Unchained - 'The Last Big Whale': Why the Crypto Contagion of 2022 Eventually Hit Genesis - Ep. 426

Episode Date: November 29, 2022

Michael Jordan, founder at DBA and former co-head of investments at Galaxy Digital, and Alex Pack, managing partner at Hack VC, talk about the potential insolvency of Genesis and DCG, the cycle of credit expansion, and the importance of DeFi to prevent these situations.    Show highlights: what will happen with Genesis and its parent company DCG where the insolvency of Genesis might have come from how the expansion of crypto lending in 2021 is impacting the markets and the role the Fed played in this expansion how the Terra collapse kickstarted a ton of contagion effects in crypto companies Alex's story of why he did not invest in Alameda in 2018 whether it is possible to prevent the "FTXs of the future" the importance of assessing the quality of collateral assets the story of when SBF called DeFi a "Ponzi black box" the mystery of where FTX Ventures got the $2 billion it planned to invest    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   Michael: Twitter Previous Unchained episodes: Is the Collapse of Crypto Lending Over, or Is It Just Starting? Alex: Twitter     Episode Links Previous coverage of Unchained on Genesis and FTX:   Why Genesis Could Very Well Be Insolvent, Not Just Illiquid Jesse Powell and Kevin Zhou on How FTX and Alameda Lost $10 Billion Is the Collapse of Crypto Lending Over, or Is It Just Starting? Did the Bahamian Government Direct SBF and Gary Wang to Hack FTX? 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   Genesis: Unchained:  Genesis Warns of Bankruptcy If Funding Plans Fail: Report On-chain Analysts ID 432 GBTC Addresses After Grayscale Says No to Proof-of-Reserves WSJ: Crypto Lender Genesis Asks Binance and Apollo for Cash Decrypt: Digital Currency Group Says No Imminent Threat Despite Owing Genesis $575M The Block: DCG CEO Barry Silbert updates shareholders, says company will emerge 'stronger'   FTX Collapse: First declaration document Unchained: FTX Bankruptcy Overseer Says Company’s Collapse Is Worst He’s Ever Seen SBF tweet: FTX files for Chapter 11 bankruptcy protection Bloomberg: Transcript: Sam Bankman-Fried and Matt Levine on How to Make Money in Crypto Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey everyone, just a quick note before we begin. Unchained is doing its annual survey. Head to surveymonkey.com slash R slash Unchained 2020 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. You're 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 the senior editor of Forbes, was the first Metremeter Porter to cover cryptocurrency full-time. This is the November 29th, 2022 episode of Unchained. Unchained Daily is now on Substack

for your recap of news and market updates. Plus, you can now upgrade to Unchained Premium, which includes new perks directly through Substack. Visit UnchainedCripto.substack.com to subscribe. Minima is a new layer one 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 nodes set up at minima.global. Chainalysis demystifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigations support for all crypto assets for organizations like Gemini, Crypto.com, and BlockFi.

Maximize your potential with the leading blockchain data platform by visiting chainelysis.com slash unchained. With the crypto.com app, you can buy, earn, and spend crypto in one place. Download and get $25 with the code Laura, link in the description. Today's topic is FTX and Elamina, as you probably expected, and its contagion effects on Genesis and the rest of the industry. Here to discuss are Michael Jordan, founder at DBA and for, former co-head of investments at Galaxy Digital and Alex Pack, managing partner at HackVC.

Welcome, Alex and Michael. Good morning. Good to see you, Laura. Good to see you, Alex. Yeah, good morning. Quick coffee on everyone. Speakers are not providing any investment advice and nothing they say should be construed as such. Any companies, any of the speakers discuss may or may not be companies in which they or their firms would actually invest. And they are discussing these companies only because they are interesting to them. And probably, you all already know, since this is a news show, nothing on the show has ever or will be investment advice. All right, the other thing, heads up listeners. Because of the Thanksgiving holiday here in the U.S.,

we've recorded this on Tuesday, November 22nd, a full week before this episode airs. This means that whatever news happens between now and then, which I'm sure will be plenty, unfortunately won't be discussed in this show. However, at this moment, we at least have some sense of how events could play out so we can discuss those potentialities, even if we don't know what eventually transpires specifically. Okay, Alex and Michael, after this long speech, let's finally get into it. Let's just start with where we're at at the time of this recording, which is that the collapse of FTX and Alameda may be knocking over another domino or two, namely, probably at this point, the crypto lender, Genesis. At the time of recording, it has not filed from bankruptcy.

And I'll just add the word yet. And in fact, the Wall Street Journal quotes a Genesis spokesperson is saying, our goal is to resolve the current situation consensually without the need for any bankruptcy filing. Genesis continues to have constructive conversations with creditors. So additionally, the Wall Street Journal reported that Genesis had reached out to finance, which declined and to private equity giant Apollo for either investment or to be. on their loan book. Okay, so knowing that this episode will come out next week, what do you think is most likely to happen with Genesis

and also to its parent company, DCG? If you don't want to make a projection, maybe just talk about how you're thinking about contagion, crypto lending in general. Who wants to start? I'm going to just volunteer, Michael. Okay. Michael.

Michael. Good luck predicting one plus week into the future in this current market environment. Oh, gosh. Well, I think it's interesting that we've seen complete silence on the DCG side. I think that the thing that we saw that was different with Alameda was Sam was actively tweeting. It was kind of crazy how actively he was tweeting. And so I think when I think of what you should look for, it's who's not saying anything.

And I've asked my friends who could possibly be working on the financing, what's going on. And the people who are working on it are dead silent. You can see their telegram. They haven't responded within, you know, they haven't checked telegram in two days. That means they're up all night working. So there's something going on in the background that there are. There is some type of financing trying to be done. It would take a traditional finance lender to step in here.

This is a lot of money. It sounds like it's $500 million. There are not, as far as I know, any crypto balance sheets that could take this. Alex, who could even be the categories of people that could step in and finance this? Yeah, I mean, it's the root, you know, the words we hear are like Binance, we've heard before, Apollo group. There are a few pretty large investment firms and tech companies even, like Google, that are on the cap table of Genesis. You know, basically, I think what we've seen over the last six, 12 months is just an incredible overreach and sort of fundamental problem with a lot of the, a lot of the CFI model. in crypto. You know, if you'd ask me a few days ago, what's a sign that something is going

to go wrong? The silence is one thing, but to actually play the other side of the argument, Michael, like, like, I mean, Sam was, like you said, Sam was extremely vocal and it's just talked and talked to sort of hide this, what we now know is, you know, allegedly this massive fraud, right? So silence is one thing. But generally, like, the more centralized, the more levered, you know, the more leverage you have. And then the more opaque you are. the bigger your problems are probably going to be, and the worst it's going to be in this market for you. So you got, on the one hand, Genesis, very centralized, but actually very, very regulated, like, about as regulated as it gets in crypto, right? I mean, they even have, they're even

operating in New York. But literally the source of, like, probably the biggest source of leverage in the entire crypto community was Genesis. I mean, at their height, there were tens of billion dollars, I think, on the loan book. So this is kind of the big, the last big whale level. right on the to get unwound yeah and the the thing really that we're dealing with today started a long time ago right it's this should have ended and resolved itself in June the fact that DCG stepped into Genesis to deal with that three arrows loss we're paying for that today that's coming to surface right now this is not something that came out of FTX there was a new Alameda hole left but the thing that happened was everyone started doubting all over

opaque balance sheets after FDX. So all of the Genesis customers started to withdraw their funds. DCG and Genesis then had to find the cash to pay those withdrawals. And they had this liquidity mismatch where they had term lending. Term lending just means that you've given someone capital with more than open. You can't just call it back. It could be three, six months. It could be a year.

