Unchained - Jesse Powell and Kevin Zhou on How FTX and Alameda Lost $10 Billion - Ep. 423

Episode Date: November 21, 2022

Kevin Zhou, cofounder of Galois Capital, and Jesse Powell, cofounder of Kraken, talk about why FTX collapsed, the warning signs, and whether it’s a catalyst for self-custodial adoption.  Show highlights: the root causes of the FTX collapse, according to Jesse and Kevin whether there were warning signs of all the risks that were to come the importance of learning from mistakes, even for new people in the space Kevin's response to the stuck funds in FTX the debate about utilitarianism and SBF's effective altruism whether the philosophy behind founders matters Kevin's and Jesse's theories of how FTX and Alameda lost billions of dollars how Alameda and FTX's books were commingled  whether people will start using self-custodial wallets whether the fall of FTX vindicates BTC maximalism whether regulation has been beneficial or harmful for American customers the role of venture capital firms and their "mixed incentives" Take Unchained's 2022 survey!   Unchained is doing its annual survey. Tell us how you think we’re doing and how we could improve, whether it be on the podcast, in the newsletter, or in our premium offering. Looking forward to hearing your thoughts!  Thank you to our sponsors! Crypto.com Chainalysis Minima Kevin: Twitter Previous Unchained episodes: How Traders Are Thinking About the Merge — and a Potential ETHPoW Chain Why Kevin Zhou Believes Ethereum Will Have 3 Forks After the Merge. The Chopping Block: Kevin Zhou on Why He Knew Terra Would Crash Jesse: Twitter Previous Unchained episodes: Jesse Powell, CEO of Kraken, on Drawing a Line With Regulators Episode Links Previous coverage on Unchained of FTX: Did the Bahamian Government Direct SBF and Gary Wang to Hack FTX? – Ep. 422 The Chopping Block: Why Lenders Didn’t Liquidate Alameda When It Was Underwater  Erik Voorhees and Cobie on Why FTX Loaned Out Customers’ Assets The Chopping Block: FTX: The Biggest Collapse in the History of Crypto? Sam Bankman-Fried on How to Prevent the Next Terra and 3AC FTX Collapse: First declaration document Unchained: FTX Bankruptcy Overseer Says Company’s Collapse Is Worst He’s Ever Seen Unchained: Bahamas Regulator Directed SBF to Transfer FTX Assets to Government Wallet SBF tweet: FTX files for Chapter 11 bankruptcy protection Vox interview with SBF: Sam Bankman-Fried tries to explain himself NYT: How Sam Bankman-Fried’s Crypto Empire Collapsed Bloomberg: Crypto Hedge Fund Galois Confirms $40 Million Exposure to FTX Learn more about your ad choices. Visit megaphone.fm/adchoices

Just a quick note that we're releasing what would typically be a Tuesday show on a Monday due to the Thanksgiving holiday coming up. But don't fret, we have a great conversation for you to tune into on Tuesday as well, a special edition of the chopping block to go over the first day declaration in the FTX bankruptcy, the U.S. versus Bahamas jurisdictional battle, Genesis and crypto lending, and all the other craziness that happened last week. As for this episode, I reached out to Jesse Powell, co-founder of Cracken, who ran a centralized exchange for a long time, and so of Galois Capital, who could offer his perspective as a trader on FTX. The two of them mentioned some past observations about FTX that, in hindsight, seems suspicious, plus discuss how Alameda, which had been seen as top traders, could have lost so much money. As you might

expect, Sam coins, such as FTT, played a big role. I also asked Jesse for his views on Not Your Keys, not your coins, since he is an exchange owner, and we dive into how FTCS's collapse reflects on the media, VCs, and regulators. This was an incredible discussion, and I hope you enjoy it as much as I did. Hey, everyone, just a quick note before we begin. Unchained is doing its annual survey. Head to SurveyMonkey.com slash R slash Unchained 2022 to tell us how you think we're doing and how we could improve, whether it be on the podcast, in the newsletter, or in our premium offering. Looking forward to hearing your thoughts. Again, the link is surveymonkey.com slash R slash Unchained 2022. And you can also check the show notes for the link.

Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I'm your host, Laura Shin, author of The Cryptopians. I started covering crypto seven years ago, and as a senior editor at Forbes, was the first mainstream media reporter to cover cryptocurrency full-time. This is November 22nd, 2022 episode of Unchained. Need to keep up with the biggest news in crypto? Get Unchained in your email Monday through Saturday. Go to Unchained Crypto.substack.com to subscribe. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigation support for all crypto assets for organizations like Gemini, Crypto.com,

and BlockFi. Maximize your potential with the leading blockchain data platform by visiting Chainalysis.com slash Unchained. With the Crypto.com app, you can buy. Buy, earn, and spend crypto in one place. Download and get $25 with the code Laura. Link in the description. Minima is a new Layer 1 blockchain designed to run in full on a smartphone.

Join over 300,000 Minima node runners on the incentive program today to start earning every month until Mainnet launch. Get your node set up at minima.global. Today, we have a conversation between an exchange owner and an institutional trader who are going to be discussing the collapse of FTX. Here to discuss are Jesse Powell, co-founder of Cracken, which Disclosure is a farmer sponsor of the show, and Kevin Soe, co-founder of Galbaugh Capital.

Welcome, Kevin and Jesse. Hey, thanks for having us. Yeah, thanks for having us. The crypto industry has been absolutely rocked by the seemingly never-ending saga of FTX, which every day seems to reveal even deeper levels of incompetence, malfecent, perhaps fraud. Jesse, since you were an exchange owner, I wanted to get your

opinion on what exactly happened here. What do you think the root of the issue was? Yeah, I think these guys, first of all, didn't really know what they were doing when it came to running what should be like a Fort Knox type of operation. You know, I think they were traders first and foremost. I think they were very inexperienced operators. And they took on a lot. I think a huge amount of work for the number of people that they had on the team. You know, like our whole security team is like, you know, 100 plus people and they were doing, you know, what the whole company is doing with like 50 people at one point. So, you know, they wouldn't have been able to do all the things that you would normally do and build.

And, you know, from the outside, we figured that this was going to catch up with them at some point, you know, that they were accumulating a lot of technical debt. we didn't anticipate that it was as bad as it is. It seems like they hadn't done any kind of accounting or reconciliation in like three years and that they basically had no controls in place and very few people knew what was actually going on there. Yeah, and Kevin, what about you? I know you're approaching more from the trader perspective, but I was interested to hear what you thought the core problem was. Yeah, no, I definitely agree with Jesse. And actually, you know, Before starting the firm, I used to work two years each at two different exchanges, one of them being

cracking. So I'm pretty familiar with some of the operations that go on within exchanges. And like Jesse said, there's a lot that goes into it. And with a small team, it's very difficult to run because there's so many different divisions. It's a full-fledged business, right? If you look at a trading operation, you don't have to do any marketing. There's very little BD, there's not too much legal overhead. There's a lot of these divisions that aren't fully fledged, but in exchange of the full-fledged business, so you have all these different divisions. And then I think on top of that, some of these guys from FTX, from Alameda, they were coming in from the Tradfai world, and they weren't super crypto-native at the time. And there were a lot of lessons,

I think, that were learned in history, everything from like Gawks to Bitfinex, I mean, to some extent like Bitcoinica. I mean, there were so many lessons along the way. Cripsy with Big Vern, all of these pieces of history that, you know, I think folks that had lived through it really internalized and folks that, you know, just just came by later, you know, they knew about it. They understood it intellectually, but they hadn't gone through sort of the experience, the harrowing experience of what it was like, you know, to see like Gawks collapse or all of these like major hacks or exploits happen, you know, in real time. So I think, you know, the attitude that a lot of these guys at FTX and Alameda took probably was a little bit too

cavalier in how they were blitzscaling their exchange, something that they thought of as kind of like a startup financial product rather than some kind of like what Jesse said, like a Fort Knox, where at the end of the day, it doesn't matter how good your systems are, how good your trading platform is if you can't manage to hold onto your user's funds, right? And that's only from the sort of the angle that these guys had some incompetencies. Now, on top of that, maybe there was actually some actual bad behavior and some fraud and malfeasance. Now, you know, that can also happen on top of them not knowing what they're doing, right? So it just like makes a bad problem even worse.

