Crypto VC David Pakman on FTX: An “Entirely Avoidable Tragedy”

If you want to better understand how cryptocurrency exchange FTX just imploded, you could do worse than talk to entrepreneur-turned-venture capitalist David Pakman. After spending 14 years with investment firm Venrock, Pakman — who led Venrock's investment in digital collectibles company Dapper Labs and even mined bitcoin at home years ago — is leaning on his passion for digital assets and last year joined the now seven-year-old crypto-venture company CoinFund.

His timing was very good or very bad, depending on your view of the market. Indeed, in part because CoinFund was an early investor in the collapse of cryptocurrency exchange FTX, we asked Pakman to hop on the phone with us today to talk about this very week. savage, which began with high-flying FTX on the ropes, and ended with bankruptcy filings and the resignation of FTX founder Sam Bankman-Fried as CEO. Excerpts from that conversation follow, lightly edited for length and clarity.

TC: When we last spoke, almost two years ago, the NFT wave was just beginning. Now we are talking about a day when one of the largest cryptocurrency exchanges in the world just declared bankruptcy. In fact, he declares bankruptcy for 130 additional affiliates. What do you think of this development?

DP: I think it's absolutely terrible on many levels. First, it was an entirely preventable tragedy. This business failure was caused by a bunch of wrong human decisions, not a failing business. The core business is doing well. In fact, it is very profitable and growing even in a bear market. It's not like it's running out of capital or falling victim to the macro environment. But its leaders, seemingly unsupervised, made a bunch of terrible decisions and did the wrong thing. So the drama is how preventable it was, and how many victims there are, including employees and shareholders and the hundreds or even thousands of customers who will be affected [by this bankruptcy].

There's also the reputational damage to the entire crypto industry, which is already suffering from questions like, "Isn't this a scam place with scammers?" This kind of Enron-like collapse of one of the most beloved and arguably the most successful companies in the space is just plain bad, and it will take a long time to get out of it. But there are also positives.

Any positives?

Well, the good thing is that the technology hasn't failed; blockchains have not failed. Smart contracts have not been hacked. Everything we know about the technology behind crypto continues to work brilliantly. So it would be different if it was a collapse because of faulty software design, or if blockchains are not scaling, or if big hacks hurt people. The long-term promise of the software and technology architecture regarding cryptography is intact. These are the people who keep making mistakes. We've had a couple of pretty big human-generated errors this year.

There are many news reports describing what happened in broad strokes. How do you explain it?

I have no direct knowledge of what they actually did or didn't do. But apparently FTX and [the trading desk also owned and run by Sam Bankman-Fried] Alameda Research had a relationship that may not have been known to all shareholders, employees or customers. And it looks like FTX took FTT, which is their token held in large amounts by Alameda, and they pledged it as collateral and took out big fiat loans against it. So they took a very volatile asset and pledged it as collateral.

One would imagine that if a board of directors of corporate executives or investors knew about it, someone would say, "Wait." What happens if the FTT drops by 50%? This happens in crypto with high frequency, doesn't it? So why are we pledging this extremely volatile asset? And by the way, half a billion dollars of the asset is held by our biggest rival [Binance]. What if they throw it on the market? »

So even borrowing against her was misguided. And then it looks like they took the proceeds of that borrowing as well, and invested it in some highly illiquid assets, like maybe saving BlockFi or all these other private companies that FTX recently purchased. But it's not like they could sell them quickly if they needed to return the proceeds of their loan. They also apparently used customer funds and lent them or maybe even lent them to their trading arm. So all that...