And that creates different kind of liquidity structures. There's different instruments in that. There could be things like GBT, the Ethereum Trust. And that's created this problem for DCG and Genesis where they need to pay cash out. And so the thing I'm looking for to resolve this is really who is going to willing to take the haircut here. Is DCG going to take the haircut? Are they going to sell gray scale? Are they going to sell Genesis?

Are they going to shut stuff down? Because they do need to raise capital somehow. And to do that, they're going to need to sell some type of asset. But Alex and I both come from private investing backgrounds. So we have a decent understanding of what their equity book looks like, their venture equity. DCG is a very active participant in the venture equity space. I think they have over 150 single names. They traditionally were a much smaller check firm.

They were a little bit like Coinbase Ventures started out to be. These were 150 to 500K relationship checks. Relationship checks means that you're not underwriting like a venture capitalist. You're looking this for some type of founder relationship. do business with Genesis, those type of things. And so that's something I think some people think they could generate cash with, which is selling off some of these DCG venture equity books. I don't know, Alex, how much you've looked at this, but have you heard some of that stuff being shopped? Is that a possibility that they could start selling off this equity?

The problem with this is the timeline and the market environment. It's obviously the worst time. I mean, maybe next week will be even worse, but today is the worst time to try to do a distressed sale or any really venture raise of any kind in crypto. Yeah, I think a lot of these assets are very interesting. I mean, grayscale is a huge cash cow. Even Genesis, I agree with you, like, knock on wood, that some big fraud doesn't get discovered in the next week. But for the most part, it's probably an asset liability mismatch on the one hand.

Or two, it's this issue of, you know, we discovered there's like DCG had this one billion. The parent company had this one billion dollar loan from Genesis. And so there was this sort of question of maybe they were double, like, levering up and doing their own trade with the parent and that sort of cloud things. But, okay, so a couple of things. So first of all, just to go back, just to make it clear, so Binance was approached and they declined to invest because they expected their, it might cause them conflicts of interest down the line. But a couple of things that I want to address that, it's actually kind of plays into what Alex was just saying. So I did an interview with Ram Al-Alawalia, who he's been tracking this very closely. And he said that Genesis is both illiquid, but also insolvent.

And so, Alex, when you talked about this $1 billion loan, I believe it was from DCG to Genesis. Oh, okay, just somehow the way you phrase that. No, no. It was the opposite. It was Genesis to DCG. Oh, wait. But then I have a question. Oh, right, right.

Sorry, that's right. But wait. How does this work with, because this was caused by 3AC, right? So these are two separate things. The first thing that happened a few months ago was DCG came out and said, we're going to recapitalize Genesis. We're going to push, I don't remember what the number, a billion dollars or whatever. I think it was $1.2 billion.

Then another thing came out a few days ago that said that Genesis has loaned a billion to thereabout, give or take a few hundred million. I don't remember the exact number. to DCG. And this, we don't know if this occurred recently, if this occurred a year ago. I think what people are speculating is that basically DCG did the same trade that BlockFi and three arrows did, the sort of market neutral, you buy a bunch of GBTC, you then sell, you hedge hedge Bitcoin on the other end to take advantage of the ARB. That would be bad. That would be where the insolvency comes from, that you're like doubling down on this trade that's broken the backs of

several other large, like, counterparties. Okay, and wait, but that's because GBDC started training below Nav. Is that essentially, I mean, that's only been getting worse. So I guess. Yeah, but the timeline of that doesn't match up. So just to take a step back, because I think we actually have a pretty good understanding of the Genesis and DCG situation. We pieced together the idea this week.

And so just two seconds of what happened, right? Luna implode, three arrows is now belly up. Genesis is owed a billion dollars by three arrows. And so now there's this billion dollar whole. The things that they, the collateral that was left at Genesis was the most illiquid collateral, right? In any type of liquidity scenario, you start to sell the Bitcoin, you sell the ETH. And the things you're left with are the things you can't sell. So you inherently have this liquidity mismatch.

And so that was the GBT and ETHE. The thing that was dangerous inside of that was the accounting of the asset, right? There are different levels of accounting. When Alex and I run our valuations, we have to tell our investors what we think things are worth, they're different assets and they're different kind of quality of the price, if that makes sense. Like really early venture stuff versus very liquid assets like BTC. The difference between the NAB and the trading price of GBTC caused a lot of these issues. They were being accounted at different rates.

And so this created a bit of an actual value gap. That's where the insolvency would come from. the value gap between the nab and the price of the actual GPDC and E. So that's the actual impairment loss. And when you say that's where the insolvency would come from, are you talking about for DCG or for Genesis? Genesis. So the money that Genesis was out and they were out to basically,

you know, they had a hold of fill came in from DCG from that promissory note, that $1.2 billion promissary note that said, we're going to step in and we will make sure that we are well capitalized that our counterparties have equity to trade against because right in a trading business, the equity is really important. People are only going to trade people with larger equity than the assets they're lending. Okay.

So one other thing that Ron was saying that when you have that kind of situation along with things like Gemini Earn and Circle Lend and their customers being probably kind of waiting to see what happens here with Genesis, that there's a question of who will be first in line. And I was wondering if you had any insight into that. Yeah. So our understanding of the thing that's really holding up this deal is that in August, Genesis called back a loan from Alameda.

It was a large loan. Everybody rethought their risk and they called it back. The concern is that Alameda went to FTX to get that capital. And that capital is now sensitive to a clawback. So there are these concepts of 90-day clawbacks and this type of thing. And if Alameda took customer funds and gave it to Genesis, now Genesis has a whole other problem, which is that itself is indeterminate. So how can you raise capital when you don't know the size of the whole and that there's this

big clawback risk? And so I think that I'm talking to people working on the financing. There are different interpretations of that clawback risk. There's different interpretations of who is where in the cap stack because this isn't really clean. This is the big issue. FTX was not a bank. They were not at FDIC insured place.

They were not a custodian. And so you start to go through the equity stack normally, which means you have senior debt, you have junior debt, you have unsecured debt. Then you have the employees, right? This is the water. What I'm describing is the waterfall of who would get paid out in some type of trust liquidation. The concern is where is Genesis in that stack, especially if the money came from some type of FDX customer liability.

And so this is confusing kind of legal minutia, but it's really important to understanding the ability to finance Genesis and DCG on a go forward. Do you have a sense of how much money it is that is at risk of being clawed back? The numbers that Genesis and was out to three arrows in Alameda was significant. We don't have the actual numbers, but the stories are two to three billion dollars. And that sounds reasonable with the traditional kind of risk that people were running. Wow. Okay. Okay. So this potentially, I mean, a could take so long, or do you know how long it would take to figure out all of this?

