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

Transcript

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 US 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 Kraken, who ran a centralized exchange for a long time, and Kevin Zhou of Galois Capital, who could offer his perspective as a trader on FTX.

The two of them mention 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 FTX'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.

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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 of Need to keep up with the biggest news in crypto? Get Unchained in your email Monday through Saturday. Go to unchainedcrypto.substack.com to subscribe. 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.

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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 Kraken, which disclosure is a former sponsor of the show, and Kevin Zhou, co-founder of Galois Capital. Welcome, Kevin and Jesse. Hey, thanks for having me. 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 malfeasance perhaps fraud.

Jesse, since you're 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 they were traders first and foremost. I think they were very inexperienced operators. And uh they took on a lot. I think uh 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 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 that you would normally do and and build. And, you know, from the outside we figured that 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, you know, it seems like they hadn't done any kind of accounting or reconciliation in like three 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 do 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. Um yeah, no, I definitely agree with Jesse. And actually, you know, before starting the firm, uh I used to work uh two years each at two

different exchanges, one of them being Kraken. So, I'm I'm pretty familiar uh with some of the operations that that go on within exchanges. And, you know, like Jesse said, there's a lot that goes into it. And, you know, with a small team, it it's very difficult to run uh because there's so many different divisions. It's a full-fledged business, right? If you look at a trading operation, I mean, there's you don't have to do any marketing. Um there's very little BD. There's not too much uh legal overhead. There's a lot of these divisions that aren't you know, fully fledged. But, an exchange is a full-fledged business, so you have all these different divisions.

Um and then I think on top of that, some of these guys, you know, from FTX, from Alameda, they were coming in from the TradFi world and they weren't, you know, super crypto native at the time. And there were a lot of lessons, I think, that were learned in history, you know, everything from like Gox to Bitfinex. I mean, to some extent like Bitcoinica. I mean, there there were so many lessons along the way, Crypsey with Big Vern. Um all these pieces of history that, you know, I think folks that had lived through it, um, really internalize. And folks that, you know, just just came by later, you know, they they 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 Gox collapse, uh, or all of these like major

hacks or, uh, 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, you know, how they were blitz scaling their exchange. Something that they thought of as kind of like a, you know, startup financial product rather than some kind of like what Jesse said, like a Fort Knox, where, you know, at the end of the day, it doesn't matter how good your systems are, um, how good your trading platform is, if you can't manage to hold on to, uh, your users' funds, right? And that's only from the sort of the angle that, you know, 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 you know, that 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. Um, I'll even share a really kind of random story about when we met we met Alameda first before they started FTX, uh, 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.

Uh, 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, uh, the right number. And you know, if it's plus or minus 10 grand, 100 grand, uh, which back in the day was a lot of money, right? You know, they said, well, you know, let's move on to the next day, right? So, I think, you know, they're you 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 um you know, definitely 20/20. Yeah, and I don't remember how big they grew to, but I feel like the latest numbers I saw were some somewhere in the 300 range, but clearly for the size of the operation, that still was an extremely lean um machine, which you know, Sam would sort of boast about, but um obviously, as Jesse mentioned, that is a kind of red flag. And you know, to see your comments about the security at 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, um I don't think they've 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. Um I've never met Sam. I interacted with uh 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 and can you talk about what 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 Kraken actually like went went out to our users and notified all of our users about it to try to contact their government representatives about it. FTX felt like the better approach was to use their contacts in DC and try to like negotiate this, you know, in in backroom deals and things like that. You know, we felt like through our experience over the years that that that was basically going to be futile.

And um you know, we were kind of beyond the point of of being able to do that to be able to 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 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. Uh 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 we've developed over the course of a decade the strategy that we have

now. You know, but I I think that was just par for the course for them to come in and think that they could do things in a way that no one else had tried before. And that would make them successful, uh not learning from the lessons of of the past. And obviously, that played out with the implosion of the 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 cuz I I remember a crack in at that time calling upon its users. Um so, I don't I That may not have been it, but I 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 FTX? Like, why did you, you know, kind of have some confidence to leave the assets on the exchange? Um yeah, so I I'm happy to talk about that a little bit. Um, there's some things that are uh confidential uh with regards to the fund, but you know, generally the idea is that slowly over time uh as a

