#84: FTX Debacle Part II
#84: FTX Debacle Part II
The FTX fraud needs to heed the crypto community to build with a values-first ethical mindset
This post is part of a 4-part series on FTX that I wrote for the Bankless DAO Writers Cohort. The posts were written in real-time as the FTX news unfolded. My hope is that in the future this series will be a prescient warning for how to stay safe from crypto frauds and fraudsters.
Read the rest of the posts in the series:
Hi friends,
FTX is clearly a fraud — a moral and ethical debacle. Don’t let anyone convince you otherwise.
My intention with this post is to unpack and synthesize the technicals of FTX’s solvency crisis, whilst focusing on my main thesis that Sam Bankman-Fried (SBF) is a sociopath whose actions evaded moral and ethical responsibility. (One percent of the general population is sociopaths, and many sociopaths are CEOs).
We should use lessons from the FTX fraud as a guidepost for embedding moral and ethical principles into the crypto products we build.
Michael Zargham, founder and Chief Engineer of BlockScience, an Economic System Engineering firm (i.e, they design crypto token systems), writes:
As with any emerging technology there is still a lot of uncertainty around the practice of engineering web3 enabled systems but it is already clear that these systems are deeply entangled with social and economic systems, and thus have the potential for a deep and long standing impact on social institutions.
Self-incrimination and the savior complex
In the first post of this series, I highlight SBF’s character flaws, including a savior complex that enabled him to spin a fictitious narrative, duping smart people into believing that he is an effective altruist and a white-knight, who generously gives to charities and rescues failing companies.
Since my last post, more incriminating information has been revealed about SBF - shockingly, most of it is self-incriminating!
Despite the advice of his lawyers, SBF spoke at the New York Times Dealbook Summit. Talking to reporters and speaking at conferences, while under a, potentially criminal, investigation, seems (naturally) dumb to most people, but these actions are in line with sociopathic behavior.
The film The Big Short highlights sociopathic behavior by satirizing the way in which criminals incriminate themselves —bragging while simultaneously revealing information.
At the Dealbook Summit, SBF bragged about being a “good and helpful” person when his interviewer, Andrew Ross Sorkin, asked him pointed questions —two of which I will highlight in the post. (By the way, I highly recommend watching the whole interview to get a sense of SBF’s nervous stupidity).
During the interview, Sorkin asked SBF:
What are your lawyers telling you? Do they think it’s a good idea for you to be speaking?
How concerned are you about criminal liability?
To the first question, SBF responded:
No, they are very much not. The classic advice right is to recede into a hole and that's not who I am. That's not who I want to be. I must talk, to explain what happened. To try to make things right. If there is anything I can do to try and help customers out..."
And to the second question, SBF said:
So I don't think that I mean I don't think I have but uh you know I think the real answer is that I know it sounds weird but but I think the real answer is that's not what I'm focusing on um it's uh there's gonna be a time and a place for me to sort of think about myself and my future but I don't think this is it like this month um this has not been fun for me but that’s not what matters.”
Are you f****** kidding me?!
The savior helping himself
We know that SBF is a sociopath who was sending customer deposits, from the FTX exchange, to his investment management firm, Alameda Research, and using FTX’s token, FTT, as collateral for loans, in order to make exorbitant multi-million dollar real estate purchases in the Bahamas for himself, friends, and family.
His plan to use customer deposits (blatantly ignoring FTX’s terms of service) was, arguably, solid — so long as the FTT token kept pumping. But, any sane person in crypto will tell you that tokens inevitably fluctuate and drop in value.
Turns out, FTX had no risk management strategy in place (only sloppy Excel spreadsheets).
What should have happened —what happens in all credible DeFi lending protocols (whose founders don’t commit fraud)— is that token-backed loans automatically liquidate when the token’s value drops to a predefined threshold, so that the loan can, at least partially, be made whole.
For example, MakerDAO, a leading DeFi protocol, regularly liquidates borrowers collateralized loans. Itovault explains the process:
The Maker system sets a margin requirement for each collateral in the DAI system. For example, ETH has historically had a 150% margin requirement. This means you need $600 of ETH in a vault (CDP) in order for that vault to issue 400 DAI. Liquidations kick in generally only when collateral values fall. If you own a vault, you only need to track collateral prices to prevent a liquidation.
When a vault’s collateral falls below that vault’s margin limit, a liquidation occurs.
The first stage of Maker’s liquidation process is the collateral auction. Anyone can submit DAI in this auction to make a claim for the value of the vault. It is this submission of DAI that destroys DAI in the Maker ecosystem and keeps the enter Maker system solvent. What happens next depends on the max amount of DAI submitted:
Maybe FTX would have liquidated under-collateralized positions of FTT if they had an accounting department!
Mansions in the Bahamas
To recap, SBF’s quantitative trading firm, Alameda Research, “borrowed” customer deposits from the FTX trading platform (i.e, commingled funds) to take out loans on DeFi lending protocols, using the FTT token as collateral for the loans, so that SBF and his cabal of roommates and coworkers could buy mansions in the Bahamas under the legal entity FTX Properties.
Even FTX’s parents, Joseph Bankman and Barbara Fried, law professors at Stanford, were, most likely, in on the sham. SBF listed them as owners on this $16.4M dollar mansion.
Looks pretty, right?
What’s Next
Besides SBF, the main culprit in the FTX fraud is the token, FTT. As people continue to point out, FTT was printed out of thin air. Although, technically, all crypto tokens are printed out of thin air, the good ones are designed thoughtfully —with sound economics, business, and engineering principles baked into the code.
Michael Zargham heeds in Engineering Ethics in Web3,
While it remains unclear where the web3 technology stack will carry our society, we believe that this journey must be undertaken with a values first mindset.
Shitcoins, like FTT, are probably here to stay, and if you do decide to invest in them, at least craft a simple risk management strategy for yourself. It could be as simple as, if X token drops to Y value, SELL.
To quote Michael Burr, in The Big Short,
Making money’s not like I thought. It kills the part of life that’s essential.