I'll even share a really kind of random story about when we met, we met Alameda first before they started FTX sometime in 2018, late 2018 or early 2019. And I actually distinctly remember talking to them about accounting systems. And this is, you know, before FTX existed. So this is just for Alameda's accounting systems. And, you know, what they were saying is that, yeah, you know, at the end of the day, you know, we do our best to try and reconcile. We spend, you know, some time, half an hour or a couple hours. I forget exactly how much time they said.

But they spent some amount of time at the end of every day to try and reconcile the records. But then they're like, you know, at the end of the day, sometimes, you know, you just can't get to the right number. And, you know, if it's plus or minus 10 grand, 100 grand, grand, which back in the day was a lot of money, right? they said, well, you know, just move on to the next day, right? So I think, you know, looking back, there were so many different signs like that that I think in retrospect were sort of clear warning signs and signals for the risk that were to come. But at the time, you know, we didn't really think too much of it, right? So it's just, you know, it's one of those things where hindsight is, you know, definitely 2020. Yeah. And I don't remember how big they grew to, but I feel like the latest

numbers I saw were somewhere in the 300 range, but clearly for the size of the operation, that still was an extremely lean machine, which Sam would sort of boast about. But obviously, as Jesse mentioned, that is a kind of red flag. And to see your comments about the security out, that was literally my very first thought. Like, how does this even happen when you have, you know, what should have been like a security team? I like couldn't even figure that out. Clearly, I don't think they really had one is the answer. So my next question actually was going to be if you two had any inklings of something being amiss beforehand. And Kevin actually already answered that. So, Jesse, did you have any experience with them prior that kind of made you think, oh, there are some

red flags here? We had no direct experience with them. I've never met Sam. I interacted with Brett on one occasion about some regulatory stuff, and I disagreed with them on that. You know, but they clearly had their own strategy they were pursuing. And can you talk about what that difference was? Yeah, there was some bill. I don't remember exactly what it was, but there's some very problematic language in it. And Cracken actually went out to our users and notified all of our users about it to try to contact their government representatives about it. FDX felt like the better approach was to use their contacts in D.C. and try to like negotiate this, you know, in backroom deals and things like that. You know, we felt like through our experience over the years that that was basically

going to be futile. And, you know, we're kind of beyond the point of being able to do that, to be able to reason with a few people, you know, behind the scenes. And so, you know, I think that was kind of like that interaction was sort of representative of their whole approach, which was like basically they thought they knew better than everyone else, you know, even, even though they were relatively new to the scene, they thought that, well, you know, things aren't better because all you guys before us, you know, maybe you weren't doing things right. And so they had like new ideas, which they thought, you know, would be better. And I mean, you know, they didn't appreciate that we actually tried all these ideas years ago. And, you know, we've developed over the course of a

decade strategy that we have now. You know, but I think that was just par for the course for them to come in think that they could do things in a way that no one else had tried before, and that would make them successful, not learning from the lessons of the past. And obviously, that played out with the implosion of their business as well. Oh, interesting. Yeah, I have a feeling maybe the bill that you're talking about is the infrastructure bill from a year ago that might have been that, because I remember a crack in at that time calling upon its users. So that may not have been it, But that was one time I remember your company did that. Yeah, that's probably it, yeah.

Okay. So, Kevin, I just have to ask you, and I'm so sorry about this, but obviously, you know, the news this week was that Galois Capital had $40 million worth of assets stuck on the exchange. And I was curious, you know, just to hear why it is that Galois didn't withdraw earlier. Like, you know, what was your experience using FTCS? Like, why did you, you know, kind of have some confidence? to leave the assets on the exchange? Yeah, so I'm happy to talk about that a little bit.

There's some things that are confidential with regards to the fund. But generally the idea is that slowly over time, as a U.S.-based business, we kept getting kicked off of international exchanges. So sort of the scope of our trading started to get more and more concentrated on FTCS. And then at that point, there was also, I think, some sense that, you know, we really didn't see this coming. I mean, in retrospect, there were so many red flags. But at the time, we thought the exchange was secure. We thought, you know, it was sort of the golden child of crypto, you know, going to meet with all the regulators and whatnot. It seemed to be smart,

seemed to be, you know, knowing what they were doing. You know, turned out not to be the case. And so I think we were kind of lulled into a false sense of security there. And then on top of that had a lot of positions open at the time that we had to unwind before we could withdraw. So, you know, just given the size of those positions. It was very cumbersome, unless we were willing to puke it and then just take on all that slippage. It was very cumbersome just to unwind all those positions to withdraw. So a mix of many different factors, but I would say that's mostly yet. And I also wanted to maybe just take a step back and sort of respond to what Jesse was saying before, which is, you know, I completely agree.

I think there's a lot of lessons of the past that new people coming into the space, whether it be new exchange operators, or new token project founders. But there's always this kind of sense that, you know, we can do things better. And I think that that is a good attitude to have. But at the same time, I think there's a lot of history lessons that a lot of the newcomers have not quite learned yet. And there is something to be said about having experience in the space, having lived through, you know, some of these events. You know, a lot of times, I think the road to hell is kind of paved in good intentions, right, where it's sort of like, you know, we think we know better and we think not only do we know better, but we know better for everybody, right, not just for ourselves, right?

In taking this kind of approach, right, very easy to become misguided and, you know, maybe here or there make certain shortcuts that they shouldn't make, right, all for the sake of the greater good. You know, I'm reminded by early on before FTX, you know, I was doing some, you know, just due diligence on these guys because we were trading counterparties with Alameda, and I stumbled upon Sam's blog, which has since become very popular, as all of CT has now been reading this over. And, you know, I thought it was curious

that he was a utilitarian, right? And in particular, and maybe just to explain very quickly, utilitarian is someone with the philosophy that, you know, people should act in a way that does the greatest good for the greatest number of people. You know, never mind how to measure this goodness, right? and which people count, which people don't count. This whole thing gets very messy, but it's generally this kind of sets, right,

where you're kind of like reducing people down to numbers and then trying to add them up to get the greatest sum. It's like you've turned it into a math problem and optimization problem, which I think is a little bit questionable to begin with. But in any case, reading through this blog and then now having reread it, I realized something, which is that not only, you know, is his philosophy that of a utilitarian, but that of an act utilitarian rather than a ruled utilitarian. right so so a rule utilitarian is someone who would say generally there are good rules to follow which yield the greatest good for the greatest number of people for example do not steal that's generally a good rule to follow we should we should invent we should create these rules and then we should follow these rules because they have a lot of utility in them right and act utilitarian is not

that way it's not so much that you you prescribe certain rules to follow it's that you judge every single circumstance and event and you decide whether or not you think the outcome will be good, right? So under that kind of paradigm, sometimes it may be okay to steal if stealing yields the greater good, right? Now obviously, this can very easily get into, you know, murky, moral, and ethical territory because the allure of having an excuse to do something for the greater good, if we are sort of not cognizant of our own biases and our own self-interest can allow us to do great evil, right? And that's sort of, you know, this sort of idea about, you know, the rotel is paved in good intentions, right? So now that kind of like stood out to me, right?

Having now sort of like revisited his blog and realized, oh, that's right, he was an apt utilitarian, not a rural utilitarian, right? So there's all these like small pieces that I think, and I'm sorry, I went on a random tangent, but I feel like there's all these small pieces that kind of add up to a picture of a person who basically told us what he was going to do ahead of time. It was right under our noses. It was right in front of us. But there was no single thing which was alarming. But when you add it all together, it paints the picture of a person who is rather ruthless. Yeah.

I don't know if you guys listened to this week's episode of The Chopping Block, but this is the exact argument that Tarun and I had with Haseeb, where he and I kind of agreed with you, Kevin. and then, sorry, Tarun and I, and then Hussie has called himself an effective altruist, although when he talked about it just seemed very different from the way Sam talked about it, so not sure what to make of that. I don't mean this as an indictment of effective altruism. I don't see it that way at all. I just think that his personal philosophy was a little bit bizarre, and I think not all effective altruists are probably act utilitarians or even utilitarians themselves.

