically had to admit that this was falling apart and not going to happen anymore. Can you talk about the narrative and how that gets approached by someone like him? I think the important thing to remember with any algorithmic stablecoin is that the entire system basically depends on faith and belief. It's like fiat currency at its most pure without having like a government or taxing body that can demand you pay something in this. So it's entirely dependent on kind of constructing this almost like this very deep seated belief in the people around you that this project is going to be successful. And the way Do Kwon did this is by trying to make people think that he was uniquely capable, uniquely positioned, or uniquely able to

be the one to achieve that goal, to create that sufficient mass of belief. And so as he started to accumulate more and more people around him who seemed to believe in the mission, it became easier for more and more people to believe that this would eventually hit that critical mass because they already saw the evidence of people flocking there. And so Do Kwon ended up as kind of this cult of personality, almost messianic figure for a part of crypto and decentralized finance. Like I remember when I first wrote my piece on terror in February, like, one of the criticisms I got was, do you really think that you thought honestly believed that Do Kwon was uniquely a genius capable of achieving this goal. And so his role during this collapse was to try to keep the faith. He had to convince enough of the community to not try to swap their tariffs for Luna and accelerate it, to hold their Luna and not sell it on exchanges

so that there's still sufficient value for the peg arbitrage mechanism to effectively wrench away from the Luna holders. And so everything he said was, I think, focused on that goal. He was trying to make sure enough people maintained belief that there was a slight chance he could keep the thing going. Yeah, and that seems so core to so much of the crypto market, right? Like Doquan is one of these figures. But, you know, part of their goal, it seems, or part of their role is to ensure that people hodl, right? Hold on for dear life, keep their crypto, never sell it, even when, you know, the prices start to crash, which is indicative of other people selling their crypto. And it just seems that this kind of cultish mentality is so important to the whole thing. I think in many cases, it often is. Like for many crypto assets, it's not like you're trying to value discounted future cash flows, right? You might with an equity. There's, for many of these things, not really any fundamental

intrinsic value. The value is the ability for the system to reach a certain amount of belief or something like that. Or if there is something you can construct as intrinsic value, like you can say the intrinsic value of Luna is getting to vote on Terra chain proposals and collecting your portion of the fees. That's still a very self-referential value. It depends on the chain in the system still being used and still being valuable. And so it's still vulnerable to a lot of that thing. And so because the value is very self-referential and is not necessarily coming from some intrinsic property, I think it's very often that the sense of community and sense of belonging becomes an important part of the narrative, because once you are a Bitcoin maxi, once you're a lunatic, once you're a link marine, once you're part of the XRP army, once you've tied your identity in some way to one of these groups, coins or whatever, it becomes that much harder for you to part and to remove that part of your identity. And so for the projects that want to create that kind of value, making

that kind of tying of your identity to the asset is fundamental to how they're going to accrue value. Yeah, no, it makes perfect sense. When we look at the effect of this crash, right, we saw Terra, which was this algorithmic stablecoin effectively go to zero. You know, it's around 12 cents. It's not worth what it was. And then we look at what else is happening with stablecoins. Does this suggest a broader risk to the construction of stablecoins, their position, the role that they play within the crypto ecosystem? Yes. I've written a lot about stablecoins. They've been one of my particular interests

over the last several years. And there's a lot of power and a lot of nuance and a lot of differences in different stablecoin models. And so like algorithmic stablecoins like this are always or very nearly always going to fail because they depend on kind of this unsustainable alchemy. There's other crypto native stablecoins like MakerDAO's DAI, which is what I call a debt-based model where the DAI is basically issued as a loan to you and your loan is over-collateralized by whatever crypto you put up. So if you want $100 worth of DAI, you're putting up $150 worth of Ether before you can get it. And so those are able to better contain their risks to a degree, though there's other flaws with MakerDAO that are beyond this podcast,