Like, it sounds like, what, minimum a year or something? I don't know. I don't think anyone has a good interpretation. A lot of this is new. If this was happening at a U.S. regulated exchange, like a commodities exchange, we would have plenty of precedent transactions. This is new. It's a lot of different laws, a lot of different jurisdictions that are going to claim over this. And so I think that to Alex's point about selling private assets, time is of the issue essence here because DCG does have debt out and they have debt interest rate payment, right? They do have this. I don't remember Alex.

You know when they actually did it? Maybe it was August of 2021 that DCG Parent Co. It was in when things were going really well, DCG opened up like a 6% revolver. Is that public now? Yeah. Yeah. But yeah, I so that, so now they sort of are going in both directions is the what I was saying earlier. Like there are loans from Genesis to DCG and there's recapitalization from DCG to

Genesis. It's just really tough because, yeah, the lack of precedent transactions. And then there's, like, there's no doubt that it's gotten a lot harder to raise institutional money for any crypto, crypto venture deals, crypto funds, crypto companies. So now you have this, this remarkable headline risk on top of the opacity and difficulty of like figuring out the legal minutia. Yeah, like there's a ticking time bomb with these, with these, payments. It's ironic because DCG was like, you know, they have this huge office in Stanford that's new that's like $50 million and they do these, like, I don't know, they are, they were a bedrock of the crypto space and they were spending cash quite, quite a lot just a few months ago.

So, yeah, life comes at you fast. Yeah, seriously. One last thing I thought I'd mention. here is that Apollo did recently hire Christine Moy to lead their blockchain strategy. That was just back in April. And I don't remember hearing too much about them being super active in the space before. So it's just interesting that they're being approached now at this moment when not that long ago, they decided to perhaps put a foot in this space. And who knows if kind of this new interest in crypto will kind of help the situation or if they'll feel like, oh, whoa, what are we getting into? Maybe we don't want to get in. I don't know. Anyway, do you have any thoughts on any of that? Yeah, I think that there are a lot of people who specialize in traditional

finance in this type of stuff. I think that the precedent transaction would be the Mount Gox claims. I think we are aware of some crypto-friendly traditional asset managers who stepped in and spent a lot of time understanding what the claims should trade at. There was a pretty institutional effort to transfer those claims. I think that they sold everywhere from $1 to $5,000 for Bitcoin. Alex, I'm sure you've been chopped those deals before. But that kind of feels like where this FTX type credit would be resolved. It isn't one of those people who understands crypto and has good debt distressed background. This is complicating two things. I know the FTX side and the Genesis side, but they're obviously interlinked.

All right. So, Michael, you kind of started to talk about the roots of what I'm now calling the crypto carnage of 2022. So maybe let's just keep going with that because clearly, you know, looking back, there's just so many ways in which all of this isn't are related. So, you know, with the idea that hopefully the crypto industry will learn some lessons from this, let's try to unpack all the different causes because I, it looks to me like there are so many. why don't we maybe start with, we can start with, I guess, the lending bit that you started to talk about, but I definitely also want to ask Alex about his tweet threads. So we'll go to that right after if you, but I feel like you didn't get to finish your full thoughts on the crypto lending. So why don't we start there?

Yeah. The way we got here was a dramatic credit expansion in 2021 during COVID, right? I think we talked about it where Genesis's lending book goes from a billion dollars to 130 billion of originations. but I think something like $14 billion outstanding. And Genesis was by far the most sophisticated lending desk. Genesis and BlockFi start to see this opportunity where the space is capital constrained. Everybody has Bitcoin and they want cash. The two most sophisticated players to do it are three hours capital and Alameda. They're running generally what's considered no price risk strategies.

These are what we talked about with the GBTC arbitrage and cross-exchange delta neutral arbitrage. That was the Alameda thing. And so lenders are generally pretty happy to give out capital there. They start to grow the value of their collateral and so they're able to grow the value of their borrow. So what we get is a boiling of the frog. There is marginal risk being added because the perception of risk is not there. The assets are growing. The value of the collateral is growing. The thing that really gets dangerous is the entrance of new, less scrupulous lenders. I'm not going to say names because we actually don't know their internal risk models, but a lot of people start offering under collateralized or completely uncollateralized lending.

Alex, I don't know if you'd been pitched some of these companies that were raising money, but they were showing spectacular amounts of revenue from their lending businesses. And this is like mid-2020, all these people have really grown their lending books and really grown their lending business and they're driving equity value. And what that does is it forces the more sophisticated people like BlockFi, like Genesis, like Galaxy to take on more risk if they want to continue lending. There is a very self-destructive nature of lending markets where the rational participants either stop lending and basically, you know, stop offering their business or take on

more risk than they're comfortable with. That's the really dangerous part of this business. And so we see that in both private market investing and lending. And so that's the condition that sets up this giant explosion where three arrows and Elmade are able to grow their books to two or three billion dollars each. They didn't start there. They started with $20 million and they grew it. And so the amount of risk on was just way more than anybody understood. I don't know, Alex, if you are on the other side of some of those lending company equity financing, but I remember BlockFi, Lendon, Celsius, all went to market with big fundraises. Yeah, absolutely. A lot of equity went into it as well. Yeah, look, I think the big problem is crypto's early use cases are very financial servicing. That's defy is by far the category of crypto that has the strongest like product market fit. And the sort of speculative. inflation, leverage loan lending, and CFI is is really big. It's the early stuff. And so what

this means is it becomes very like crypto prices and activity becomes very susceptible to these debt crises. And it becomes very susceptible to macro issues. So yeah, why did all these lenders pop up and grow so fast? To be honest, it was probably because of the Fed. Like it's because you have very low interest rates for multiple years. And many forget that literally the way that the Fed and sort of other central banks influence the economy is through the credit markets, right? And since quantitative easing, they literally buy and sell like private market debt, right? So when the Fed wants to raise interest rates, the actual mechanism by which they do so is de-leveraging, like they take debt off of the markets. And that trickles down to crypto in a really big way,

right? So yeah, even in a period of de-leveraging like that's happening now over just a couple percentage points. Basically, you're seeing every big source of credit that's been pooling in crypto just blowing up and collapsing one by one. So the main one was three AC and and this sort of incestuous, you know, these lenders and then the borrowers, these big trading firms. But the other one was Tara too, which started and Tara was actually like a sort of hidden version of leverage. And Alex, did you see, do you see Do's tweet this week? He actually finally emitted what happened, which is crazy. Doe, to reference this, Doe is responding to Dan from CMS.

Dan is saying it looks like this is the transaction that killed Luna. And Doe confirmed it publicly for the first time for the audience. Luna was buying Bitcoin to kind of shore up this stable coin. It was the idea of the value of the collateral. The Luna Foundation sent, I believe it was $1.5 billion, UST, something like that, to the desk to go buy Bitcoin. But what happened was they depeg themselves, right? What happens is the desk has to sell all that UST risk.