Yeah, and yeah. I mean, people, if they listen to the shopping walk, they'll hear that I asked him this, but I'll just mention this because the last time I interviewed Sam, I did ask him a question, like, when you make these political donations, is your guiding, like, motivation to do that, your EA philosophy, or is it to help the crypto industry? And he basically said it was the EA thing. So, you know, but that was like, like another way of thinking about the question is could it, what I really was asking him is like, are you an effective altruist using crypto or are you a crypto person? Like, that's kind of what I was trying to get at. It's what you talked about. It's like, when you think that you have a better idea of what to do with, like,

other people's money or whatever than they do, then like it just leads to, you know, you to do things like, oh, I'm going to justify using people's customer funds. Anyway, but I'm curious for Jesse's response to all this. Well, I agree with everything Kevin said. And I was a philosophy major in college. me too well more like literature and philosophy but love it cool you know my concentration was was ethics and law and um you know this kind of stuff was the stuff I would write papers about and um you know like Kevin said this utilitarianism is a slippery slope you know like you said you can just you decide that you know that five dollars is better spent on on a political donation not knowing that this person

was going to use that five dollars you know that was the last five dollars they needed for their saving surgery or something like that. You have to make a lot of assumptions about, you know, the relative value of things. Either Sam is just making all this stuff up or, you know, it seems like, I mean, from that, from that Vox article, the screenshots that were posted, I mean, it sounds like he was pretty much like an ends justify the means kind of guy like, like Kevin said, I'm just going to do what I think is going to get me the best outcome in this scenario without having any specific kind of like, you know, moral compass basically to, or even his own, like, internal persona that he was trying to maintain. You know, he's sort of saying, like, I'm just going to be a chameleon and do

whatever's going to get me further ahead, like in any, in any situation. And I'm going to, if donating to the Democrats is what does it, that's fine. If stealing client funds is what does it, that's fine. Ultimately, you know, I don't even know if we buy that he was actually going to use all this money that he misappropriated in the end for some some greater good like what would that be you know i mean i think delivering cryptocurrency to the world is a pretty great good you know i mean it might be the best the biggest thing that any of us could could work on and do in our lifetimes but you know i don't know what the greater thing that he was planning on like investing and would have been um i don't think he said that oh actually i know some of them oh really one is pandemic preparedness another one

was some kind of AI thing, like protecting people from future AIs that would hurt humans, something like that called Anthropica. Tarun mentioned this in the show. Have you heard of that? Do you know it? Okay, those are the two. On my show, he talked a lot about pandemic preparedness. But as Tarun put it, because the Ontario's teacher pension invested in FTX,

Tarun was like, okay, so he stole from the grannies to protect people from an AI that might hurt humans. 10,000 years from now. That was what he said. But anyway. Pretty much. The pandemic preparedness thing also sounds like something that would just play well in the current climate, you know, with the media and everything. So I wonder if that's even true. It's current thingism. It's current thingism. Yeah, exactly. And maybe just to say one last thing, too, you know, I'm starting to think more and more that the personal philosophies of the founders of these exchanges matters a lot, you know, especially given what happened. Because from what I remember with conversation with Jesse, Jesse is a deontologist,

which is the complete opposite of a consequentialist, meaning that it's the means that matter much more than the ends, right? So, you know, I'm more inclined. And I think he's, you know, being truthful when I, you know, when I talked with him about it. I think he was being truthful. So, you know, then I have some very strong confidence that Jesse is not only going to look for what's the best outcome for people? What's the best outcome for him? But he's going to try and do the right things in the right ways, right, to reach those goals. Right. And I think, you know, I think that really matters, you know, at the end of the day. I think character really matters in this space. Huh. Okay. Well, we can discuss this like at infinitum, but I actually want to just stick into some more

details. You guys, I'm sure you've probably at least heard, if not read the first day declaration that the new CEO, John Ray, published, but he mentioned certain things like corporate funds were used to purchase homes and other personal items for employees and advisors. It also said that Alameda loaned $2.3 billion to Paper Bird, which is an entity wholly owned by Sam. It also lent $1 billion to Sam himself, $543 million to the Director of Engineering, Nishad Singh, and $55 million to Ryan Salomey, who is the co-CEO. So all that together accounts for about $4 billion. The New York Times reported that Alameda CEO, Caroline Ellison,

said that Alameda had taken out loans to make venture investments. And I remember that earlier in the year they announced that their venture investment plans were going to total $2 billion. The information also reported that Alameda invested at least $20 million in paradigm, and that Alameda Research and FTCS ventures committed hundreds of millions of dollars to Sequoia, Altameter Capital, Multi-Coin Capital, these are venture funds. And that some of the funds also backed K5 Global, which is an advisory and investment fund run by Michael Kivis, who's a close advisor to SBF.

So it's just very curious. So obviously, that's a huge amount of money. I don't know what that totals, maybe somewhere in the ballpark of four point. 5 billion or something. People think maybe about $10 billion is missing. I was kind of curious, what are your theories on where the money went and why so much went missing? Is it like bad trading? Because people have said to me, oh, they were on the top of the leaderboards. We thought they were great traders. Like, what's your theory on what happened with all this money that's missing? I'd love to hear Kevin's take on this. Yeah, sure. I'm happy to start. So, you know, I think

I think, you know, there's a there's a Twitter account. I can't believe I'm saying. There's a Twitter account called Zerox FBI Femboy. And this person writes a blog called Milky Eggs. And I think, you know, theorizes on a lot of where the money went. I don't entirely agree with all the assessments, but I think it's pretty comprehensive. And I mostly agree. So I think it's all of the above. So I think, you know, first off, you know, when they first started and they were on top of the Bitmex leaderboards, I think they were like the Rank 2, rank 3, and rank 7 accounts on Bitmex. You know, I think back then the game itself was a lot easier. And you could have like a rag tag prop shop, you know, just coming out of Tadfai. There were not many institutional players. There were not many sophisticated players back then. And it was kind of easy to do market making across a lot of different exchanges. But for the most part, from these shops that they came from predominantly Jane Street,

Jane Street's not particularly known for speed. Now, they're not slow, but they're not known for being like very high frequency, right, in terms of like HFT, for example. So, you know, I think as things progress and you started having a lot of these bigger players like Jump Tower, you know, HART, these really proper kind of HFT market makers come in. Then they started squeezing out a lot of these like crypto-native firms on the market-making side and probably profits started drying up, right? And, you know, at that point, they probably started thinking, well, you know, it's very,

it's a lot harder now to make sort of like, you know, risk-neutral kind of market-neutral returns on just market making, maybe they'll get more into like riskier stuff, right? And, you know, more into like long short, punting or, you know, speculating on VC investments, that sort of thing. I remember that, and this was, I think, even before we met the Alameda team in 2018 to 2019, but there was some, a little period before that where there was a fracture within Alameda itself. Because Sam had a co-founder, Tara McCulley, who, uh, eventually went on to start Lantern Ventures. And basically there was an internal disagreement

where two-thirds of the team kind of wanted to take more risk and one-third of the team wanted to take less risk. So the one-third of the team branched off and went to Lantern. And then the two-thirds stayed with Sam. You know, each part of the team went with each of the different co-founders. So basically, you know, where things may have started sensibly, with kind of this kind of check and balance system between people want to take more risk and people take less risk. There was some kind of self-selection process after that split. We had all of

the risk takers on one side and all like the lower risk, you know, the lower risk tolerance people on the other side. So now all of a sudden, now things start to get more extreme, right? So that's one thing. I think probably the fact that they were using a lot of like, you know, possibly amphetamines or other pharmaceutical drugs probably didn't help. I think, you know, once you start, you know, messing with like the dopamine system, particularly the Mesolimbic dopamine system, which forecasts reward and pleasure, it can really start affecting your judgment on, you know, possibly taking on more risk or just general cognitive impairment and function. I thought it was very interesting that people brought up the fact that Sam is hard

stuck at Bronze 2 in League of Legends. I think this is, you know, if you play three years and you're stuck at that ranking in League of Legends, there's just something wrong. You're just not learning anything. You know, you just, it's just like it's very, it's, it just seems like he's struggling to pick up and learn new things, right? Like, I think there was a great analogy on Twitter, which is like, if you've been trying to figure out how to learn to ride a bike for three years and you still can't ride a bike, you probably are a little bit impaired cognitive, right? And that's kind of what I think that represents, even though it's kind of a bizarre example. I think they did do a lot of speculation on venture investments, and in particular in the Solana

ecosystem, with these high-float or low-float, high fully diluted value coins. And now reflecting back, you know, at the time, I thought it was like, it's a little bit greedy to do it that way, you know, because you want some high marks on the books, you know, this, this and that, but I didn't think it was like that nefarious. It was just like slightly shady, right, to have these projects always do that on Solana. But now I'm thinking maybe it was actually way more nefarious than that, because maybe they already had the intention of using it as collateral, so they needed it to be as high mark as possible, right?