but those are better able to contain their risk because they're not dependent on just like this single self-referential asset. And then like even among the asset-backed ones before, with the biggest, of course, being Tether, there's a lot of variations. Like Tether, when they settled with the CFTC, was revealed they only had adequate backing on 26% of the days or something like that, that the CFTC looked at. Their payments processor was allegedly money laundering for the Colombian cartels. And so when you see a collapse like Terra, you see how it takes out effectively the entire Terra ecosystem that is dependent on it. Basically every other project built on the Terra chain or dependent on it in some way suffered badly during this crash. And then you look to an asset-packed one like Tether

with a very checkered past and some well-documented improprieties, and we don't know exactly what it would look like when it fails or if it would fail, but it's a much larger pool of liquidity. It's a much larger portion of trading volume. And it is much less expected to crash. And so when an asset like that, if an asset like that were to de-peg, you would expect it to suck a lot of the liquidity out of the system and hurt really any project dependent on it. The other wrinkle here is that because decentralized finance tries to be very modular and composable, you end up with

protocols basically building on top of each other and integrating each other. And so the issue with this is stablecoins are like one of the base units that protocols very often include as like a part of their protocol design. And so when stablecoins fail, they can cause tons of other protocols to fail or perform in unintended ways. And it can even go a little bit deeper than that. Like when Tether was hacked in 2017, they were able to force a hard fork of the Omni network that the tokens were on because they represented such a large economic majority. And so when you think about that for something like Ethereum, if USDC, which is one of the most commonly used stable coins there, were to have some kind of issue like that, and they were to try to force a fork of the chain, whichever one they declare the tokens are going to have value is where a lot of other protocols and things need to follow because they are in some way dependent on those tokens having value.

And so the issue with stablecoins in general and the issue with crypto building so much around stablecoins is that when they fail, they devastate everything that depends on them. I guess you could say in a way it's like a structural flaw in the system that has been created. Yeah. And that's why I write about and read about stable coins so often is because they are this base unit that people have given so much power to because it made a lot of things easier. People think in dollars way easier than they think in ether. People want to be able easier than they think in ether. People want to be able to trade against a dollar, against a stable unit of account, because it makes their trades make sense. But because of that decision made for, at the time,

seemingly rational reasons, you can end up with systems that lose anything that would make them valuable. And so like if crypto, if you say any potential value comes from the fact that it is censorship resistant, that it is resilient, that it is like the system supposed to be outside of any entity's control. When you start to give a single entity that control, you eliminate the only defining or valuable feature about it. And I'm guessing because of the way that you explain stable coins earlier to the audience, that if these stable coins were not present in the

system, it would be much more difficult for people to invest and get involved in the crypto market because it would create even more barriers to entry and investing and getting involved in crypto is already quite a difficult and confusing process for a lot of people. Yeah, I think that's very true. I think many DeFi users have benefited from, like DeFi as a whole has benefited from the fact that users are able to see dollars, see something they recognize, and that it's very easy for them to price the appreciation of their assets against dollars, even for ones that aren't on centralized exchanges, right? Even if it's an NFT or something that you're trading directly on chain, being able to figure out what that value is in dollars is very appealing since that's still what most of these people are thinking in. And so, yeah, if stable coins were clamped down upon, I think that would represent a challenge for a lot of the cryptocurrency industry. Just to put this into perspective for the listeners, Tether is the largest stablecoin.

USDC, which you mentioned a minute ago, is the second largest. And before this all happened, Terra or UST was the third largest stablecoin in the crypto ecosystem. And I want to ask specifically about Tether, because you mentioned there have been questions in the past. I think there continue to be questions about the degree to which it is backed. What we saw in the past week is its peg did waver very slightly for a little while. And, you know, there's been reporting that there has been $7 billion in redemptions of Tether in recent days.