US-based business, we kept getting kicked off of international exchanges. So, uh sort of the scope of our trading started to get more and more concentrated uh on FTX. Um, and then um at that point there was also, I think, uh some sense that, you know, we really didn't see this coming. I mean, in retrospect there were so many red flags, but you know, at the time uh you know, we thought the exchange was secure. We thought, you know, he was sort of the golden child of crypto, you know, going to meet with all the regulators and whatnot. Seemed to be smart, seemed to be, you know, knowing what they were doing. You know, turned out not to be the case. And uh so, I think we were kind of lulled into a false sense of security there. And then on top of that um had uh a lot of positions open at the

time uh that we had to unwind before we could withdraw. So, um you know, just given the the size of those positions, it was um uh very cumbersome unless we were willing to puke it. Uh and then just, you know, take on all that slippage. Uh it was very cumbersome just to unwind all those positions uh to withdraw. So, uh a mix of um many different factors, but I would say uh that's mostly it. And I also wanted to maybe just take a step back and sort of respond to to what what Jesse was saying uh before, which is, you know, I I completely agree. I think 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 um token project founders, but there's always this um kind of sense that, you know, we can do

uh things better. And I 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, the a lot 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, uh 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 um make certain shortcuts that they shouldn't make, right? All for

the sake of the greater good. You know, I 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 uh been uh reading this over. And you know, I thought it was curious that he was a a utilitarian, right? And in particular uh and maybe just to explain very quickly, utilitarian is a is someone with the philosophy that, you know, people should uh 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 what what which people count, which people don't count. This whole thing gets very messy, but it's generally this kind of sense, right? Where you're kind of like reducing people down to numbers and then trying to add them up to get the greatest sum, right? It's like a you you've turned it into a math problem, an optimization problem, which uh you know, I think I think is a little bit questionable to begin with. But in any case, reading through this blog I and then now having reread it, I realized something, which is that not only, you know, is this philosophy that of a utilitarian, but that of an act utilitarian rather than a rule utilitarian, right? So an So a rule utilitarian is someone who would say, uh 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? An act utilitarian is not that way. It's not so much that you're you you have to prescribe certain rules to follow. It's that that 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 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 this sort of idea about, you know, the the road to hell 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 act utilitarian, not a rule 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 at the 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, um 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 uh sorry, Tarun and I, and then Haseeb um has called himself an effective altruist, although when he talked about it, it just seemed very different from the way Sam talked about it. So, not sure what to make of that. I I don't mean this as an indictment of effective altruism. I don't see it as 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 I mean, people if they listen to the Chopping Block, they'll hear that I asked him this, but I'll just mention this cuz the The 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 kind of what I would 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 um when you think that you have a better idea of what to do with like other people's money or whatever than than they do, then like it it just leads to you know, you to do things like, "Oh, I'm going to justify like 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 you know, 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 and um you know, this kind of stuff was the stuff I would write papers about and um you know, I mean, like Kevin said, this utilitarianism is a slippery slope, you

know, like you said, you you can just you decide that, you know, that $5 is better spent on on a political donation not knowing that this person was going to use that $5, you know, that was the last $5 they needed for their life-saving surgery or something like that. Um you you have to make a lot of assumptions about you know, the relative value of things. E- 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 it sounds like he was pretty much like an ends justify the means kind of guy like the 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 any specific kind of like

you know, moral compass basically to to or 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 it what does it, that's fine. If stealing client funds is what does it, that's fine. Ultimately, you know, I don't know 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. Uh but, you know, I don't know I don't know what the greater thing that he was planning on like investing in would have been. Um I don't think he said that. Oh actually I 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 like hurt humans. Something like that called Entropica. Tarun mentioned this in the show.

Have you heard of that or do you know it or No. Okay, those are the two. On my show, he talked a lot about pandemic preparedness. And 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 might hurt humans 10,000 years from now." That was what he said. But anyway, Pretty much. Yeah. The pandemic preparedness thing also sounds like something that would just play well in in the current climate, you know, with the media and everything. So, like I wonder if that's even true. It's current-thingism. It's current-thingism.