But when you have a situation like that, the higher the artificial mark is, the worst the liquidation is when it finally comes time to do liquidation. And on top of that, them using FTT, as collateral to borrow funds from FTX or for FTX to borrow funds from Alamina, whichever way that relationship went, using the exchange token itself creates also a bunch of reflexivity because now as the solvency of the exchange gets called into question, the value of the token plummets further putting the exchange in a weaker balance sheet state, further pushing it into insolvency.

So these are the kind of like that spiral effects that we saw with Luna. this one is not as extreme. It's not as reflexive, right? Maybe the multiplier, if you want it to quantify it, the numerical value of the debt spiral effect is lower, but it's still, you know, let's say greater than what? Greater than some critical threshold in which these kinds of spirals can happen. Because honestly, you know, a $500 million sell of some kind of like fairly high market

cap token in top 50, top 100 by CZ should not crater the price to near zero and bankrupt in exchange. That should not happen, right, if things were constructed properly. And then there are also, you know, suspicions that, you know, Alameda had unique accounts which could not be liquidated on FTX. Well, that's what the first day declaration said. So this is like a fact, according to the new CEO, John Ray. Yeah. And I think this is true. So they've, they, they, they, there are screenshots of this document. It's called the CLP program. And we've also heard about it ourselves. I think it's in it's in Japanese or I forget what

language, but basically from what I understand of the terms, the CLP program is a program that market makers can participate in. And if they put extra collateral on the platform where they have certain levels of margin

normally, then during extreme situations, they'll actually get a call on the phone rather than auto-liquidated. And then on top of that, there are certain risk checks that are bypassed, by the risk checking system. So, you know,

basically from our study of their, of their systems, there's two cues that your orders go into in the API, whether you know, you click through the screen that generates, you know, that order placement into the API, or you actually connect up to their API and send them packets.

There's two cues. The first is the risk queue. And your order goes through that. Once that's finished, then it goes into the matching queue, right? And the risk queue, there are some nuances there. And from what we've been

told normal customers go through the risk queue and things are checked in serial. So there's a number of different things that have to be checked one after another, right? And I think it has to do with the fact that there's like multiple assets and, you know, they do cross asset collateralization. There's a whole bunch of different collaterals that you can use. You can use anything to collateralize anything almost, right? But then with the CLP program, they basically run it in parallel. And there are some like race conditions, but they're willing to overlook that because like your credit is good or you've signed a document with them, you know, that sort of thing. So I do think that that program exists. I think that not many people even knew that it existed and probably Alameda

was there from the very beginning with this kind of favorable treatment. Now, I think whether or not they actually looked at people stops and pass that information to Alameda to go run people stops or push them over there. I mean, that I don't know. I wouldn't really speculate on that. Maybe they did. Maybe they didn't. It just really depends on, you know, just how much, you know, how much malfeasance there was. But at least I would say there probably was at least some kind of advantage for Alameda with this CLP program. We're going to take a really quick ad break and hear from the sponsors who make the show possible. Join over 10 million people using crypto.com. The easiest place to buy, earn, and spend over 150 cryptocurrencies. Spend your crypto anywhere using the crypto.com

Visa card. Get up to 8% cash back instantly, plus 100% rebates for your Netflix, Spotify, and Amazon Prime subscriptions. Download the crypto.com app now and get $25 with the code Laura. Link in the description. Eager to make more informed decisions around crypto using data you can trust, chainelysis is here to help. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigation support for all crypto assets for organizations like Gemini, crypto.com, and BlockFi. Gain unparalleled visibility and maximize your potential with the leading blockchain data platform by visiting chainelysis.com slash unchained.

What's the most important thing about crypto? It's not transactions per second. It's not convenience. And it's not even smart contracts. It's decentralization to achieve censorship resistance. so we can all be free. Minima is a new layer one blockchain designed to run in full on a smartphone so that anyone can participate in building Minima's decentralized network as an equal. Join over 300,000 Minima node runners on the incentive program today to start earning every day until mainnet launch. Get

started at minima.global. Back to my conversation with Kevin and Jesse. So Jesse, what do you think happened to all this money? How could there be? be this much missing. It's kind of crazy. I wonder how much of it was just lost through market making. If they wanted to, they felt like they needed to prop up their own books and make a liquid market. And they were willing to bleed off some amount of money just to do that over time. And they knew that if their markets weren't liquid, that they would just lose the exchange game, period. So it could be some was due to that. You know, I think to Kevin's point, like I think they probably started to take on some some directional bets. You know, and if they were market making a bunch of these shit coins, they would have been

holding those coins. But it seems like, you know, maybe Luna was like the start of this for them, like the real liquidity crunch. And, you know, there's just like this cascade of other dominoes falling that ultimately led to this. And, you know, I think that if you had had other lenders, you know, like if we on Cracken, for example, you know, when we look at sort of like the equity value of somebody's account for like margin trade. We look at tokens that they have, and each token gets its own, like, discount rate, basically. You know, like USDC is basically like zero discount. You know, Bitcoin might be like 5% discount or something like that.

And then you go all the way down the list, you know, and some tokens are like 95% discount, you know, to the current price in a liquidation scenario toward the account equity because we just don't feel like we're going to be able to liquidate that asset. like it might be very volatile or it might be illiquid markets. And, you know, if FTCS went outside to try to get a loan against their FTT, someone else should have looked at that and said, hey, like this is, you know, you want like a $5 million, $5 billion loan against this asset that, you know, there's like $50 million of liquidity out there. And if we ever had to liquidate this, you know, it would be basically going to zero. So, you know, maybe, maybe you would put a cap on how much you let.

out, you would lend out like up to $50 million or something like that against all the FTT or against $500 million worth of FTT if you market at the current price. But because they were lending to themselves, they obviously ignored this risk and just marked it at like the most favorable rate possible, which allowed Alameda basically to borrow client funds against like a collateral that was like almost worthless. You know, they just greatly exceeded what the risk level should be to the lender. FDX never should have lent Alameda client funds at like a one-to-one ratio, basically. They should have marked it down like 95% really to even be reasonable. I think they probably just basically took out a bunch of leverage bets on coins that ultimately

just crashed. And I can't believe they were taking out loans to make like seed stage venture investments. I mean, that's just like madness. Clearly I'm working at the wrong exchange because because, you know, no one, Cracken hasn't bought me a $30 million penthouse. A billion dollar loans. Well, since Cracken is still around, I think maybe you are working at the right exchange. We'll see. It hasn't played out yet. Yeah, maybe just to add to what Jesse said, I actually read their margin docs.

And basically, there was a couple of things that really stood out to me at FTX, which is, there is a collateral weight factor, which was basically putting FTT at a 5% discount. So something that should have been like 95% discounted was 5% discounted. And on top of that, another very weird feature is that in their loan book, in their lending pool, right, you can borrow all sorts of different assets, right, but you couldn't borrow FTT. And I think maybe that the reason for that is that they designed that on purpose, because they didn't want people having a lot of FTT too short it, right? Like even when they started and they opened their books for FTT,

they started with the spot market and it took a lot of time and a lot of lobbying by their customers to introduce a PURP book on FTT. If you guys remember, when it first launched, it was only a spot book. Well, you know, these days when they launch new tokens, they list the spot and the futures and the perps at the same time. So why all this very strange treatment for FTT, which is different than everything else. And my thought is that, you know, there's, you know, there's a little bit of smoke there.

I wouldn't, you know, maybe it's fire, right? But certainly there's a lot of smoke there suggesting that they knew exactly what they were doing. And they were like in a wonky financial engineering way trying to create something that is hard to go down because they themselves held so much of it and were using it as collateral for so much debt. Right. So they wanted as few shorters in the market as possible and therefore wouldn't even lend it out. So, you know, I think those are, you know, all these like small. interesting tidbits, I'm now coming out. No single thing by itself is that suspicious. They're all like slightly suspicious, right? And then you add them all together and the entire picture looks kind of

horrifying. Yeah, one last bit that I just had my jaw on the floor was in that Vox piece. I don't know if you remember, you know, she kind of asks him, you know, about like what happened with the money. And then he says something like, oh, yeah, you know, we had these accounting issues. Like for instance, oh, FTCS doesn't have a bank account. We'll just have customers send their money to Alameda. Three years later, whoops, all the money got sent to Alameda and we never, you know, put it in this stub account for FTCS or something. And I was like, oh, my God.