What would it take for Tether to break its peg permanently? And what would that mean for the crypto market? And I guess, is there any risk, do you think, of that happening in the future? Tether, the way it should work is people give dollars to this company. This company keeps the dollars, gives them the token. And at some point, people give the tokens back and get the dollars back. The actual history of Tether is not well described by what I just said. And so that's part of the complicating feature here. Only a couple dozen entities are even allowed to redeem Tethers. Tether can at

any time deny redemptions in their terms of service, it says, for any reason or no reason. If they don't want to give you dollars, they can give you whatever other securities, Bitcoin, lint, horses happen to be in their vault and say that that's a redemption. And so when Tether breaks its pegs in the broader marketplace, that generally means that the firms that can redeem Tether are incentivized to go out, buy it, and then redeem it at Tether for the same reason that people want to go out and buy Terra and redeem it for Luna. Except in this case, they should in theory be getting dollars instead of Luna. So when the peg breaks, that means for whatever reason, the market-making firms are not immediately trying to arbitrage that back up. In the case of the recent de-pegging, I think that could be because several of Tether's largest firms were exposed to Terra in different ways.

And so they had more pressing concerns than what was on aggregators, at least less than like a 1% de-peg in Tether. We saw Wix and Kraken down to like 93 or something, But in most places it stayed within about a penny or so. And so it's possible they just decided it wasn't worth it yet. But again, complicating this fact is the fact that like Sam Bankman-Fried of FTX and formerly of Alameda has described the tether redemption process as messy, which again, it doesn't seem like it should be. Seems like it should be you send the tokens, you get a wire process over, but that must not be it. And so for whatever reason, people didn't want to arbitrage it. They have sent it's back up to like 0.998 or something, which is the redemption value is 0.999. So it's not worth really trying to arbitrage that. And so if Tether

were to de-peg, like seriously de-peg for an extended period of time, what that tells me is for some reason, no one wants to arbitrage it. And the implication of that is the people who normally arbitrage it can't redeem. And so that means Tether is likely refusing redemptions. And so after the Tether broke during this tarot de-pegging, Tether went and wrote a blog post where they talked about how their peg never broke because they were doing these 7 billion in redemptions or whatever. And so if you just went back to Tether and were one of the two dozen people they let do it, then you could redeem. And so the peg wasn't really broken. However, that again feels very deceptive because from March of 2017 until November of 2018,

Tether did not process any redemptions directly. All Tether redemptions were handled by Bitfinex. And what ended up happening during this period is Bitfinex got cut off from their banks and Bitfinex's scammy payments processor, who was money laundering for the cartels, allegedly, was no longer able to process withdrawals because all of their funds had been frozen in a multinational international

drug investigation. And so because of that, Bitfinex wasn't able to handle withdrawals or redemptions because they had lost banking and had no access to this payment processor. And during that period, what we saw happen was the Tether peg break. And so them now trying to go back out of the system, it is challenging to figure out what exactly would happen. I think many protocols would struggle. A lot of assets would suddenly crash in value. And we even have some hint to this from the chief financial officer of Bitfinex and Tether himself, Juan Carlo De Vecini. In 2018, after the Crypto Capital Corp, that's the money laundering payments processor, had their accounts frozen, Juan Carlo De Vecini started desperately messaging Oz Yosef of Crypto Capital Corp to ask him for money or tethers or anything and says something like, this is not just

us, this is the entire crypto ecosystem. If we don't get this, Bitcoin could crash to $1,000. And so even then, there was kind of this taxed acknowledgement by Tether and Bitfinex executives that if they are unable to redeem, if they start to lose value, it would have a very large and significant effect on the rest of the crypto market. It's just wild to think about the potential implications of that, if it were to happen, you know, because Tether is so built into the crypto ecosystem and what it's so essential for. Now, you mentioned there, if this were to crash, a lot of people would lose a lot of money. What we've already seen over the past six months is the price of major cryptocurrencies like Bitcoin

and Ethereum dropped by 50%. We've obviously seen crashes like what happened with Terra and Luna. So people have been losing money. And one of the proposals that I thought was really funny, Ethereum co-founder Vitalik Buterin said recently that crypto investors who lost money on the Luna collapse should be protected, pointing to the Federal Deposit Insurance Corporation, the FDIC, which protects people who have money in banks, which was created after the Great Depression. Now, obviously, crypto is supposed to be this decentralized financial system. But whenever these things happen, it seems like they become much more open to centralization all of a sudden,