And so it really drains all the liquidity out. And so this sets up the condition for Luna to depeg. They were selling the asset that they needed to keep the peg on, which drives the peg the other way. And so we get this realization that the thing that blew up three arrows in Alameda for the first time was that transaction. And so now we actually know the source of the crisis. Wait, wait, wait, you're saying that when the Luna Foundation Guard went to implement its plan to have the BTC backstop, that the first kind of payment to purchase that BTC is what kicked off the death spiral? No, sorry, there was a specific, you know, steady lads deploying more where I probably got it wrong. but there was a famous transaction where the LFG tweets that they're sending, I know, Alex, what was it exactly?

It's like a billion and a half? Yeah, they basically were selling a bunch of UST for Bitcoin to shore up their balance sheet. Ironically, this was sort of a version of de-leveraging. We should stop having all this totally uncollateralized, unbacked U.S.T. We should get it off our books and give it to Genesis and exchange for some Bitcoin, which is maybe more real. collateral to back our algorithmic highly levered stable coin. But yeah, I like we we did a rough estimate and by the time 3-8, like by the time the madness of the Thetaeta death spiral happened, like that was basically $15 to $20 billion worth of leverage that was just just got unwound in

like two or three days. Right. And yeah, Genesis was one of the counterparties. 3A, I mean, Alameda, everybody, everybody lost and nobody really said exactly how much they lost. and that. Yeah, $15 billion getting poked out of the system can quickly lead to whatever, you know, another $8 or $10 billion from FTX, $10 or $20 billion more from Genesis. The important thing, right, is that Voyager and BlockFi also were involved in this. And then Sam stepped in to bail them out. So a lot of this pain got taped over. And now we're seeing the fact that there was not assets there. That's, that's, that's, that's, that's, that, significant value destruction is now showing up in a lot of places because a lot of those people

were lending their assets to the people who are running these anchor yield farming and other Luna. They were long Luna, the asset, which got destroyed. And so there was just a tremendous amount of value destruction there. Okay. Wait, but just let me fully understand because I still don't understand. So the Luna Foundation Guard goes to sell UST in order to purchase Bitcoin. And then that kicked off what exactly?

That was the depegging. This is during the depegging. If you remember, the liquidity of the market got really bad. The idea, the depiging happens around the idea of the three pool. There was a proposal to add the three pool to add UST as the fourth stable coin. And I believe, did the vote pass out? So I don't remember correctly. It doesn't, but regardless, this all happens around.

these acute points where people need to make some transfers of assets and transfers of risk. And we start to see UST get away from the dollar. I think it trades at 98 cents. The problem with all algorithmic stable coins is that your confidence decreases as you needed to grow, right? The lower, the farther away it gets from the peg, the less likely people are they feel like it's going to get back.

And so what they were doing was they had a lot of an asset, UST, they were selling that to buy Bitcoin to place in the reserve to shore up, you know, steady leads deploying capital. But what it does is you have to send that UST to somebody and that person's now less confident that it's going to go back to a dollar. So their risk manager says, so this is actually good risk management. Their risk manager says you can't hold a billion and a half dollars of a stable coin that could go to zero. You need to get that to a better asset. That could be Eath, it could be Bitcoin, it could be USDC, it could be Tether. You're basically going to buy it anywhere you can. And so all of this transfer causes a complete drain because of the risk

manager of the person they transferred it to. So that takes the peg from 98 cents, I think down to 92, and then that just starts the complete unwinding of UST and Luna. And we don't know really on the Alameda side where their losses were because in the market, they were representing that they did a good job on that trade. But we just don't know because it was so opaque. Okay. Okay. And I view the sort of high level story here is these are all de-leverging events that happened as interest rates started to rise. And they were very opaque. Ironically, Terra was the most like on-chain. You actually could calculate pretty reasonably like how much leverage. And I don't think anyone of Three Arrows was doing that, that sort of very simple napkin

math or I guess Genesis. Yeah. So this is all like this is a very simple. were sort of very opaque forms of leverage that had been built up over the last few years that all sort of popped over a multi-month period as rates rise. And then, you know, sprinkle a little bit of like just fraud and competence on top, which is, you know, gets it's the FTX part. Yeah, a lot of those, Michael and I probably, I don't, I didn't really guess that FDX was going to, that did that we were going to have this other like serious leg down. And I have, like, a serious, like, long term negative opinion of Sam. But still, yeah, so once you get fraud in there too and just sort of this opacity, it gets really, it just keeps spiraling.

Okay. So in a moment, we're going to talk about how your suspicions of Sam and your negative opinion of him first began. But first, a quick word for the sponsors who make this show possible. Eager to make more informed decisions around crypto using data you can trust, chainelysis is here to help. Chainalysis de-mistifies cryptocurrency by providing industry-leading compliance, market intelligence, and investigation support for all crypto assets. for organizations like Gemini, Cryptna.com, and Block5. Gain unparalleled visibility and maximize your potential with the leading blockchain data platform

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to start earning every day until mainnet launch get started at minima.global back to my conversation with Alex and michael. Alex, so you have alluded to this and so have I, you had an experience early on with Sam. And it was interesting because, you know, I want to finish that with and Alameda or and FTX. I guess technically you were supposed to be talking about Alameda, but FTX came up in an inadvertent way. So why don't you tell us what it is that happened when you considered investing in Alameda in 2018? Yeah. So we were one of the first venture capital firms to consider investing in Alameda. This was before FTX existed. So it was just down. at the time, investing in Sam. And I think we were probably the earliest one that did the most

serious diligence around 2018. This is my, like, I, I'm an investor in early stage crypto infrastructure. I've ceded a bunch of defy protocols and layer ones. And I love, and I've backed exchanges and trading firms. And so I love this. I view it as like sort of tech-enabled liquidity provisioning for crypto. It's important infrastructure, what Sam was doing and building. So I met him early on in 2018 and like we were very excited we basically did a handshake agreement to do a deal pending diligence and then the diligence was just nuts like it was just months and months of work we spent probably like five months five six months on diligence and and typically yeah what's the normal oh i mean we were writing like a like a single digit million check so it uh you don't

you know like a few weeks sometimes is diligence for that right um we're not you know we're putting it a billion dollars here but the the reason we just kept like we spent all this time on this was because there was just so much to unravel. There was like peeling off layers of this onion. There were these financials that he would show us about Alameda in the early days that were very reminiscent of the spreadsheets that I've seen in the bankruptcy filings, just these like chaotic footnotes randomly strewn around the sheet that say like, sorry, we don't have this information, just a startup, you know. There were like all these hidden losses that came to light only after months of diligence. The losses, we can never think they were called like untraceable losses by the team

and by us internally. You can never figure out if there was like just massive infrastructure problems, if they like forgot that they were cussing some assets or like sent it to a wrong address and lost the assets or if there was fraud or whatever. But like half of his team ended up leaving after that big incident. So it's called like the April fiasco. So it probably wasn't just an honest mistake. And then there was all this ambiguity about where the money was going and he was creating FTX sort of in secret while he was talking to us to raise money for Alameda and this came to light and he didn't want us to invest or have exposure to FTX. So he was like, he was sort of like using or proposed to use our money if you would have taken our investment