And then other people started tweeting like, oh, yeah, when I deposit my money on the bank slip, it said Alameda. And I was just like, whoa, like, customers were literally sending their money straight to Alameda. And so I just feel like it appears, at least from that Twitter DM, that there literally was no separation and that Alameda just kind of considered customer funds their own funds to trade. That's how I read that. Am I wrong? Yeah, I think that's exactly what happened. Now that I'm thinking back, I think I remember that too, right?

So, like, you know that somebody on Twitter posted, hey, look, here's the wire instructions. for FTX OTC and it clearly says on there the name of the firm is Alameda. And I think that we actually have those same wire instructions. I think when we traded with FTCOTC, we also had to wire money to Alameda OTC. So like, I think that this is like, these are some of the things where it's just like, you know, you really just can't be doing that, you know, because like it's, it's not clear that in the back end everything is being tracked correctly, like this whole stub account issue. you know like the like you know i'm i'm i'm sort of reminded of like uh there have been other times

with other exchanges where it's like you know just uh we we we've managed to catch money disappearing out of the account and i'll give you one example which is pretty bizarre right which is that one of our counterparties uh was settling a trade with us and we told them to settle it to i don't want mention the name of the exchange to this this exchanges account but Instead of sending Bitcoin, instead of sending the tether to the tether address, they sent it to the Bitcoin address. So it's still recoverable because it was still Bitcoin-based tether at the time. But we need the exchange to go and figure out how to retrieve the funds and then credit us.

So the exchange charges some amount of money for doing that. And we noticed that they actually charged us twice because they just kind of like forgot. They didn't remember if they charge us or not, but they charge us twice. So I'm sure like these kinds of things like happen all the time. I remember doing a trade with Alameda, just like somebody has said on crypto Twitter, where they settled their leg of the trade, but forgot to remove money from our account. And we had to go ping them and say, oh, by the way, you know, I think you guys forgot to take money out of our account. But, you know, trade settle on your side. So go feel free to do that. And then, oh, sorry, we forgot, you know. So it was just a lot of that kind of like sloppiness everywhere. And I'm even reminded of another. another anecdote where I was talking with basically one of the employees at FTX. And I was asking him, you know, because the person was looking around for vehicles to invest in, right? And I'm like, but wait, you guys have like, don't you guys have like a really profitable prop shop? Like, why don't you just invest in Alameda?

I mean, you work there. You work at FTX. I mean, you know, why don't you just invest there? And he's like, well, Sam won't let us. And I'm like, well, why is that the case? Well, it's just really messy because like all the bookkeeping and stuff, you know, it's just very hard to say exactly what the right marks are and what exactly the PNL is at any time. So, you know, right now it's just like it's just Sam's money. As I'm remembering of this,

I feel like the writing was on the wall, right? But it's just like each of these instances are just far apart from each other and each one like not suspicious enough by and by themselves, you know, but there's like, I think there's tons of instances like that, you know. Jesse, do you want to add anything on that? You know, the using of like other bank accounts is something that some exchanges have done, you know, Quadriga did it extensively. And I think in part, you know, it's just, it's a problem for the industry that it's very hard, or at least historically, was very hard to get bank accounts. It's gotten easier over time. And I think, you know, these days, if you're a legit crypto company, you can get a bank account now.

They're friendly, friendly bank serving crypto. But for a time, yeah, it certainly was very difficult. And some exchanges. But would that have been the case when FTCS started in 2019? In 2019, no, they should have, yeah, I think they would have been able to get a bank account in 2019 if they had been willing to do a little bit of diligence, maybe get a license or something like that at the time. It's definitely shady. You know, sometimes you question sending money to the CEO's wife's bank account or something, which is stuff that, like, happened at Quadriga. But it's another thing to, like, send money directly into a hedge fund. rather than like your exchange account, you have to wonder like, okay, what are these guys actually doing with my money?

So that's definitely sketchy. Yeah, wasn't there like an exchange in the old days? Like there was something like the rock tradering or something. You're supposed to mail an envelope of cash or something like that. It was something wild. It was something crazy, basically. There was another one where they would tell you to go into a bank and you would have to deposit some amount that ended in some number of cents. And then that was how they would match, like, your order to what amount of Bitcoin you were buying.

Yeah. Yeah, this was like, I think even before the Duala days, I'm just blanking on the name of that exchange. Trade Hill? Was it trade hill? Yeah, maybe trade hill. That sounds like a trade. Was it trade? Yeah.

Okay. So I have, like, one kind of perhaps projection. I'm curious to hear what you guys think of this, if you think this will actually happen. But I thought that one of the kind of consequences of this. whole thing will be that will maybe have more people doing the self-custody thing and participating in defy. But I wonder what you thought of that because, you know, the history of crypto has been littered with numerous incidents like this. Like obviously, this appears to have been fraud. And some of the other ones were more like hacks, which it's a different animal, but, you know, kind of the same thing.

You know, customer puts their coins on an exchange and then lose the coins. You know, I was just kind of curious if you thought that would happen or also to hear because Jesse, as far as I can tell, I think you are an advocate of this mantra and not your keys, not your coins. And yet, you run an exchange. So you probably have some sort of more nuanced view on like when that applies or like, you know, how people should think about this philosophy. And yeah, so it's just curious for your thoughts on all that. Yeah, I hope that more people take their coins off and self-custody. I know not everyone's comfortable with it, you know, and if you've only got $20 worth of Bitcoin and you don't really know what you're doing, maybe that's a reason to leave it on because it's not that much

to risk, but also, you know, it's not that much to risk on the other side to self-custody it. I do have more people learn about that and try to do that. You know, from the exchange perspective, for us, we don't get paid for keeping your coins on the exchange. You know, we don't charge any kind of like account balance fee. There's no monthly fee. There's no dormancy fee or anything like that. And so if you're not trading with the money that's on your crack in account, that's just a liability for us. You know, we're vaulting your assets for free, basically. So we're taking all this liability in the event that we get hacked or, you know, something happens to your account. So it's just risk for us. And why would we want to have this risk if, you know, we're

not getting anything from it, you know? So if you're not trading with your coins, you're not staking them, there are non-custodial ways to stake as well, my preference is you just take it off. because it's just risk that we don't need and we're not benefiting from. But do you think that that will actually happen, that more people will try to do the self-custody thing? Or do you feel that the vast majority of people find that sort of onerous for them? Yeah, I think it is onerous for many people, especially if you're actively trading.

Obviously, you don't want to just be moving your money on and off all the time. But we've already seen a lot of withdrawals. I mean, if you look at the blockchain, most of the exchanges are getting net withdrawals. And I think that means people are withdrawing to their own custody, which is fantastic. But, you know, it's probably just a matter of time before this is forgotten. And, you know, a new wave of people come in, you know, just like everyone forgot about Gox. And, you know, in the next bull cycle, there will be a new wave of people coming in to crypto. They'll have no idea about FTX.

They'll certainly have no idea about Mount Gox. And unfortunately, it will probably be like another hard lesson to learn again at some point. I think we as an industry need to do a better job of just like calling out the bad actors. I think the ranking sites need to like come up with some other metrics by which to measure venues other than just like trading volume, you know, like maybe some kind of like degree of like seriousness of the business or longevity of the business. I think one of the big things that caused FTX blow up to be as bad as it was was that, you know, even people that were experienced gocks, you know, their worst case scenario was like a hack.

People just thought like the hack was the way that like, you know, an FTX would get taken down. But because of all of the media hype, the media fluff pieces, the political contributions, you know, all of the people that Sam seemed to be hanging out with, you know, they had the same. celebrity endorsements, all this stuff. I think that helped to build up this status, you know, which, you know, just like Bernie Madoff, basically, and just like Elizabeth Holmes with Aranos, you know, like surrounded themselves with, with the elite people who, you know, from the outside, you see that, who they're associated with. And you think, oh, wow, this person just must be totally legit. Otherwise, they wouldn't be associating with all these, you know, other elite people.

You know, that was obviously wrong. I mean, you sort of bought his way into that perception with client funds. And I think people just didn't think about that. Like could he be buying all these stadiums and all this stuff? Like, you know, people saw him spending so much money and I think thought, wow, he must just be making so much money. There's no way like he's extremely competent. Even if he does lose some money, he's making so much money that, you know, he would cover

the hole or whatever, you know, not thinking that actually what's going on is he's actually spending all the client's money to buy all the status. You know, I think that's maybe like a new thing for the industry. I don't think we've had like a legit bad actor like that before who just intentionally stole client funds. You know, I think everyone else has gone down has been hacks, I think. Kevin, correct me if I'm wrong. I don't know. Big Vern was a bit shady, I would say.