not saying that these things aren't centralized anyway, which I think you could very much argue. What did you make of that proposal by Buterin? Yeah, I think Vitalik was trying to allude to a proposal that had been put forward by a Twitter account called At Persian Capital, which had done the math in the remaining Luna Foundation Guard reserves, Terraform Lab reserves, and went through and identified where the smallest Terra account holders was and how fully you could reimburse them, sacrificing some of the larger accounts. And so I don't necessarily think Vitalik was looking for a government to step in and provide the insurance. More, I think he was trying to emphasize that the people who should most immediately be made whole are the smallest and presumably least sophisticated investors who were involved in this. And there's some precedence for this, right? When Bernie Madoff's Ponzi scheme collapsed, they eventually were able to claw back, I want to say like 70 cents on the dollar and anyone who had less than like 1.4 million invested

was made entirely whole. And the rest of the losses were basically distributed between the people who had more than that invested with the assumption being if you had more than a million and a half invested in a Ponzi scheme, you could afford to lose a million and a half or lose that portion of it or whatever. And so I think it was a good faith effort to try to emphasize that the people who should be made whole from this are not Terraform Labs or not Luna holders. It's the smallest people who had this asset that was supposed to be worth a dollar. And I think that is probably the best way to handle this because like the anchor deposits were, there was a couple of large wallets that accounted for a very large percentage of the deposits. And so I think that same way we have accredited investor laws in the United States, once you get past a certain amount of assets, it's presumed that you can fend for yourself and that you can at least keep from putting all of those assets in one place. And so I think it's a good faith effort to try to make the most vulnerable who were affected whole again. It's interesting that he didn't make the comparison to Bernie

Madoff that you made, though, and he made the proposal. Yeah, yeah, that's true. That's true. He did not. But I think at Persian Capital, who originally suggested the scheme, might have made that allusion to it. Okay, gotcha. Picking up on the Ponzi scheme point, though, someone else you mentioned, you know, not too long ago, Sam Bankman-Fried, who is, I believe, the CEO of FTX. He recently described part of his business on a podcast, and I believe it was Matt Levine who quickly told him that what he was describing sounded exactly like a Ponzi scheme. And then I noticed the other day, he also said, which goes against what a lot of crypto people are saying, that Bitcoin will never really work as a payments network. What do you make of Sam

Bankman-Fried and the kind of things he's been saying as of late? I think Sam Bankman-Fried is a earn-to-give effective altruist, which I think is nearly always an immoral act which causes harm. And the really frustrating part with Sam is that he's transparent about it, is that he'll come out and say, we put some money in the box and we wait for everyone else to pile their money in the box, and we try to take a bunch of money out of the box. He is being very honest about how he thinks these mechanisms work. And he believes that it's okay. These exist. They exist. So I should make my money from them. But my issue with it is the current value of an unsustainable scheme is basically entirely predicated on the belief that eventually you'll be able to identify people who don't recognize it as an unsustainable scheme. And so Sam is basically taking advantage of the fact that

he can recognize these unsustainable schemes, that he knows they can rapidly appreciate, and that he knows that eventually there will be people who do not recognize what he does and that these are unsustainable. And I think Luna and Terra is a really striking example of this because he very recently did a thread where he said this system was transparently going to falter. Like to him, it seems obvious that this was flawed, but then he says that, and nonetheless, Alameda was one of the investors in Terra and purchased a bunch of Luna tokens. They listed it with 20 times perpetual futures on their exchange and were making fees from it. And so he was entirely willing to profit from what he knew or says he knew was an unsustainable scheme that was inevitably going to cause harm.

