On Cryptocurrencies and The Sam Bankman-Fried/FTX Affair
As of November 29, 2022, Sam Bankman-Fried, the disgraced CEO of FTX and Alameda Research, is still scheduled to speak with business journalist Andrew Ross Sorkin at the annual New York Times Dealbook Summit. This shouldn’t be too surprising. Bankman-Fried, like many fraudsters before him, used the money he stole to buy political influence. And now it seems this money was well spent.
Over the next several months many will try to figure out how precisely Bankman-Fried fooled so many. Some will investigate conspiratorial explanations focussed on his political connections and connections to Ukraine. There may well be very fishy reasons for how Bankman-Fried succeeded in rapidly accumulating so much wealth and power. But on the face of it, the mechanics seem straightforward. Bankman-Fried ran a hedge fund and a cryptocurrency exchange. His fund was beginning to tank, and rather than simply close it down — which would have been painful but not illegal — he doubled down, and withdrew funds from the accounts of users of his cryptocurrency exchange to prop it up. Like many gamblers on binges, he probably felt he could keep everything afloat if he could just win one big bet. Probably he even intended, at least on some level, to eventually return that money he had taken. We’ll never know.
The popular story is that Changpeng Zhao, CEO of rival cryptocurrency exchange Binance, lit the match that set the FTX empire ablaze. But the real first mover was the cryptocurrency news publication Coindesk, which obtained an FTX balance sheet that looked suspicious. It was only after Coindesk’s article was published that Zhao tweeted that he would likely sell his holdings of FTX’s native token FTT. It’s worth pointing this out because while the legacy press cozied up to Bankman-Fried for his supposed philanthropic endeavors, and indeed the financial support that he directed towards it, a new independent press performed real journalism. It’s heartening to see that this work can still be done.
Now that Bankman-Fried’s companies have tanked, the legacy press has folded his story into a narrative about the dangers of cryptocurrencies. This gets things backward. Like other cryptocurrency exchanges, Bankman-Friend was taking a technology meant to liberate people from depending on a trusted third party and turning it back into traditional banking — with all the attendant behind-closed-doors wheeling and dealing that traditional banking involves. It’s as if someone removed the airbags from his car, crashed it and died — and everyone blamed the airbag industry.
In order to grasp this point, it’s necessary to understand the fundamental ideas behind cryptocurrency — which too often vanish in the mist of price speculation or propaganda. A government, broadly speaking, is a corporation with a monopoly on the legal use of violence within certain borders, or, in the case of hegemonic powers like the former Soviet Union or the United States of America, well beyond its own borders.
The other thing that a government has a monopoly over is the coinage of money. In the US, for instance, private coinage of money has been illegal since 1864. This makes the government a unique kind of corporation. If, for instance, you would like to make a new type of tissue, Kleenex might employ multiple strategies in order to stop you from buying advertisements arguing that your tissue is flimsy and useless, to leveraging their entrenched status and cash reserves to discount their own tissues heavily, effectively forcing you to operate at a loss. Or they might simply work to improve their own product, and let the consumer decide. But nobody will arrive at your house with a gun and put you in jail cell for inventing a new tissue.
But that’s precisely what will happen if an American citizen tries to invent a new method for exchanging goods. Many examples exist of attempts being made throughout history. Gold was one such attempt. But it was actually illegal to own gold from 1933 to 1975 in the United States: The threat that it might overtake the dollar was too high. With the invention of Bitcoin, the landscape changed. The inventor of this new “cryptocurrency” was anonymous, so no single government could decide on the legality or illegality of his invention. Nobody had jurisdiction. Moreover, the invention was merely a computer program. A government can ban commodities, or metal currencies, but can a government ban a computer program?
A globalized world makes attempts at suppression much harder. No government controls the whole world — the World Police is a fantasy and will remain one. That means that sovereign nations are free to pass whatever laws they choose on the question of cryptocurrencies. To take three examples, China has all but banned the technology; the United States has pursued a strategy of incoherence, and El Salvador has recently passed a law stating not only that cryptocurrencies are legal, but that they are not securities — which implies that it is legal to invent new ones and that they do not incur capital gains taxes.
For all these reasons the main danger to cryptocurrencies is not their enemies but their false friends. Cryptocurrencies like Bitcoin and Ethereum function in a peer-to-peer manner. When I send Ether to a friend from my wallet, no huge cloud software service is necessary. But governments and government-friendly actors, like Sam Bankman-Fried, have managed to corral large swaths of users into centralized exchanges. These are systems that effectively rebuild the old banking system on top of this new technology. Bankman-Fried and FTX persuaded users to deposit real Bitcoin and Ether into their exchange. Then they pretended that the money those users had deposited remained there. In reality, Bankman-Fried had withdrawn it in order to speculate with it. In the United States, banks do the same thing; they are the only entities legally allowed to do so.
Bankman-Fried and other exchanges offer a devil’s bargain: Users get convenience, but they give up all the features of cryptocurrency that made it revolutionary in the first place. And these are not the only false friends. Metamask, the most popular hot wallet for Ethereum transactions, will soon begin collecting the IP addresses of all its users. And even less shady exchanges such as Coinbase still require their customers to submit deep “Know Your Customer” information, and reserve the right to freeze the funds of anyone who violates their terms of service.
Strangely, since most people in the developed world own at least one computer, the main bottleneck for cryptocurrency is the centralized structure of computer services. Whereas at the beginning of the internet age, computer users operated in a peer-to-peer way (e.g., someone on one computer would send a message or share a file directly with someone on another computer), today almost all sharing is fake. You don’t actually share a picture when you go to Instagram, you merely add a picture to a huge database on Instagram’s servers, and then your friends log in to that huge database to view those pictures. Same thing when you send an email on Gmail, or write a DM on Twitter. In each of these cases, you’re merely renting a share on someone else’s system.
To use cryptocurrencies how they were meant to be used, we’re going to have to go back to using computers that we own, instead of logging into big centralized data servers owned by massive corporations. The main project working on in a holistic way at the moment, is a new operating system and network called Urbit. The alternative is more Sam Bankman-Frieds.