That's true. Wait, what's that big, what? I don't know what that is. Cripsy. That was Cripsy. He's still out there, right? He hasn't been at large. down, right? He's like hiding out in China somewhere.

Probably. All these guys, I mean, who knows if the quadriga guy is dead or alive? Who knows, really? I'm still waiting for Sam to mysteriously die in India. Yeah, exactly. Exactly. That's right. Yeah, no, I think actually Gerald Cotton probably is the

other big one that's known. But you're right, I can't think of. And the one guy shows up as a Xeroxifu, right? It's wild. The timeline's just wild. But yeah, no, I definitely agree. with, you know, Jesse's sentiments here. You know, it's just...

Well, one other thing that I wanted to ask about was, so we talked about how FTT was a big part of what happened here. And I mean, any of the other Sam coins, like Sierra or Oxy or MAPs or FIDA or whatever, these all are, which like I literally hadn't heard of some of these until a few days ago, I'm sure you have seen encrypted Twitter. A lot of Bitcoiners are taking a lap right now. They're all like, you know, we told you that all these coins that you guys are creating,

It's like a bad idea and stuff like that. And Jesse, I know you're a Bitcoiner. I don't know if you would consider yourself a Bitcoin maximalist. Obviously, you run an exchange so you're selling a bunch of different coins. But I was just curious, like, does this vindicate, you know, what Bitcoin maximalists in particular, where they're more like focused just on one coin, not just like being a Bitcoiner who also is interested in other coins, but like specifically maximalists? Do you think that this vindicates them or what's your thought on that? No, I don't think so.

You know, I mean, it doesn't vindicate anyone anymore than, you know, someone who thinks that Tesla is the best car company and then the Bernie Madoff situation happens in a bunch of other investors who were not invested in Tesla get wrecked. You know, I mean, this really doesn't have anything to do with Bitcoin or the other coins or defy. This is just a straight up fraud, Ponzi theft. You know, I mean, he could have been custodying anything. It could have been Pokemon cards or stocks or whatever. You know, he just had custody.

of client assets and he stole them. And that's it. You know, and it's unfortunate that the Bitcoin and crypto community are the victims here. But I think we need to like keep repeating this for politicians, you know, so they don't come back to try to attack defy and crypto and say that somehow this proves that, you know, we need more regulation around defy. You know, if anything, this proves we need more regulation or better regulation around centralized venues, you know, which, which, and I would love to hear from Kevin, like, you said earlier you were getting, you were getting shut out of other venues, and so you became concentrated in FTX. Why were you getting shut out of other venues? And what was it that FTX was doing that, for example,

Cracken or Coinbase, you know, weren't doing, which would have allowed you to kind of remain onshore in the U.S. Yeah. So, I mean, we were getting kicked off because, you know, we're basically a U.S.-based firm. And then, you know, I think there's been a lot of improvements of, you know, the Krakens sort of matching engine API and just overall systems recently. But, you know, one of the reasons we slowed down our training earlier on was just because, you know, there was more liquidity on sort of like, first of all, on derivatives in general. And then second, it's nice to have like being able to use like any asset less as collateral,

that sort of thing, you know, just like fewer rejections, I think, through the API and, you know, through the web sockets. You know, that being said, it's not like, you know, FTX, was like super great either, right, to use as a product because like there were certain like weird bursts of latency here and there. Sometimes their systems would fall over too. So, you know, and then, you know, going through the risk check in cereal, you know, consumed up a lot of time, you know, tens of milliseconds, maybe even hundreds sometimes. You know, I think it's just a sort of balance of considering all the different offerings between all the different exchanges. And, and I think there, there is something to be

said that because FTCS was kind of like a little bit skirting regulation a little bit more than let's say Cracken and Coinbase, they're able to kind of get away with like listing some like really random, you know, crazy stuff, right? Like all sorts of shit coins and like vol products and leverage tokens and all sorts of like random stuff. And even though I don't like particularly like any of those products or almost any of them, still if there's trading and, you know, there is retail appetite or even institutional appetite for those products, then, you know, I think market makers tend to think, well, then there must be money to be made there. So, you know, they'll bring some of their business over. So, you know, I think those are just some of the reasons.

Well, Jesse, this leads me to a question to you because, as you just implied in your question to Kevin, I've seen a lot of people say that a big reason that this happened here is because regulators in the U.S. have not come up with clear regulation here. The other The kind of like flip side of that argument is that leaving FTCS. aside, we haven't seen a U.S. exchange that has seen this level of fraud. And so in that sense, that's an argument in favor of the regulators who say like, oh, our existing laws work quite well and we don't need new laws. So it's kind of curious to hear your take on, you know, whether or not existing regulations have helped U.S. customers or if you think, you know, this kind of.

lack of regulation that's specific to crypto has hurt U.S. customers? I think overall hurt, you know, it basically forces people to go offshore for things that they otherwise would be able to get, you know, in the United States. Just take like futures trading, for example. It's not available in the United States. Trading certain tokens, which the SEC would probably call securities is not allowed in the United States. And there's actually no, there's no license to be able to do that whatsoever. It's not just a matter of like getting the right license. There's no license. And so the SEC would say, yeah, there's just no way to do this, this activity, period, in the U.S. unless there's a change to the law, which explicitly

contemplates this new activity. So people are forced to go offshore because the domestic businesses are prevented from offering these services. And, you know, Coinbase even went to the SEC to ask them, if they could offer this like 3 or 4% yield product and, you know, it seemed like a very conservative product and the SEC rejected it. And so they weren't even able to launch that thing. Meanwhile, FTX is offering the same product basically with 10% yields from the Bahamas. And so if you're a U.S. client, you know, why wouldn't you just go go do that, right? Like, I mean, maybe you've been comfortable that you're safe and secure domestic exchange in the United States, but there's this other exchange offshore that's offering 10% yields. So, like, that's pretty attractive. And if the

regulators aren't doing anything about that, you know, we ask the regulators all the time, you know, when they, when they hassle us about certain products, or we try to get approval for certain products that our competitors are offering, you know, why aren't you guys going after, why are you preventing us from doing this? But you're also not going after the guys offshore that are doing it. And, you know, basically it comes down to, like, laziness and convenience. And I think they don't recognize that by not shutting those guys off and at the same time preventing domestic businesses from from doing that activity, they're basically forcing all of the consumers to go offshore to do what they want to do. So it's like the worst of both worlds. But one question about that

because both I and I saw, I forget who it was, it might have been Adam Cochran or somebody, like my thought was, oh, maybe all of this makes Coinbase feel better. about the fact that they didn't end up launching the earn product because it shows kind of how risky it is to try to take customer funds and then earn yields on them. So like what do you say about that? And then I mean, on the other hand, like when you talk about how FTCS was offering 10%, like clearly the methods they were doing to using to do that were risky. So. No, they were loaning Alameda money. Like, yeah, they were, yeah, they were. certainly doing some very risky stuff. That was probably the most risky loan you could ever make.

You know, I think to get three or four percent, I think you can do in conservative, reasonable ways without taking a lot of risk. They could even be, you know, doing it internally. You know, like Cracken has a margin program, basically, right? So we have a pool of funds and going into the margin pool, and clients are effectively borrowing that on the exchange to trade on margin. And we could easily offer three or four percent returns if we were able to open up funding the margin pool to clients because the margin rollovers are at like 20% a year or something like that. So we could easily do that without having to go outside of our system and without having to trust a third party. It's all like kind of self-contained and we have full over collateralization

and liquidation control and all that stuff. So I think you can you can get numbers like that, especially in today's interest rate climate, you know, without too much difficulty. But, you know, to even be prevented from from offering something like that, even conservatively, it's a huge problem. And I think the regulators don't acknowledge that. And I think as a country, we also need to understand what do we want our public policy to be here and what do we want our national objectives to be here with crypto? And if it's to own more of the crypto business and develop more of the crypto industry domestically, then we have to update these laws. And then we have to do something for the good actors.