Yeah exactly. Yeah. And 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 uh from what I remember with conversation with Jesse, uh Jesse is a deontologist, which is the complete opposite of a consequentialist, meaning that uh it's the means that matter much more than the ends, right? Um so, you know, I'm more inclined and and I think he's, you know, being truthful when I, you know, when I talked to 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 to reach those goals, right? And I think, you know, that 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 ad infinitum, but I actually wanted to just dig into some more details. You guys, um I'm sure you probably at least heard, if not read, the first day declaration that the new CEO, John Ray, uh 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 dollars to Paper Bird, which is an entity wholly

owned by Sam. It also lent 1 billion dollars to Sam himself 543 million dollars to the director of engineering, Nishad Nishad Singh, and 55 million dollars to Ryan Salame, who is the co-CEO. So, all that together accounts for about 4 billion dollars. The New York Times reported that Alameda CEO, Caroline Ellison, said that Alameda had taken out loans to make venture investments. And um I remember that earlier in the year they announced uh that their venture investment uh 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 FTX Ventures um committed hundreds of

millions of dollars to Sequoia, Altimeter Capital Management, Multicoin Capital. These are venture funds. And that some of the funds also backed K5 Global Global, which is an advisory and investment fund run by Michael Kives, who's a close advisor to SBF. So it's just very curious. So obviously that's a huge amount of money. You know, I don't know what that totals, maybe somewhere in the ballpark of 4.5 billion or something. People think maybe about 10 billion dollars is missing. I was kind of curious, you know, what are your theories on where the money went and like why so much went missing? Is it like bad trading? Cuz 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. Um yeah, sure. I'm happy to start. So, you know, I think uh you know, there's a there's a Twitter account. I can't believe I'm saying this. There's there's a Twitter account called 0xFBIFemboy. 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 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 two, rank three, and rank seven accounts on on BitMEX.

You know, I think back then the game itself was a lot easier. And you could have like a ragtag prop shop, you know, just coming out of TradFi. There were not many institutional players. There were not many sophisticated players back then. 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. Not now. They're not slow, but they're not known for being like very high frequency, right? You know, in terms of like HFT for example. So, you know, I think as things progress and you started having a a lot of these bigger players like Jump Trading, you know, HRT, 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 and 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 Mac Aulay, who

eventually went on to stand to to start Lantern Ventures. And basically, there was an internal disagreement where 2/3 of the team kind of wanted to take more risk, and 1/3 of the team wanted to take less risk. So, the the 1/3 of the team branched off and went to Lantern, and then the 2/3 stayed with Sam. You know, you know, you know, each each part of the team went with each of the different co-founders. So, basically, you you know, where things may have started sensibly, you know, 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 of like the the you know, the lower risk, you know, the higher 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 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 3 years and you're stuck at that rank 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 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 3 years and you still can't ride a bike, you probably are a little bit impaired cognitively, right? And that's kind of what I think that represents, even though it's kind of a bizarre example. I think they they did 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, cuz 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 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 worse the liquidation is when it fully 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 Alameda, you know, 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, right? So this is these are the kind of like death spiral effects that we saw with Luna. This one is not as extreme. It's not as reflexive, right? Maybe the multiplier if you if you want to quantify it, the the numerical value of the death spiral effect is is lower, but it's still, you know, let's say greater than one, greater than some critical threshold in which these kinds of spirals can happen.

Because honestly, you know, a $500 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 an exchange. That that should not happen, right? If things were constructed properly. And then uh there are also, you know, uh suspicions that, you know, Alameda had unique accounts which were could not be liquidated uh on FTX. And 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 they've uh they there are screenshots of this um document. It's called the CLP program, and we've also heard about it ourselves. Basically, I I think it's it's in Japanese or uh I forget what language, but basically it uh I will 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 the platform where they have certain 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 their risk checking system.

So so, you know, basically from our study of their um of their systems, there's two queues 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 the API and send them packets. There's two queues. 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 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 a 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 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's stops and pass that information to Alameda to go run people's stops or to 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. Just really depends on, you know, just how much, you know, how 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.

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So Jesse what do you think happened to all this money? How could there be this much missing? It's kind of crazy. You know, I wonder I wonder how much of it was just lost through market making. You know, 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 um if their markets weren't liquid that 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, if they were market making a bunch of these coins, they would have been holding those coins, but it seems like, you know, maybe Luna was was like the start of this for them, like the real liquidity crunch. And you know, there's 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 Kraken for example, you know, when we we look at sort of like the equity value of somebody's account for like margin trading. You know, we look 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 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 like liquidate that asset. Like it might be very volatile or it might be illiquid markets. And you know, if FTX 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 dollar loan against this asset that you know, there's like 50 million dollars 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 lend out. You would you would lend out like up to 50 million dollars or something like that against all against all the FTT or against you know, 500 dollars worth of FTT if you market at the at the current price. But because they were lending to themselves they obviously like 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 the lender. FTX never should have lent Alameda client funds at like a one-to-one ratio basically. You know, they should have marked it down like 95% really.