to basically fund this sort of separate business that we had no part of or exposure to behind our backs, which is the opposite of what he did today allegedly. Like, you know, he has this side business, Alameda, that nobody has any information on or ownership in. I think it's just him and Gary that are on the cap table. And it had crushing losses. And he decided to just give all the FTX money, not just investor money, but, you know, customer deposits apparently to prop up Alameda. So this sort of shell game of like, I'm going to use a bunch of money here to pay this, to pay off my other entity that I own over here that nobody knows about. So it was, we just saw a bunch of red flags and we passed pretty early. And it wasn't great for us, actually. Sam was pretty

upset at us and he called us out on Twitter. He posted this like tweet thread about us a couple years ago saying, yeah, this horror story with this bad VC. Everyone should avoid this VC and they asked too many questions and they were, they were stringing us along and stuff. Yeah. So that's sort of the high level. It was interesting. I mean, I've had to deal with this for four years. But I look, I didn't expect it to end in this way, even after all this early stuff that I encountered. And so you, did other VCs know that your firm is who he was talking about and, like, avoid you for, for that reason? Well, yeah, yeah. It was very specific information in his Twitter thread about us. It was like, it was like, I'm not going to mention names, but you know who you are. And then he went on to mention some very specific, like, situations and this, like, trip to China. And we're like, we were one of the most prominent. I was, I was a co-founder of Dragonfly Capital at the time. And we did. this. And, you know, we were one of the most prominent VCs in China and the U.S. It was like kind of

obvious. And yeah, we, we lost a few deals. People, I think, think of VCs as like, we make all the decisions and we're the masters of the universe. But we're in sales, like the best deals are always very competitive. And Michael and I fight over deals. And we should, you know, it's like you have to sort of win allocation. And so for a while, Sam was going around saying, hey, if you want to take FTX ventures or Alameda research money. You can't take galaxies or dragonflies money. So now, you know, we lost a few deals for that reason. Alex, I think it's worth also bringing in CZ at this point because, you know, I don't know if you were involved, but originally Alameda was building a derivatives exchange for Binance was my understanding. Binance ended up acquiring

GEX. Is that right? No, the acquisition did not go through, but it came very close. Yeah. Yeah, they spent a lot of time on it, right, because Binance did not have a strong derivatives. book and this is the Alex's old partner, Bo and CZ and Sam have this different side of the world. This is the kind of onshore and offshore China exchanges. Alameda research started in Berkeley, but really went quickly to Hong Kong. And so this is happening a little bit out of the purview of the major USVCs, right? Like the San Francisco, New York crew does not really know that this is emerging because the both information and social networks are very different over there.

And so I think that that's a lot of how Alamedan FTX snuck up on the U.S. kind of capital markets and technology-focused investors that Alex's background and his team have a very strong, you know, trading capital markets, Asia pipeline that we don't have here. And so I think they saw this earlier than us. And because of that, they also had a much different sense of diligence, right? They had people that they could call and say, do you see these people on markets? What type of activity are they doing? You know, what type of activity are they doing? You know, what type of of size are they? How much smarter are you than them? And there wasn't really that side of the equation that we could ever get to check out, which was they told us they were the best, but none of their competitors told us that they were fearful of them. So that was always a sign for people that were sophisticated there. Yeah, it's very difficult to do diligence on a offshore, supernational, like international, yeah, supernational exchange. Yeah, most of the investors in FTX or first-time investors in crypto projects and maybe never even invested in

exchange before because that's not a there aren't many like startup exchanges even but let alone one of these international entities that have to have very odd you know banking relationships and things like that and then add that to a founder who just like habitually lies to or exaggerates or you know lies by omission or whatever it ends up being it's very tough to discover something like this if they're like very gung-ho on just not telling you the truth and obfuscating things. As far as I know, no investor looked under the hood and found fraud. That the fraud was not discovered. I don't know if anyone else feels as heard this, but I don't know anybody who requested documentation was given it and said that this is.

They did the initial equity financing. It was around a billion dollars. And they sent out a pretty limited data room, but it was a data room. It showed enough information that for the size of the check for the maturity of the business that people could get comfortable with it. My old firm spent time on it. We requested more information, more on the Alameda relationship. We wanted to understand who and what because we wanted to own it, right? Like, anytime you invest, you want to be on the same side aligned with your founder to make sure that all decisions are made through the best interest of the investors and everybody. That's the idea. And a lot of people couldn't get comfortable with the alignment, not fraud.

I don't think any of us expected that the numbers weren't there and that the bank accounts were commingled. Those type of kind of more operational due diligence is not a big thing at early stage venture firms. It's just not where they spend as much time. And I don't think they would know the right questions to ask. And so a lot of this is like anything, it's not a single event. It's a three or four things that happened at the same time. And what was happening in the private financing markets at the time was if you told a founder, I need more information to do this deal, they would say, I'm just going to go with an investor who

doesn't feel that way, right? Capital is a commodity. At the time, it was a very accessible commodity. And if you said, I need to do more work, unless the founder really, really loved you and wanted to work with you, and in exchange, doesn't care, right? Exchange just needs the capital to go. They didn't need to provide more information. So like the lending markets, the private markets were getting into a state that they were self-destructive, that the fact that there were less scrupulous, investors meant that if you did your work, you just weren't investing. Like, I can't tell you, Alex, I don't know how many deals you feel like you lost because you asked for information, you asked for time. And they said someone else is going to do this without doing the work,

basically. Yeah. Honestly, it sounds like a lot of race to the bottom type things. Like when you were talking about the crypto lending situation and about how people kind of loosen their standards because of competition, it sort of feels like the same thing is happening here in the and the VC thing, that when the entrepreneurs have the upper hand, they can kind of force that situation, which leads to these outcomes where they might have been perpetrating fraud. And nobody seemed to pick that up, who was closely working with them. But Alex, because of your experience, I did want to ask you, you know, in your tweet thread, you said, I sat on this story for years because I was afraid of Sam's retribution. And I also talked in a recent episode about how it's

sort of the same for journalists when you maybe get a tip, but then you find out, like, other than the one person who tipped you off, like, nobody will talk about this thing, because, you know, whoever they're, you know, their issue is with, they're very powerful. So I was curious, like, if you had thoughts on how it is that, you know, VCs can overcome this or how the industry can overcome this and, like, kind of catch bad actors beforehand in a preventative way. Yeah, yeah. It's it's it's quite tough, especially if you have this founder who's, I think at this point, it's very obvious. He was very, he was very intentional about a lot of this stuff that he did, very vindictive. And yeah, actually, I think even going back to Michael's point earlier that,

like a lot of investors, they saw audited financials, you know, of FTX. But no one, as far as I know, I talked, you know, a lot of people called me after, after my tweets last week, nobody saw any balance sheet of Alameda. And as far as I know, we might have been the last one to really see the full, all the weird spreadsheets, all the financials. Yeah, so I think Sam learned after his experience with us, like, hide all the bad stuff into this box. And this back box is called Alameda. And it's separate. Nobody gets to invest in it. Nobody gets any ownership or information in it, but me. And all the bad stuff happens there. And I can have audited financials here. And, you know, Alameda is just one line item, right? We don't have to dig into what's actually going on with the surface.