We can't just say too bad when their offshore competitors are out competing because they're able to have a better product because they're not enforced against. I completely agree with Jesse. I think in some ways, even if the US government's goal

was a little bit against crypto, anti-crypto, right? Even then strategically, doesn't it make sense for them to welcome as much business onshore as possible and then try and control things afterwards, like why be so aggressive about crypto in such, you know, early days and push everybody offshore, push all the businesses offshore, push all the users and consumers offshore. And then finally, when they do get some kind of like iron grip over their domestic, you know, crypto industry,

you know, 90% of it is already offshore, right? Like, what was the point of that? Even from their own incentives, even from their own goals, right? So, you know, I definitely agree. I think, you know, government's generally been pretty heavy-handed on regulation. And a lot of it's not directed at crypto. A lot of it is like legacy on regulation that crypto maybe happens to fall under, but it's a little bit gray, but people want to be safe so they don't want to mess up or anything like that. So it's like it just kind of shows just how far the system has come, right, to where it is today where it's just that hard to do business in the U.S., which shouldn't be the case. Yeah, there is a lot of gray area. And the problem is that.

that the regulators have largely taken the approach that anything gray is black and they want to kind of capture as much control as possible. And for the businesses, you know, we've we've disagreed with regulators at times. You know, we might think a product is completely okay and legal to offer and they will have a different interpretation. Because the fines available to them are so high. You know, if we went to, if we took them the court to try to prove our case, you know, first of all, it might take years. But if they won, you know, the fines available to them are just obscene. You know, it could be something like $5,000 per transaction, you know, which is counted as a trade or something like that, you know, which would, you know, they're like

millions a day. So, you know, they potentially could be awarded some fine against us. It's like a trillion dollars. All right. So even fighting over just being able to offer a specific product could be like existential for the whole business, right? Like the fine could just could blow up the whole business. And so what ends up happening is the companies will just like not offer that product because it's not worth risking the whole business for. Yeah, definitely. And I, you know, I do particularly think that, you know, in spite of what happened at FTX,

I do think having a loan book within an exchange is a good idea. In the sense that you can allow users to choose whether or not they want to take that risk and fully disclose all the risk to them and say that, okay, we can do one or two things. We'll just keep your money, not re-hypothecated, not loan it out. It just sits there and does nothing, right? But you just take on absolutely no risk, completely segregated. Or you can take a bit of risk, get that 3 to 4 percent yield. But if something catastrophic happens, we may or may not cover that loss.

We may still just cover the loss. We still might just make you whole, but we may not. And these are some very weird tale situations that are possible, right? So I think as long as I think all these risks are kind of disclosed, then people can kind of choose for themselves what their risk appetite is, whether they want to be like ultra-conservative or try and get some yield out of their balances. So, yeah, so I don't think there's anything wrong with that kind of product. It's more just that, well, there wasn't kind of like malfeasance at FTX.

And then on top of that, that product wasn't well designed if you can accept as collateral things that are just extremely illiquid. And when it comes time to liquidate certain loans that borrowers post as collateral, then you're not able to do so without taking account equity values. Yeah, actually, it's funny because I was going to ask you what you thought was going to happen of crypto lending. I'll kind of throw out a few topics. You can sort of pick where you want to go with this, but we touched on the media a little bit. We have now touched on regulators, although I do think

we could actually talk about that even more. One thing I also noticed was that Jesse you had a tweet thread about VCs missing red flags. And in general, I feel like there's this kind of constant tension we see in crypto, which started with these cypherpunk ideals. And then now these VCs have been very influential in this. space. And, you know, we kind of see this tension just constantly play out. There was that whole phase a few years ago with the fair launch coins versus the VC coins. And obviously, a lot of VCs right now are being reprimanded for their role here in what happened with FTCs. So all those things are crypto lending. You can take any topic that you want, but we'll maybe just have each one of you say a few

last words. And it can be about any of those topics. Yeah, sure. So what I would say is that, you know, I don't quite believe the VCs on what they say on their word, because the VCs tend to benefit a lot from what happened, at least earlier on with FTX and the Samcoins, right? Like if you're a VC and you're buddy, buddy with SVF and you get allocation into all these different Samcoins, then like you yourself as a fund now get to mark up the book extremely high because the flow is so low, FDV is so high. And then if you were to do distributions based on mark to market profits to investors in the token itself, right? So you issue out these distributions in the token itself, then you get to mark your carry at an extremely high overvalued price, right?

And this would be very different if they had to sell the token back down into dollars and then distribute the dollar profits to their limited partners, right? So there's a lot of this kind of like synergistic kind of like symbiotic relationship between the BCs and Sam, just on the Sam coins. And then, you know, kind of on the FTX side, I think a lot of the VCs honestly are willing to overlook a lot of things because if you look at the Web2 playbook way back in the day with the, you know, dot-com bubble, you know, a lot of these, you know, there are these VCs that surely didn't think that these, there were some businesses that were good, but they still invested into them because they thought that, you know, the growth would be good enough that they could get it to the soft bank round, that they could then get it to the public and then finally

dump on the public, right? So it's not like, it's not like crypto is unique in that sense of these games of people buying illiquid stuff and then, you know, with enough momentum flipping it high enough to then dump it onto the public's head, right? Like this has been the playbook for a lot of Web2 VCs for a long time already. And now we're just seeing the crypto variation of that, right? So like all these, you know, VCs, you know, I don't really take them on their word because I think that there's a lot of mixed incentives. And, you know, as well as with the exchanges themselves too, right? Not just FTCS, but, you know, exchanges in general, you know, there's all these kind of like dealings between,

you know, the token market makers. So not like the principal market makers, but the ones that contract with the token projects and the exchanges who get listing fees. I mean, this is more like 2017, right? Where it's just like, it's literally in everybody's incentive that everybody makes money except for retail. And they all, not even in a collusive or conspiratorial way, but just out of their own incentives, cooperate with each other to dump on retail as the inadvertent action, even though it's none of their goals to dump on retail that is kind of nationally calibrating outcome if they're all following their own interests, right? And they all take a little piece of the pie, right? So I think, you know, you have a lot of this kind of behavior. It's not that they're outright colluding.

it just so happens that their interests are aligned to dump on retail. And then some people just don't say anything. It's not that they think it's right. It's just that, you know, well, it benefits them so they don't say it. Yeah. There were some investors that passed on the FTX round and said that they had, they saw some crazy things. You know, not all the investors share all this information. You know, I think they're obviously, they don't generally come out publicly when they spot something that looks like a fraud because they might be wrong.

They don't want to get in trouble for, you know, disparaging somebody and get a lawsuit against them or something. And they don't want to like burn the relationship with the founder, you know, like VCs try to preserve the relationship even if they pass because they could always be wrong. You know, they want to want another opportunity to come back later. And so, you know, maybe they weren't as critical as they should have been. And maybe, you know, the worst case, they just didn't invest. But many investors took a look and I think we're just either, you know, maybe they got some incentives in tokens that tip the scales for. for them, or maybe they were just fomoing at the time. And, you know, they saw this hockey stick growth from FTX and they were used to investing in growth companies like, you know, Instagrams and social networks and chat apps and stuff like that where, you know, all that mattered was like your user growth and revenue. And there was not really any concern put toward, you know, the actual like infrastructure of the business, you know, like how secure it was or anything like that because, you know, worst case scenario for a photo sharing app

is like people get to steal the photos, which obviously has been pretty bad in some cases. But, you know, it's not like at the level of losing $10 billion, which is probably even more than the company was worth at the time, right? So like that possibility exists in crypto for custodians that you can lose more money than your company is worth. You know, I think VCs maybe didn't really appreciate that at the time. I do want to touch on one other topic, which was the regulation.