Uh to to even be reasonable. You know, I think they probably just basically took out a bunch of leverage bets on on coins that ultimately just crashed and you know, 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 uh you know, no one Kraken hasn't bought me a $30 million penthouse. $30 million loans. since Kraken is still around, I think maybe you are working at the right exchange. Yeah.

We'll see. We'll see. Hasn't played out yet. Um yeah, maybe just to add to what Jesse said. I actually read um their margin docs and basically there was a couple things that really stood out to me at FTX, which is um there 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 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 to short it, right? Like even when they started and they opened their books for FTT, they started with the spot market and it took up a lot of time and a lot of lobbying by their customers to introduce a perp 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 the spot and the futures and the 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 um now coming out. You know, 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 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 with the the money and then he says something like, "Oh, yeah, you know, it we had these accounting issues. Um like for instance, oh, FTX 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 sub account for FTX 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, "Woah." Like customers were literally sending their money straight to Alameda. And so I just feel like it appears at least from that uh 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 or Yeah, I think that's um exactly what happened. Now that I'm thinking back, I think I remember that too, right? So, like, you know, that 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 FTX OTC, 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 if there's it's it's not clear that in the back end everything is being tracked correctly. Like this whole sub account issue, you know like like you know, I'm I'm I'm sort of reminded of like there have been other times with other exchanges where it's like you know, just we we we've managed to catch money disappearing out of the account. And I'll and I'll give you one example, which is pretty bizarre, right?

Which is that one of our counterparties was settling a trade with us and we told them to settle it to I don't want to mention the name of the exchange to this this exchange's account. But instead of sending Bitcoin, they instead of sending the tether to their the tether address, they sent it to the Bitcoin address, right? So it's still it's still recoverable cuz it was still Bitcoin-based tether, right? At the time. Um but you know, we need the exchange to go and like figure out how to like 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 charged us or not. Um but they charged us twice. So I'm sure like these kinds of things like happen all the time. I I

remember doing a trade with Alameda just like some of the somebody has said on crypto Twitter where they settled their leg of the the trade but forgot to remove money from our account. And we had to go ping them and say, "Oh by the way, um you know, I think you guys forgot to take money out of our account. But you know, trade settled on your side so go feel free to do that." And they're like, "Oh, sorry. You know, we forgot, you know." So it was just a lot of that kind of like sloppiness everywhere. And I'm even reminded of another anecdote where I was talking with basically one of the employees at FTX and uh I was asking him, you know, cuz 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? You 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, what why is that the case? Well, he says, well, it's just really messy because like all the bookkeeping and stuff, you know, it's just very hard to say exactly you know, what the right marks are and what exactly the P&L is and any time So, you know, right now it's just like it's just Sam's money. As I'm remembering all of this, I feel like the writing was on the wall, right? But it's just like each of these instances are just so far apart from each other and each one like not suspicious enough by 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 the using of like other bank accounts is something that some exchanges have done, you know, Quadriga did it extensively. And I I think in part, you know, it's just it's a problem for the industry that that it's very hard or at least historically it 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 you can get a bank account now. They're friendly friendly banks serving crypto.

But for a time, yeah, it certainly was was very difficult and some exchanges been the case when FTX 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, it's 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.

You know, 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. Yeah. 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 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, that this was like I think even before the Dwolla days. I'm just blanking on the name of that exchange, but Trade Hill? Was it Trade Hill? Yeah, maybe Trade Hill. That sounds like a trade hill maybe. Okay. So, I have like one kind of perhaps projection. I'm curious to hear what you guys think of this um 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 DeFi.