And so I think that Sam Bankman Freed is an amoral actor willing to use his wealth to try to influence politics, regulations, and anything else so it benefits him with apparently not even enough shame to try to hide it. Hearing that explanation, I have to ask, maybe this goes a bit beyond the podcast, but then what do you make then seeing someone like that who is very clearly, as you describe, sitting next to people like Bill Clinton and Tony Blair and anyone who is powerful and influential in the world, he can happily get next to because he has all this money from these amoral schemes that he can then spend to get next to these people and get into the

ears of these powerful people. And they are happy to take it. I think that the corruption of our public figures runs very deep. And it does not surprise me that Sam would want to spend his money to spend some time on stage with a sexual predator and a war criminal. Very well said. There are so many things that I can ask. And so I want to start to close our conversation by talking broadly, right? We were talking about Vitalik Buterin's proposal for something like an FDIC, but within the crypto network. But that does bring up a broader question, seeing this collapse, seeing this broader collapse of the crypto ecosystem over the past six months. You know, what is happening on the regulatory side of things? Do you see this speeding up any regulatory efforts in the United States?

So there have been several proposals put forward so far about how to regulate stable coins in the United States. Almost all of these are focused on what I call the asset-backed stable coins, and they all, to differing degrees, basically try to fold them into the existing banking regulation framework. And I think that that is likely the future of asset-backed stablecoin regulations in the United States. They're going to end up under some combination of the purview of the Treasury, the OCC, and the Fed. And they're going to have a lot of limitations on what they're going to be able to do because of that. And I think the stablecoin companies themselves have already

recognized this. Paxos went out and bought a bank charter. Circle was trying to get approval for an OCC bank charter. And so I think there's a recognition among them that they're likely going to end up in that kind of regulatory framework. The bigger challenge for regulators is something like Luna or Terra. You can have the SEC go after like Luna and Terraform Labs is the initial issuers of Luna as like an unregistered security or something. But you're then kind of playing enforcement whack-a-mole and sense like the marginal cost to start a new one of these schemes approaches zero because you can fork the code and just start over and keep doing that over and over again. Whack-a-mole type enforcement like that is going to be challenging to effectively dissuade,

like the more algorithmic type stablecoins. I expect we'll see them start to try to instead pressure exchanges to be more stringent in their listing requirements, to be more thoughtful about the types of assets they list, and that they're going to requirements to be more thoughtful about the types of assets they list, and that they're going to have more and more expectations about how they manage their trading, what types of contracts and futures and leverage are available, and what types of know-your-customer checks and stuff that their customers are going to have to go through. So I think what we'll likely see regulation look like is the SEC will pursue certain individual cases. I think there's a very good chance Doquan is one of those. He'd already been subpoenaed by the SEC, and now he's a very attractive target. The scheme has collapsed,

so they're not doing any harm, which is always the SEC's fear, that they're going to break something and then people will blame them. Here, they get to come in after it break. They get to go after the very clear figurehead at the middle, And if they can put him away, that's great press for them, right? And so I expect they will try to go after Do Kwon. But that doesn't really fix the problem. And they can't, it's not sustainable, at least with their current levels of funding and our current level of political will for them to keep going after individual schemes. And so, yeah, that's going to be an ongoing challenge. And there's going to continue to be many of these types of schemes. Justin Sun has already started a new one on the Tron

blockchain called USDD offering 40% APY right now instead of 20%. Because he's like, what if we do it twice as fast? Maybe that'll fix all the problems. And so I'm not entirely sure what our regulations are going to look like. And I have very little faith in our regulatory bodies at this point. There is a revolving door between crypto and many of the U.S. regulatory agencies with any time a regulator leaves the SEC, the CFTC or the OCC, multiple crypto firms are trying very hard to recruit them. And so you end up with these like deep conflicts of interest

in these like really perverse incentives that have been destroying our regulatory state for years. But we're really seeing how much it's been crippled when you're seeing what Sam Bankman the second largest donor to President Biden is describing as like a scheme that's transparently going to falter. Yet there's still, still despite that, not enough political will for anything to be done until well after people have been hurt. Until well after the scheme has collapsed, people have lost everything and people have lost their lives. Yeah, it's incredibly concerning, right? And I completely agree with you. As much as I want to hope that there is serious regulation coming down the pipe. I'm also seriously concerned that