And I think we all have to come together as an industry right now and stop fighting about proof of work versus proof of stake because politicians have just been like salivating for an opportunity like this to attack crypto. And I think we need to just be totally clear that we're not willing to give up any ground in defy and that this is 100% just a basic Bernie Madoff style fraud. And just as Bernie Madoff was not an indictment of the stock market or Wall Street, you know, no one was calling for more controls on the stock market or NASDAQ after Bernie Madoff. You know, we shouldn't be hearing that kind of stuff about crypto either. And if we are hearing that, you know, either someone's being intellectually dishonest or, you know, they're using this as just a fake reason to attack crypto. So we need to clear up at any time it's mentioned, you know, we need to just clear that up

and make sure that everyone understands. This is a fraud on the crypto community. It's not a fraud of crypto or buy crypto. And so, you know, I'm very concerned about the political blowback that's coming here and it's going to land on the victims, unfortunately. You know, anything, it's not going to be targeted in the right place, which is how do we actually help consumers get access to safer products? Yeah, I mean, if anything, this was a good.

guy from Tradfai coming into crypto, wrecking all the crypto people. So if anything, we're the ones who got attacked here, you know, by FTX and Alameda. Yeah. So, yeah, completely agree. You know, Laura, I actually just, I had one question for you, if you don't mind, which is having, you know, how to career in media, what are your thoughts about why it's the case that, like, SBF gets all these puff pieces in the media, but then the media goes out and just slams, oh, you know, all the mainstream media, it goes out and slams Jesse and Brian at Coinbase and, you know, it doesn't look upon them very favorably. Like, why do you think that that is the case from your own experiences in media? Well, so, so first of all, I consider myself to still be in media.

You know, now I just have my own little media company. But the other thing that I would say is to not paint the media. Like, it's not a monolithic thing, obviously. They're, you know, good reporters, bad reporters, just as like, you know, there's fraudulent exchanges and, you know, above board exchanges. What I would say is that I think in this particular case, I think probably you're talking about the New York Times piece that came out on SPF earlier this week. And, you know, the main reporter in that, he's like three years out of college. And another big piece that he wrote on Sam was if he wants to go after the salt conference in the Bahamas in April. And I think maybe at that time, he had really kind of, you know, who knows? I didn't, I didn't read it again recently

now. But my sense is like he probably spent a fair amount of time with Sam and like had some sort of impression of him at that time. And then maybe it was just like a little bit slow on the uptake of like just how much of a fraud this was. And maybe that's why the piece just seemed a lot more sympathetic than it probably should have been. You know, I just maybe want to explain that one particular situation. I think, you know, for some of the other. critical coverage. So Jesse probably knows, like, you know, when you underwent that, it sort of seemed like a bit of a, what's worth it? Like, there was internal fighting at Cracken, basically, is what the story was. You know, that story probably, like, in general, when people

do stories, and you probably even hear, like, comedians will say this, like, you know, you don't punch down, you punch up, you know, which isn't to say that the, every reporter goes in being like, oh, I'm going to, you know, take down the people in charge. But it's more like you want to try to give voice to people who maybe are the ones who have less power. So maybe in any kind of conflict, that is what will happen. And so maybe that's why those pieces might have come across as like, oh, the Times is like attacking Jesse or attacking Brian or whatever. That's probably like maybe another way to look at it. Obviously, I don't work at the times. I don't even know like a ton about what happened in those situations other than what I read there.

but maybe that is like one way that I would look at it. One thing that I do want to say because obviously the media, you know, like, you know, Forbes where I used to work, put SPF on the cover, Fortune did as well. Unfortunately, I don't remember if I read both of those pieces. It's sometimes one of those things like you see one of those pieces. You're like, I'll save it for later and then, you know, you don't get to finish it. When you are doing this kind of work, there are certain markers that you look at of like

legitimacy and the VC backing that Sam had. would probably, you know, check that box off for you, you know, any like Sequoia being very closely affiliated with you. That that's like, oh, like this is, you know, one of the best and, you know, like it's a VC firm that does its due diligence or whatever, you know, just there are certain shortcuts that you take. Or I shouldn't even take it, call it a shortcut, but it's more like, you know, when you see so many stamps of approval, it kind of gives you a sense of like what the quality of this person or their enterprises. So that's another way maybe that I could explain all of that that happened. But when it comes down to it, I really think the situation, frankly,

was that, you know, at least so far, we know that only four people knew about this. Like, I have talked to some, you know, high-ranking people at FTX. They were just completely blindsided. They did not know. So I think when you just have that kind of secret, like, you know, that's something that's just, it's going to be hard for that to come out. And the last bit I'll say is that, and I can't remember if I said this on the show previously. So for listeners who maybe heard it, you know, you could skip ahead. But I had been tipped off to a few things about Sam previously. Nothing related to this, just other things. And when I had tried to get people to talk to me about it, nobody wanted to talk to me because Sam was a gazillionaire. He was very powerful in the

industry. They were worried about their careers. They would work. that he could like bury them in the ground with like a tiny little lawsuit that would be you know you know super difficult for them to defend but easy for him to just like spend a bunch of money on you know people just weren't willing to talk and so it's just fascinating to me and granted like I said the tips that I got were not related to this but still it's like what happened with Harvey Weinstein you know that story took decades to come out even though apparently that whole time it was an open secret in Hollywood that he would pray on young actresses this way, right? So, like, at that time, again, because he was so powerful, people did not want to speak to the media, even though everybody knew this was happening. And when you have that kind of, like, threat from someone, it's hard for everyday people to, like, be the ones to step forward and talk to the media. So that's another reason why, like, I do see a lot of blame going to the media. And yet, I feel like there's just a lack of awareness of, like, all the hurdles that you need to go through as a reporter to be able to publish

that kind of thing. And not only does it start with sources being unwilling to talk to you, but it ends with like the publisher maybe not wanting to publish it or the lawyer at the publication being like, you know, we can't do this for, you know, X, Y, Z reason. Like I can't remember for the Harvey Weinstein one, there was a previous reporter. I think it was, yeah, I think it was Ken Aletta at the New Yorker. And he just couldn't get across the finish line. He had done a ton of reporting. He couldn't get across the finish line. He ended up giving his notes to Ronan Farrow, which, like, That's crazy. Like, if I spend a bunch of time, I definitely wouldn't want to give my notes to another reporter that's like competing with me. That's terrible. But, you know, at that point, Kenaletta was just like, wow, I have been trying to get this guy for years. Like a lot of people have been trying to get this guy for years. You're closer. Like, we should get this over the finish line. I'm going to give you some help. And so even when I, with, you know, the Dow attacker thing, like people have asked me, like, why didn't you name the Tao attacker in your book? Like you, you know, eventually publish it, but it's not in the book. And if you read my book, you know, it's 12 chapters. Four. of them are all about the Dow attack. And yet I knew who it was, but, you know, and so that just,

you know, I'm not going to give too much information what happened there. But, you know, that just goes to show, like, even though I had like great evidence, you know, the thought was, let's let's put this in a publication that is used to dealing with this kind of situation. Because book publishers, they're not, they just pretty much never have that kind of thing on their hands. And, and yet, you know, yes, I published it in Forbes, but you don't know how many, how many publications I pitched before then. And, you know, I had people coming back to me saying things like, oh, well, you know, how do we know that this isn't a case like one newsweek named Doria Nakamoto, Satoshi Nakamoto? And, you know, I didn't want to like give all my information away either,

you know, because what if they steal it, you know, but like I knew how good my evidence was. And it's really, you know, thankfully, just because of how much my Forbes editors and I, we trust each other. We like have worked together for a long time. And so they, you know, were like, like we'll we'll do this like you know we we trust you and you know they verified all the evidence and then they were like yeah this is strong doing that kind of work it takes so much work like and like I said just all these people will put up like little roadblocks or like little hurdles for you to to pass long the way so you know so when I see all these tweets being like the media should have figured this out I'm like okay you guys just you know you just should understand what it takes to

do this kind of work and actually get it into print like that is the really hard part. So, and I, which is not to say like, you know, the media was perfect in any regard. But the media never is. I mean, it's one of the hardest jobs. You're like publicly performing all the time and like people just like, well, you know, I criticize you the moment that you, you publish your work. So. No, I appreciate that. No, I totally understand. Makes sense. So, okay. Well, anyway, this has been so amazing. I know we're like way over time. But you guys, this, yeah, has been awesome. you each tell people where they can learn more about you and your work?

All right. I'm Jesse Powell. You can learn more about me on Twitter. My handle is at Jess Powell, J-E-S-P-O-W. Yeah, and you can find out more about us at at Galois underscore Capital on Twitter, G-A-L-O-I-S- underscore Capital. Perfect. It's been a pleasure having you both on Unchained. Thanks for having us. Yeah, it was fun. Thanks for having us. Thanks so much for joining us today to learn more about the meltdown of FTX, Jesse, and Kevin. Check of the show notes for this episode. Unchained is produced by me, Laura Shin, without from Anthony Yoon, Mark Murdoch, Matt Pilchard, Juan O'Ranvich, Sam Shrebram, Pamishamdar, Shashonk, and CLK transcription. Thanks for listening.