But I wonder what you thought of that because, you know, the history of 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 cuz Jesse, as far as I can tell, I think you are an advocate of this mantra, 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 I was just

curious for your thoughts on all that. Yeah, I hope that more people take their coins off and and self-custody. I know not everyone's comfortable with it, you know, and if if you've only got 20 $20 worth of Bitcoin and you don't really know what you're doing, maybe that's a reason to leave it on cuz it's not that much to risk, but also, you know, it's not that much to risk on the other side to to to self-custody it. I do hope that more people learn about that and try to do that, you know, from 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 Kraken account, that's

just a liability for us, you know, we're we're vaulting your assets for free, basically. So, we're taking all this liability, you know, in the event that we get hacked or, you know, something happens to your account. So, it's just risk for us and and why would we want to have this risk if, you know, we're we're not getting anything from it, you know? So, if you're not trading with your coins, you're not staking them, you know, there are there are non-custodial ways to stake as well. My preference is you just take it off because it's just risk that that we don't need and we're not benefiting from. And 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?

Um yeah, I think it is onerous for for many people, especially if you're if you're actively trading, you know, 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 like net withdrawals. And I think that means people are 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 in the next bull cycle, there'll 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, you know, unfortunately, there'll probably be like another hard lesson to learn again at some point. I think we as an industry, you know, 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 to measure venues other than just like trading volume, you know, like maybe some kind of like degree of like seriousness of of the business or longevity of the business. You know, I think one of the the big things that caused FTX blowup to be as bad as it was was that, you know, even people that were experienced GOX, you know, their their worst-case scenario was like a hack. Like people just thought like the hack was the way that like, you know, FTX would get taken

down. But because of all of the the media hype, the media fluff pieces, the political contributions, you know, all all of the people that Sam seemed to be hanging out with, you know, the the celebrity endorsements, all this stuff. I think that helped to build up this status, you know, which, you know, just like Bernie Madoff, basically uh and just like Elizabeth Holmes with Theranos, 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 um you know, other elite people." You know, that was obviously wrong. I mean, he sort of bought his way into that

perception with client funds. And you know, I think 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 and I think thought, "Wow, he 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 uh 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 clients' money to buy all this status. You know, I think that's maybe like a new thing for the industry. I don't I don't think we've had like a legit bad act actor like that before who just intentionally stole client funds. You know, I think everything else everyone else has gone

down as has been hacks, I think. But I don't know, Kevin, correct me if I'm wrong. I don't know, Big Vern was a bit shady, I would say. That's true. Um Wait, what what's that Big Vern? I don't know what that is. Kripsky, that was Kripsky. 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, probably. You know, all these 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 the other big one that's known. But you're right, I can't think of And then there's the one guy shows up as 0xSifu, right?

This is so wild. The timeline's just wild. But but yeah, no, I 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 any of the other Sam coins like Serum 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 in Crypto 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 um and stuff like that. And Jesse, I don't 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 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 I think so, you know, I mean, it doesn't vindicate an- anyone any more than, you know, someone who thinks that Tesla's the the best car company and then the Bernie Madoff situation happens and a bunch of other, investors who were who were not invested in Tesla get wrecked. You know, I mean, this this really doesn't have anything to do with Bitcoin or the other coins or DeFi. This is just a straight-up fraud,

Ponzi, theft. You know, I mean, he he could have been custodying anything. It could have been Pokémon cards or stocks or whatever. You know, he's just had custody of of client assets and uh he stole them. And that's it, you know, and it is it's unfortunate that um 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 DeFi and crypto and say that that somehow this proves that, you know, we we need more regulation around DeFi. You know, if anything, this proves we need more regulation or better regulation around centralized venues, you know, which

which 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, Kraken or Coinbase, you know, weren't doing which which would have allowed you to kind of remain on shore in the US? Mhm. Yeah, so I mean, we were getting kicked off cuz, you know, we're basically a US-based um firm. And then um you know, I think there's been a lot of improvements uh you know, the Kraken's uh sort of matching engine, API, and just overall systems recently. Uh but, you know, one of the reasons we um slowed down our trading earlier on was just because, you know, there was more liquidity on sort of like first of all