that is not going to happen, especially when you see the close relationships between people in the crypto industry who have a lot of capital to spend on political donations, getting close to major politicians who would be in charge of those kinds of efforts at politicians and regulatory agencies, right? As you mentioned there, there have been a lot of people harmed by not just the collapse of Terra and Luna, but also by the broader collapse that has occurred in the crypto industry over the past six months. I wonder what you make of, you know, how we should think about that in terms of who should be punished and where the blame should be laid. Like one of the things that really stands out to me is that there was this kind of bull run in the crypto market for about 12 months, right?

From October of 2020 to about November of 2021. And then there were a lot of people who should have known better, who kind of jumped on that bandwagon and who repeated all of the bullshit of the crypto industry and of the whales and the people who were making money off of this, who should have known better and then sent a lot of people into that funnel to lose their money to people like Sam Bankroom-Fried and many others. I wonder what you make of that and how we should think of the people who are losing money and also the people who helped to perpetuate these scams and convince people to buy into them. I generally don't want to blame the people who are just buying in. And I think that it very often makes sense why people are attracted to this.

And I think it's kind of more broadly, I talked about this a little bit once with Ben McKenzie and Jacob Silverman on my show, what they were referring to as casino capitalism, where you can't watch TV without being bombarded with ads for crypto or for gambling or for all of these things. And more and more, it seems like there's a lot of people who do not believe, they believe that gambling is going to effectively be their only way to make it, to have a really meaningful existence because of how much we've stripped social services and the social safety net and the paths for social mobility. And so because you have all these disaffected people, they're trying to solve very real problems for themselves. They're trying to find a way they can still hope and believe in the future. So I think in almost all these cases where the blame needs to be laid are with the individuals who can recognize that this is a

scheme that's transparently going to falter or who are creating and designing these schemes and who are attempting to basically separate the fools from their money, attempting to try to find the marks for these. And I also think that there needs to be stronger action against many of the promoters. And so something I had a conversation with John Reed Stark, former chief of the SEC's Office of Internet Enforcement about once, is back when he was at the SEC's office, they went after a whole bunch of different promotion schemes, fake stock newsletters, voicemail scams, and a bunch of stuff like that.

And the SEC now seems to have very little desire to do any of that when it comes to cryptocurrency. There've been a few isolated cases against like Floyd Mayweather and a couple of other major promoters, but there are a ton of undisclosed shills and stuff on crypto Twitter. And if you look around, you can get like lists of prices to get certain people to tweet certain things because they're circulated between like different companies that promote and connect these. And so I think there have been a whole lot of people who have been illegally promoting securities, who have been immorally promoting scams and unsustainable schemes. And I think that focusing the efforts on those who are creating, propagating and promoting them is the best

chance of minimizing their harm. I couldn't agree with you more. And I also agree with you when you say that it's hard to blame people who are buying into cryptocurrencies or these other forms of gambling that seem to be perpetuated through our society because there are so few avenues for people to actually get ahead these days, right? Social mobility is for many people like a thing of the past and they're really relying on this one trick that'll make them a lot of money and hopefully that'll work. And otherwise, like, how are you going to get ahead? So I completely agree with that. And I

think, you know, it's the people creating them, people promoting them that we should really be focused on because they're the people who are really to blame with what's going on here. I want to end with this question. I think this has been an incredibly informative conversation. As I said, we've seen this collapse in Terra and Luna. We have seen a broader sell-off

over the past six months of major cryptocurrencies that continued after the collapse of Terra and Luna. We've seen NFT prices collapse. We've seen trading volumes on OpenSea and Coinbase decline. And A16Z, I believe, put out a release today saying that dark days ahead, that the winter is here, things like that. So where do you think the crypto market is going next? And do you think there's any chance that we defeat these things and completely rid them from the things that we need to worry about? I don't think crypto is going away. Damn.