So again, that's really hard. I mean, I think if you step back and think about how do you prevent these FTXs in the future, these incidents is just sort of sociopathic bad actors, but like there's stuff that investors can do on better like risk management, more holistic diligence. We could refuse to invest. We could try to ask each other for sure. And, you know, there's some like some stuff that we can do by just sharing stories with each other. But this doesn't really scale, right? This is really tough. And yeah, once you, to your point,

like there's no coincidence that this happened during just like a bull market within a bull market, like the zero interest rate generational, like post-COVID boom, and then the crypto boom within it, it's just hard to get, yeah, it's a race to the bottom. I think the two things that you actually can do on a systematic level to stop this. One, you obviously need regulation. of centralized crypto platforms. This is the classic way to weed out bad actors, right?

But it's very difficult here because these are supernational organizations. I mean, in many ways, these orgs, like FTCs and Binance and so forth, they're like the East India Company of hundreds of years ago. Like, they're just these, they operate in,

they interact, like, they negotiate directly with governments and heads of state. And it's, it's tough. Like, we don't have like a global regulatory body to deal with them that effectively. And that so, but that's, you have to do something, right? And then the third area is, is actually the most ironic thing, which is like the way that Sam

and Alameda made most of their money was like in defy. They got really early into defy. They made all these defy coins that they pumped up the values, the mark to mark values of and they used to convince like Genesis and so forth to give them huge loans. And then they basically at the end, the way they went down was because they tried to like kill defy and pursue this like secondary regulatory agenda or the shadowy regulatory agenda in D.C. Yeah, I mean, the technology behind what like MJ and I invest in, this like D5-based financial system, it's all about like how do you create non-custodial, open, permissionless, fully transparent,

like financial rails. And and that's the kind of thing that we have to, I hope we can get to long term. It might take years, but. I think that's the important thing, right, is that it's a combination of citizen journalism that caught this, right? I think it was parsec in the block noticed that the stable coin wallets were drained, right? If we could have seen the Silvergate leg, the Alameda bank account, if it was on stable coins, if it was on chain, we would have observed the solvency or not. And so there's a proposal, Mike Belchie has a good tweet threat about this, that exchanges may need to hold customer accounts and stable coins on chain. And that might be the best way to do the audit, because these things are very auditable. So I think the really important thing

as an industry is we need to make falsifiable claims and we need data-driven investigations. And so when people come out and say things like ETH is a scam, well, that's not productive because, you know, that's not a falsifiable claim. That's an opinion. But when you say things like, hey, the FTX wallet has not sent out a withdrawal in four hours or it stopped or the stable coin wallets, these are evidence-based things. And instantly the market knows what to do with that information. Now, people certainly got hurt because it was this combination of fully transparent and opaque systems, right, that caused this exacerbated a banker on. Everything got banker on, but I think that that's what we really need to do going forward is evidence-based reporting

using very clear on-chain data. And then on the other side, of course we need to regulate things that are acting with trust. Any trusted system needs to be regulated. That's the point. The idea of Defi is that you don't have trust. You have trustless systems that you can verify. And so you don't need to regulate those things without those issues. I think that Alex and I would want to put a big caveat on this, that Defi still is not faultless. There are issues. There's an issue going on as we're talking that AVE is being attacked by an Oracle manipulator is maybe the best way to describe what they're doing with it.

But it's the same problem. And to give a quick two seconds on that, the quality of collateral. is what caused a lot of these issues. FTX was generating SRM and CRM and FTT, their exchange token. They were posting that as if it was a dollar of that was a dollar of stable coin. It's certainly not. And so the lenders need to underrate the quality and liquidable, whatever that word is, the ability to liquidate that collateral.

And what we're seeing today is that low liquidity collateral has a really hard time finding a right value. And so people are manipulating that. That can happen in defy as it can happen. centralized exchanges. It's the same concept. And so the citizen journalism, the transparent versus trusted systems plus this kind of collateral underwriting are a lot of the primitives that we need to focus on. Yeah. Real journalism, too, not just citizen, but like the Coin desk article was what. Yeah. Coin desk basically leaked, not even much. They leaked like a small subset, I think, of Alameda's balance sheet. And then at first when that article came out, I was like, whatever, like, what does this mean?

It doesn't, none of this is useful. And then people started, like, to your point, they, like, they started doing like this on-chain forensics to try to figure out. And then it become actually very exciting. And, and it, I think it actually, like, part of it cracked the case. Right. So you had these three, three big elements of like on-chain sluiting that went on. One, like, all the loans were obviously off-chain. But yeah, the value of the collateral assets is on-chain. So this is like the most basic thing. Like, you could see for yourself, FTT is like, Sam thinks it's worth $8 billion. And there's only like a one billion circulating supply and the trading volume is a couple million a day and 80% of that trading volume happens on the FTX exchange. Like these are, you can sort of make

your conclusions about, well, are they being marked to market appropriately? So that was one. And then you had these money flows out of between, this was, I don't know, do you remember this crazy thing that came out? Like there was this tweet a few months ago that Sam posted and he said, heads up just rotating some old FTT wallets, like nothing big happening. And in the background, it was obviously like he was moving like $10 billion of FTT from Alameda to FTCS or vice versa. It didn't really matter because like on the other end with the part we didn't see was that he was moving like billions of dollars of FTX deposits of real money and then like sort of swapping it with FTT collateral. So again, we don't see all side. We don't see both legs of

trade. But seeing one side and then just having a small leak of the centralized off-chain part can help a ton, really. So let's talk a little bit more about these kinds of tokens like FTT. I don't know what the takeaway is. Is it that this spells the end of coins that are kind of closely associated with a single company? Or is it just they didn't do this kind of coin right? And there's a way to do it where it doesn't cause these sort of systemic risks? Or what are your thoughts? I think it's less about the nature of the coin and more about the place that's going to treat it as quality collateral, right? I can create MJ coin overnight and nobody here should take it to be worth anything but zero. That's the truth.

The most sophisticated DFI systems like Compound and AVE have pretty interesting risks going on under the hood. There's companies like Gauntlet, companies like Chaos Labs that are trying to assist DFI protocols and how do you actually treat a coin? What's the difference between FTT, Bitcoin, and ETH? If I need to sell $100 million of it, how much am I going to get out? What type of risk does that create? These are the very interesting questions that we need to look at going forward. It's like, what is quality collateral and how do you price it? And so I think that it's less about the exchange tokens.