on derivatives in general. Uh and then second, it's nice to have like being able to use like any asset as as collateral, that sort of thing. You know, just like if you were rejections, I think, through through uh the API and, you know, through the 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 serial, 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 FTX was kind of like little bit skirting regulation a little bit more um than let's say Kraken 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 coins and like ball products and leverage tokens and all sorts of like random stuff. And even though I don't like particularly like any of those products um or almost any of them, uh 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. Um so, you know, they'll bring some of their business over. So, you know, I think I think those are just some of the reasons, you know. Well, just see so this leads me to a question to you because um as you just implied uh 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 US have not come up with clear regulation here. The other kind of like flip side of that argument is that leaving FTX US aside, we haven't seen a US exchange that has seen this level of fraud. And so in that sense, um 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 US customers or if you think you know, this kind of lack of regulation that's specific to crypto has hurt US customers. I think overall hurt. You know, it basically forces people to to go offshore for things that they otherwise would be able to get, you know, in the United States. Um just take like futures trading for example. It's it's not available in the United States. Um trading certain tokens which the SEC would probably call securities is not allowed in the United States and 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 there's no license. And so the SEC would say, "Yeah, there's just no way to do this this activity period in the US." Unless there's a change to the law which explicitly contemplates this this new activity. Uh so so people are forced to go offshore because the domestic businesses are prevented from offering these services. And um you know, Coinbase even went to the SEC to ask them if they could offer this like three or four percent yield product. And uh you know, seemed like a very conservative product and um 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 US

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 your 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 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 um you know basically comes down to like laziness and 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 to do what they want to do. Uh 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 uh like my thought was oh maybe all of this makes Coinbase feel better about the fact that they didn't end up launching the 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 FTX was offering 10% like clearly the methods they were doing to using to do that were risky. So Yeah well they were loaning Alameda money like 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 I think you can do in in conservative reasonable ways without taking a lot of risk. They could even be you know doing it internally you know like Kraken has a has a margin program basically right? So we have a a pool of funds that go into the the margin pool and clients are effectively borrowing that on the exchange to trade on on margin and um and we could we could easily offer three

or four percent returns if we were able to open up funding the margin pool to clients because the the margin roll overs are roll overs are like 20% a year or something like that you know so we could easily do that without having to go outside of our system and without having to trust a third party. You know it's all like kind of self-contained and we have full over collateralization and and liquidation control and all that stuff. So I think you can you can get numbers like that um especially in in today's interest rate climate, you know, without too much difficulty, but you know, to to even be prevented from from offering something like that even conservatively uh it's a huge problem and and I think the regulators don't acknowledge that and I think as a as a country we also need to understand like

what do we want our our public policy to be here and what do we want our national objectives to be here with crypto and and if it's to own more of the crypto business and and develop more of the the crypto industry domestically then we have to update these laws. And then we have to to do something for the the good actors, you know, we can't just say too bad when their offshore competitors are are outcompeting because they're able to to have a a better product because they're not enforced against. I I completely agree with Jesse. You know, I think um you know, in in some ways like even if like the US government's goal was like a little bit like 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, more than 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 I definitely agree. I think you know, governments generally been pretty heavy-handed um on on on regulation and and a lot of it's not directed at crypto. A lot of it is like legacy um

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, right? 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 US, uh which shouldn't be the case, right? Yeah, there is a lot of gray area, and the problem is that the regulators have have largely taken the approach that uh anything gray is black, and um you know, they they want to kind of capture as much control as possible. And for the businesses, um you know, we've we've disagreed with regulators at times.

Uh you know, we we might think a product is completely okay and legal to offer, and um they will have a different interpretation. Because the fines available to them are so high, you know, if we went to if we would took them to court to try to prove our case, you know, first of all, it might take years. But if they won, you know, the 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 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. Mhm. Yeah, definitely. And 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 is a good idea. In 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, you can we can do one of two things. We'll just keep your money, not rehypothecate it, and not loan it out. It just sits there and

does nothing, right? But, you know, you just take on absolutely no risk, completely segregated. Or, you can take a bit of risk, get that 3 to 4% 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 tail 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 think I think I don't think there's anything wrong with that kind of product. It's more just that well, there was kind of like malfeasance at FTX and then on top of

that, the 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, uh the borrowers posted collateral, then you're not able to do so without taking account equity values net. Yeah, actually it's funny cuz I was going to ask you what you thought was going to happen to crypto lending. I'll I kind 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 you

know, started with the cypherpunk ideals and then now these VCs have been very influential in the 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 FTX. So, all those things or 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. Um 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 Sam coins, right? Like if you're a VC and you're buddy buddy with SBF and you get allocation into all these different Sam coins, then like you yourself as a fund now get to mark up the book extremely high because the float 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 token itself, then you get to mark your carry at an extremely high overvalued price, right? And this is 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 these kind of like synergistic kind of like symbiotic relationship between the VCs