I don't think there's a version of this where they're forced entirely out of the picture. This is my second bull run in crypto. I started crypto commentating towards the end of the 2017 bull run. I've been doing it since. And during every bull run and in the first several months after the bull run, when the last few people are trying to extract whatever value they still can, you see the dumbest products and schemes. And then eventually everything crashes. Most of the grifters go away for a while and there will be some at least moderately interesting cryptocurrency projects. Or at least like at least the people still working and trying the projects are like true believers in the ideals at least. Whether or not the projects are good on their merits is a separate question, but like at least they're honestly trying to accomplish something rather than just take. And then eventually the markets pick up again. The money starts to flow back in. The grifters are attracted again and you see the scams and schemes get even bigger.

And so I think that there's been enough harm this time. We're going to see some new regulations. I think the SEC is going to take a more active role in regulating cryptocurrency exchanges. And I think that that will have a byproduct of at least four U.S. citizens changing the types of assets that are available for them to trade. I think that many cryptocurrency projects, and especially many A16Z-funded Web3 projects, will not survive this winter. And that's probably a good thing, because most of them are not good ideas. The things don't fundamentally need the resiliency, the censorship resistance or anything else

that cryptocurrency is good for. And they take on all the negative attributes of cryptocurrency, the cost, the expense. And then even more fundamentally, you'll hear cryptocurrency advocates talk about the immutability or the public ledger is these good things. But for a lot of the projects being funded in the Web3 space, I wouldn't want every interaction I have with that project to be recorded forever on a global and decentralized network of computers. I don't want every tweet I make to be stored forever. Sometimes I want to delete them because they're bad.

And so there was a proposal by someone to start like a DAO for funding abortions. And while I appreciate that their goal is to fundraise and to help these people who are now in this incredibly vulnerable position because of the U.S.'s regressive politics, the end result of transferring funds on a public ledger that's easily surveilled to people who are trying to do dangerous things has a lot of potential externalities. And so I hope many of those projects disappear, but A16Z will have already gotten liquidity on enough of them to raise their next fund. They'll be back as soon as the money comes back and investing again, presumably with no better idea of what a good product looks like. And so we'll see marginal benefits. We'll see,

I think, cryptocurrency exchanges continue to get more tightly regulated, more serious. I think stablecoins are going to get folded into the banking regime, which should hopefully help reduce some of their systemic financial risk and improve their behavior, which will hopefully help certain things. But I expect crypto to continue to exist. And I expect because what crypto is good for is censorship resistant. And the most common use case for censorship resistant is crimes, things you shouldn't be doing. I think we'll continue to see a lot of that. All of the strengths of cryptocurrency are not without very serious externalities and downsides. And that's the challenge with crypto.

And I don't think that's going to go away. I also don't think that any regulator or government is in a position to really just entirely stop it. Like I mentioned, there's ways you could try to do it. You could target Circle and try to get them to fork the chain. There's ways you could try to weaken crypto. But no government I've seen has anywhere close to the political will to try to organize something like that. Yeah, no, it makes sense.

And hopefully the SEC can find the will and the teeth to take on crypto in the way it can't with Elon Musk, apparently. Bennett, this has been an incredibly informative conversation. It has been great to get your perspective on everything that's going on here, you know, beyond what you've said on Crypto Critics Corner. So I so appreciate you taking the time. Thanks so much. Thanks for having me on. Bennett Tomlin is the co-host of the Crypto Critics Corner podcast and writer of The Fud Letter. You can follow him on Twitter at Bennett Tomlin. You can follow me at Paris Marks,

and you can follow the show at Tech Won't Save Us. Tech Won't Save Us is part of the Harbinger Media Network, and you can find out more about that at harbingermedianetwork.com. And if you want to support the work that goes into making the show every week, you can go to patreon.com slash tech won't save us and become a supporter. Thanks for listening. Thank you.