That's a completely different question of good exchange token design. but the idea of collateral quality and underwriting, I think, is a thing that we're going to see a lot of innovation on. Yeah. And the transparency of defy is ultimately, it's like, you know, come for this sort of like wild west, like everything, permissionless finance. You could trade any assets. Stay for like these transparent, composable systems, right? So, yeah, with FTT, just real quick, you could think of FTT as basically like pseudo and BNB. is pseudo equity of of FTX the exchange. Right. So you have these tricky situations in TradFi, too, where a public company in a moment of Bull Run mania decides to take out a debt alone

collateralized by its own equity. And it doesn't often work out very well in those situations because their likelihood to repay their interest payments is highly correlated with their stock price, right? but that's a known, like that's a known situation. I believe it's illegal for any financial service company doing that, though, right? Like the Norwegian banking crisis, a lot of these banking crisis were caused by this type of behavior and you regulate that out. Yeah, like these, these CFI lenders shouldn't be throwing up their hands like, oh, I have

no idea how to value this FTT. Like, it's a known, yeah, centuries of like equity collateralized loans have occurred in the world. Yeah, the big issue, I think, to MJ's point. is you had the situation where there were these employees at these lending companies whose job was to increase revenue and increase AUM and they were incentivized in a way to say, well, maybe this thing is actually pretty safe. And anyway, it's all private. Who's going to tell on me? Like I, but in Avey or compound, the decisions about how do we treat the value of collateral, how do we market? At what point do we,

do we margin call? And the margin call happens algorithmically. There's no like call up your broker and say, hey, I'm good for it. Can you not margin call me today? Give me an extra week. None of that is possible in defy. And that's the benefit. That's why it's so much more robust and anti-fragile, really, than a lot of these C-Fi lenders. Alex, do you think regulation had something to do with this where we see a lot of these pseudo equity tokens? I think a lot of investors are frustrated with the state of the governance token world where it's clearly being priced as the market as pseudo equity, but it doesn't have any claims, it doesn't have any control. And if you treat that as collateral, if you're posting governance tokens and there's no claim on cash flows, no claim on rights, like what actually is

it? And I think the U.S. regulatory environment and lack of clarity has contributed to these complicated, non-obvious token models. I don't know how you feel about that. Yeah, it's a, It's a reasonable point. Generally, I think tokens that have fundamental value and actually have cash flows and claims on on like cash flows are much more interesting. They're the most. They're the exciting. And that's why like in many ways, tokens is an evolution on the concept of equity, right?

Of shares. But the problem is the more you make your token like actually valuable and have a claim on real world resources or assets, the more you have to worry about. the SEC coming in and saying, oh, this is security, right? I don't know if that was the biggest impact here, as opposed to just the mass fraud, which, you know, leveraged a lot of the ambiguity and novelty of crypto to sort of hoodwink, trad-fi people or various people around the world. But it's not, yeah, we do need, yeah, of course.

I mean, we've been banging on this drum for years, like we need a little bit more clarity so that we can have, know what these assets actually are. But do you think we are to blame it all in terms of the community had a bit of a naivete of the dual use of these things? You know, I spent a lot of time thinking about things like nuclear energy. I think everybody believes it's a great tool, but it could also be used. It's got a dual use. The other side of it is you can weaponize it and create really bad outcomes. And so one of the questions I've been thinking through post-FTX is, what naivated we have with these open permissionless systems that someone like Sam could exist?

The thing I think my conversations all landed the same place is I just never contemplated this level of fraud, sophistication, and cynicism. His first mask slip was on odd blocks. I don't know. This is the famous description. It was so cynical that even the cynics are like, what you did? You want to share the story? It's like unbelievable given what happened today. He's describing this is a famous exchange with.

the odd lots career in mat levina i believe is the actual other guest and he's describing defy as this black box where you're printing collateral out of thin air and then you're posting that to get dollars out he's just describing this rude goldberg of pansy in such a literal and direct way with no utility value whatsoever like no discernment for why this thing should exist and what type of risk transferring risk pricing you know bootstrapping of users whatever the most generous interpretation of of yield farming and defy was, he took this radically cynical approach. And I think it was the first time people are like, whoa, wow, that guy's thinking different from us. And so I think one of my questions is really when you have a dual use technology, like what is the sobriety that we need to have, the type of guardrails

we need to put in place where a very bad actor could step into the system and use it. And he's not going to use it the way that the crypto believers are going to. This is the first time that I think a lot of us had to do that soul searching. We had to take a step back and say, everything we're doing is not just for use for good. It can be for drastic bad. How do we prevent that? And how do we weed out that thing so that what we're doing is actually a force for good?

Yeah, the exact, I looked this up just now, the exact phrase, he basically called defy farming a Ponzi black box. And then Matt Levine was like, wait, so are you just saying you're in the Ponzi business? And SPF says, yeah, yeah, I would agree. That's a good summary of, I'm in the Bondi business. Yeah, I mean, I think, again, the problem is really, the more centralized, the more highly levered, the more opaque you are, the worse it's going to be for you, and the harder it is. I think actually this may have been intentional.

And this was part of Sam's phase of, like what he said with Matt Levine. This was actually part of Sam's phase of like, okay, I've like basically like raped and pillaged defy, I've taken a bunch of money out of it. and now I would like to close it up, close up the shop and sort of regulate it. So I actually think maybe there was some malice going on here too, where he's trying to sort of discredit what's happening. But the fact is, like, the other, the last piece of like intel that FTX was going down, which is the part that convinced me.

Like I had basically up until a day before withdrawals were paused, I didn't even think that FTA, I just, it was so unbelievable that they would do something this egregious and lie to everybody for years. But the part that made me realize something was really wrong was they started withdrawing from every defy pool that they had any money in. And there was one specific defy pool even that it was called like gearbox. And it was crazy. They had like $5 million in it.

And there was a huge withdrawal fee. And the withdrawal fee was going to go to zero in like five days. Like there was a governance set. So yeah, it costs like 5 or 10 percent to withdraw from this pool. But if you just wait five days, you don't have to pay anything. And they took everything out immediately. And I was like, oh my God, this is like what could be going? How bad can it be that they're just eating this huge, some traders eating this like ridiculous

like P&L loss just for like a few days worth of liquidity? So yeah, I think generally defy it's the more transparency, the better. Like you have to defy your way out of this problem with more transparency and more stuff happening on chain. Yeah, going back to the cynicism and the, the match. box analogy that he made on the Oddlots episode. Yeah, I feel like is kind of the same exact thing that a true crypto believer would describe, except that they would do it in a way where, you know, it's all about building this to centralize such and such. And you use this as a

bootstrapping mechanism to get people in early. And then eventually like all the people participating in the network are user owners. And it's this kind of, you know, grassroots thing, rather than this top-down company that would have existed in an earlier stage of the internet. And what he did was he took that concept and then this stripped it down to the most kind of traitory way of looking at it, which is just like the financial bid

and not any of the kind of building aspects. I kind of mentioned this before. But yeah, even when I interviewed him, I was kind of trying to figure out, are you like this effective altruist who is just using crypto like for the money-making abilities to further your other ends, or are you actually a crypto person? And yeah, just certain things like that now, looking back, it's like pretty obvious that he definitely had this more sort of

traitory aspect rather than this kind of, I'm going to build something, you know, for the crypto space. You know, he didn't really talk about all the kind of ideals that a lot of crypto people espouse. The best framing of that I've heard is there's crypto 1.0, cracking, Coinbase, Galaxy, Genesis. And some of those were run by real believers. Like Jesse at Cracken is a true believer. I think you've spoken to him recently. He speaks very differently. They don't take those type of risks. They do proof of reserves. Right. And so we do have some crypto 1.0 or that survived this. And it turns out the ones that survived tended to be run by a believer. And so that was an interesting data point. And then the crypto 2.0 stuff worked. Purely on chain, radically open,

credibly neutral stuff worked. Unuswap is functioning perfectly here. The one point. five stuff is the dangerous stuff. That was the Sam stuff. That is, hmm, I can run these extractive games on these open systems because not everybody has to play by the same rules. There are no rules here. And Sam was actually creating his own zoo to hunt him, right? Like he was literally breeding animals to hunt them.