and Sam. Just on the Sam coins. And then, you know, kind of on the FTX side, I think a lot of VCs honestly are over 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 these VCs that surely didn't think that these there 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 SoftBank 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's 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 there's a lot of mixed incentives. And you know, as well as with the exchanges themselves, too, right? Not just FTX, but you know, exchanges in general, you know, there's all these kind of like dealings between, you know, the 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 Nash equilibrium 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 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 anything. Yep. There there are some investors that that passed on the FTX round and then said that they had they saw some crazy things. Um, you know, not all the investors share all this information. You know, I think they're obviously they don't they don't generally come out publicly when they spot something that that looks like a fraud because they might be wrong. You know, they don't want to get in trouble for um, you know, disparaging somebody and and get a lawsuit against them or something and and um, you know, 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 tipped the scales 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 for

sharing app is like you know, people get to steal the photos, which obviously has been pretty bad in some cases, but you know, it's not it's not like at the level of losing $10 billion, which was 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 on one other topic, uh which was the regulation, you know, and and I think we all have to come together as an industry right now and uh 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 we need to just be totally clear that, you know, we're not willing to give up any ground in in DeFi and that this is 100% just a a basic Bernie Madoff-style fraud. Uh you know, and just as Bernie Madoff was was not an indictment of uh the stock market or Wall Street, you know, no one was calling for more controls on uh the stock market or Nasdaq uh 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 to attack crypto.

So, we need to clear up that anytime 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, you know, by the 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. Uh you know, and I think it's not going to be targeted in the right place, which is how do we actually help consumers get uh uh access to safer products. Mhm. Yeah, I mean, if anything, this was a guy from TradFi coming into crypto, wrecking all the crypto people. So, if anything, we're we're the ones who got attacked here, you know, by uh by FTX

and Alameda. Yeah. So, yeah, completely agree. Um you know, Laura, um I actually just I had one question for you if you don't mind. Mhm. Which is having a you know, had a 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 all you know, all the mainstream media goes out and slams Jesse and Brian at Coinbase and you know, 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 I I consider myself to still be in media, you know, now I just have my own little media company, but um the other thing that I would say is to not paint um the media like it's

not a monolithic thing, obviously. There you know, good reporters, bad reporters just as like, you know, there's fraudulent exchanges and um 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 SBF earlier this week and you know, the the main reporter on that, he 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 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 was just like a lit 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. And it like there was internal fighting at Kraken basically is what the story was. You know, that story probably like in general what when people do stories and 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 um 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 I don't even know like a ton about what happened in those situations other than what I read there, but um maybe that is like one way that I would look at it. One thing that I I do want to say because obviously the media you

know, uh like you know, Forbes where I used to work put SPF on the cover, Fortune did as well. Um unfortunately, I don't remember if I read uh both of those pieces. It's sometimes 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 um would probably, you know, check that box off for you. You know, I mean like Sequoia being very closely affiliated with the you that that's like, "Oh, like this is you know, one of the the best and um 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 um or I shouldn't even take it I 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 or their enterprise is. 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 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 I can't remember if I said this on 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. Um nothing related to this, uh 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 worry 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 uh 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 prey 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 I feel like there's just a lack of awareness of like all the hurdles that you need to go 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, XYZ 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 Auletta at the New Yorker and he just couldn't get it 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 Ken Auletta was just like, well, 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 Dow 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 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 cuz 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 in Forbes, but you don't know how many how many publications I pitched before then. And you know, thing that 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 when Newsweek named Dorian 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, we're like, "Oh, 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 along 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 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. Um 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 will, you know, uh criticize you the moment that you you publish your your work. So, No, I appreciate that. No, I totally understand. Makes sense, yeah. So, okay. Well, um anyway, this has been so amazing. I know we're like way over time. Um but you guys, this yeah, has been awesome. Why don't you each tell people

where they can learn more about you and your work? All right. Um I'm Jesse Powell. You can learn more about me on Twitter. Uh my handle is @jesspow, j e s p o w. Yeah, and uh you know, you can find out more about us at @galois_capital on Twitter. Uh g a l o i s _capital. Uh 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 out the show notes for this episode. Unchained is produced by me, Laura Shin, with help from Anthony Yoon, Mark Murdock, Matt Pilchard, Juan Arredovich, Sam Sriram, Pam Shrimdar, Shashank, and CLK

Transcription. Thanks for listening. Mhm.