And he had the exclusive pass. He owned all the entrances. It's an incredibly cynical approach to life. But it's this 1.5 idea that I think we needed to get. right for the industry to succeed. The 1.5 idea being just taking all the opaque, extractive nature of some of these financial systems and applying them to open systems where you can exploit them because of the open permissionless nature. Yeah, and people should listen to one of the recent episodes of the chopping block where Haseeb talked about how he had lunch with Kyle Davies at

some point who said, oh, I figured out what Sam's doing. And so obviously this is what third or forthhand that I'm repeating the story. But basically, you know, Sam had saw that during the ICA craze, like people were minting this money out of thin air, but then, you know, it brings all this, like, regulatory pressure on you and there are other issues because then you have to like, you know, provide these services to people. But his idea was to create coins, but then to be the main buyer of them, which could kind of obviate some of those issues. But then as Hasib and Turun pointed out, then if you're posting your coin that you created as collateral for the loans that you took out in real money, then of course it's very reflexive when the price goes down and then you just

end up in a really bad situation. So very quickly, because we're running out of time, I just want to ask about two more things. One is, Michael, when we had our premium interview, I asked you about FTC's Ventures. And it was announced last January that they were investing $2 billion. And at some point, I guess Bloomberg had reported that they merged. But then Amy Wu, the head of FTCS Ventures and Sam Bankment Free, both denied that. And you had an interesting theory about what was happening there or like why that confused the industry. So can you talk a little bit about that? Yeah, well, first off, no one knew where the money came from. That was the first question. Two billion dollars. I mean, paradigm and injuries to do that. But they have really strong capital raising arms. And so everyone's understanding was that FTC's ventures had nothing to do with FTCX. It was just a name that Sam licensed. and that the money was actually Alameda's money. That was our understanding. And when we heard that... But did you confirm that or is that just your theory? That is complete speculation and that's things that we heard, but we heard it from good sources. The thing that everyone was really

suspicious about with FDX was their spending. This is actually what CZ got, as far as my understanding, but really tried to... Everyone in buying it's like, where are they getting all this money from? We know $2 billion is a lot of money to raise. And the rate at which they were deploying it was incongruous with a company that was doing, I don't know, 50 or $75 million of EBITA. It wasn't like it wasn't $2 billion of EBITDA that you could be putting out in a year of private finances. And that's the type of cash that we have to talk about. FTC's was not that good of a business. If you looked at their earnings, right, like it was not some money printing machine. Sure, it had significant volumes, but it wasn't taking out a lot of profit from the business.

And so that's what everyone was trying to figure out, where is the profit coming from? And we all just naturally assumed those all amoeia. Okay. And then the last thing I wanted to ask about was the fact that FDX was also investing in the same venture capital funds that had invested. Or I don't know if it's literally the same funds, but, you know, they invested in Sequoia and some of these other VC firms. So that was kind of interesting and weird. It's like a sort of circular investment thing. And I was kind of curious for your thoughts on that. I think that's actually pretty innocuous.

A lot of the founders who we had backed, we have great relationships with. And they want to invest in the ecosystem. And so they will invest in the funds. I think I would say that's extremely normal. The other thing that's extremely normal is people like Sequoians and have like a private wealth arm almost where they will manage the partners capital mostly, but some very high performing founders get access to that. And it's just like, you know, they have very good funds on the platform.

They have good risk management, all of that stuff. So that's not completely incongruous or unprecedented, nor do I think it creates the type of conflict that you would think from the outside. People like myself and Alex love to have founders invest in us because we have great relationships with them. They're our personal friends. We've been successful together. And they're great deal source, right? Like they send us lots of deals. And founders call them and say, who are your best investors?

And so I don't, I personally don't have as big of issue with that. the order of, I don't know if there was any type of, hey, if you invest in us, we'll invest you. That's clearly unethical and inappropriate. But I have not, someone like Sequoia would not take that type of arrangement. I'm sure that that exists in some lower levels, but not at that level of institution. Yeah, I think the one area that that I was surprised, I totally agree. We, like, there are lots of founders that have invested in my firms, things like that. But it's like, to have a founder of a pre-IPO company invest hundreds of millions of dollars. That's weird.

I was actually quite shocked when I read that article or that headline. Yeah. And to be clear, I think it was like $500 million in Sequoia. Was that it? Or maybe between various firms. Well, the big thing that came out was crazy was he, Sam sold $300 million of secondary. Right? This wasn't just that.

That is the weird thing. That is a, that is a. Well, and he gave himself a $3 billion loan through Alameda. Yeah. But I guess the point is that $300 million for secondary, even in a world where secondary is common, is very atypical. That's a lot of money off the table for sophisticated investors to feel comfortable with it.

The logic is that it avoids dilution, right? Secondary, you're selling already issued shares instead of diluting everybody. And so people are comfortable with it, but 300 is. That's a shocking number. And that wasn't public as far as I know. So I think the issue that was really incredible here was just the same. scale of the fraud and recklessness going on. Just take everything you've ever seen that maybe could be an issue, like sometimes founders invest, whatever, and then just magnify it by 100x.

And look, it's not like, yeah, cases of fraud happen a lot in like low interest rate environments in a new tech. Like Enron happened around. Enron was like a bandwidth company, right? And even Madoff, He was like the pioneer and inventor of electronic trading. So you use these sort of new concepts and new jargon and language to confuse people in order to perpetrate like pretty classic like fraud schemes, if what, like half of what these reports are saying is true. Yeah. So it's just a, it's just like a, I think it's honestly a once in a generation scale,

like magnitude of like sort of fraudulent catastrophe. But yeah, I hope I hope people don't. take away that this is like uniquely created by the concept of a token or the concept of FTT. Like we talked about in many ways, like the fact that these things were, even some of these things were tokenized and some of his activity was on chain was probably the reason why he was caught in one to three, like it was a three year up and down cycle. Whereas made off was 30 years, you know? So, you know, a lot more leaked and people figured this stuff out because of what was going on on chain.

Yeah, yeah, I agree that that definitely hastened things. All right, well, this has been so amazing discussing all of this with you guys. I just loved your insights. Where can people learn more about you and your work? I'm just on Twitter at different MJ. We're DBA will start having a public face pretty soon. And I'm on Twitter at Alpaca P, like my last name, PAC. And also we're Hack VC.

We're an estate venture firm. We have a website that is hack. dot VC. Awesome. Well, thanks so much for coming on the show. Thank you for having us. Thanks so much for joining us today. To learn more about the contagion effects of FDX, check out the show notes for this episode. Take the Unchained Survey Survey Survey on the podcast, our premium offering, and more. Visit SurveyMonkey.com slash R slash Unchained. It's produced by me, Laura Shin, with off from Anthony Ewn, Mark Murdoch, Matt Pilcher, Juanor Ranovich, Sam Shreram, Pamma Jim Dar, Shishonk, and CLK transcription.

Thanks for listening.