The People of Crypto (part 3 -- The Gray)

Welcome to the third and final part of my series about the people of crypto. Today, “The Gray”. First though, it’s time for two truths and a story.

Truths:

1. Researching the heroes and villains of crypto was entertaining, and it felt like reality TV.

2. The gray feels more like real life, with characters that are relatable.

One aspect that makes them relatable is a push-pull dynamic with authority figures. I have two younger brothers, and growing-up we had an inside joke about our parents’ rules. I broke the rules, the middle brother followed them, and the youngest brother… he didn’t have any. For example, in high school, my curfew was midnight, and most nights I was late (despite speeding the whole way home). My middle brother was never late. And the youngest brother, as we found out visiting home from college, was magically exempt from any curfew! As the benevolent leader that I was, I would often lecture my brothers about their good fortune for having me taking the heat. I saw it as my solemn duty to break down barriers. Imitating President Reagan’s speech when the Soviet Union was breaking up, I’d say “Mr. Gorvbachev… tear down this wall!”

Today’s characters – the gray – are being forced to act like rebellious teenagers, trying to find the balance between doing cool, new things and following the rules. They’re two of the largest players helping define an industry. To do that, they need to tear down a few walls.

Let’s meet them. First up is CZ.

Changpeng Zhao (CZ) – The Foe of FTX

CZ was born in China. After the Tiananmen Square massacre in 1989, when CZ was 12, his family moved to Vancouver. He went to McGill University in Montreal, and then he landed an internship at the Tokyo Stock Exchange followed by a full-time gig at Bloomberg in 2001. He was a software engineer, and his job was to help Bloomberg build futures trading tools. In 2005, he launched Fusion Systems, a startup dedicated to building automated, high-frequency-trading platforms for stocks. He caught the crypto bug in 2013, and he pitched other Fusion executives on pivoting to crypto. Here’s an excerpt from an email he sent them:

After launching a crypto services company and then being CTO of a China-based crypto exchange, he finally launched his primary claim to fame in 2017 – Binance. Eight months after launching, it was the largest crypto exchange by volume. His personal brand rocketed upwards too, and by 2018 he was on Forbes’ list of the richest people in crypto, with a net worth of nearly $2B.

So about the gray – what’s good and what’s bad?

What’s good

A few things. First, he’s built a platform that has stood the test of time. Despite the collapse of other exchanges and tokens, Binance has weathered the storm (as covered in People of Crypto Part 1: The Bad, linked here). Second, he’s taken steps towards transparency, trying both to legitimize crypto and also to reassure investors and customers during those collapses. He engaged Mazars, a global audit firm, to do the first ever audit of crypto assets in November 2022. While Mazars has signaled they will stop doing crypto audits for the time being (more here from TechCrunch), Binance’s move towards transparency is still a step in the right direction. Compared to FTX – where they adopted a youngest brother approach to rules (there aren’t any!) – CZ seems like a poster child for transparency.

What’s bad

In 2019, because of a security oversight, Binance was hacked and $40M in customer funds was stolen (more here from CNBC). And throughout the years, users have complained about bad customer service. But the most concerning issue is how CZ handled the FTX collapse.

On November 2, 2022, CoinDesk published a report claiming Alameda Research (the trading firm SBF owned) was reporting assets on the balance sheet that it didn’t actually have. On November 6, CZ tweeted that “due to recent revelations that have come to light, Binance will liquidate its holdings of FTT tokens.” And he added “We aren’t against anyone, but we don’t support people who lobby against other industry players behind their backs.”

This is a big deal. First, let me explain FTT tokens. Back in 2019, Binance invested in FTX alongside Sequoia and other large investors. It was a bit unique since FTX competed with Binance as a crypto exchange, but on its own not a concern. And then in 2021, Binance sold its stake back to FTX in exchange for $2.1B in assets. The assets included a chunk of FTT, FTX’s own token. If FTX were to be insolvent (as the CoinDesk report basically said), then FTT would probably definitely decline in value. So on the one hand, it makes sense for CZ to plan to liquidate the FTT he was holding (5% of the total market cap of FTT, or $580M at the time). Binance has stood the test of time by avoiding risks like these, but announcing his plans like this is a red flag. If you were CZ and wanted to sell FTT for the maximum price (to protect your company, users, and shareholders), you would probably avoid tweeting anything and quietly start selling FTT. But CZ took to Twitter.

Crypto prices were already declining and macro conditions were bad, so he must have known his tweets would prompt a massive sell-off in FTT. To me, this feels like a deliberate and unnecessary move to cripple FTX.

Now, on to the second tweet about lobbying behind people’s backs. As noted in “The Bad”, SBF had been working with politicians in Washington to shape any crypto regulation. The more time Sam spent with them, the more rumors circulated he was trying to advantage FTX and hurt his competitors. After the FTX blow-up had run its course, CZ admitted he believed the rumors. So again, he’s kicking Sam and FTX when they are already down.

Those attacks made his next announcement very surprising…

Hang on, what!? For those that have not been on crypto Twitter, it is generally a ridiculous and entertaining place, with memes flying around faster than me on my way to miss curfew. When this announcement came out, people lost their minds. Then, one day later, on Wednesday November 9, he announced Binance had backed-out after having done high-level due diligence and being concerned about the size of the balance sheet hole FTX had.

It’s like the scene from the Lion King, where Simba (me) thinks Scar (CZ) is going to help Mufasa (SBF) off of the cliff. Instead, CZ lets SBF go, and FTX (a $32B crypto empire) crumbles. It’s hard not to think there was at least a little ill will here. Even if CZ’s later move to save/buy FTX was legitimate, the early move to tank FTT and call-out lobbying was aggressive (and exacerbated the need for an FTX savior).

Brian Armstrong – The Rich Rebel

Brian was born near San Jose, CA to two engineering parents, went to Rice, and graduated in 2005 with degrees in economics and computer science. Early in his career, he worked as a software developer at IBM, and then he made the mistake choice of becoming a consultant. He learned about Bitcoin in 2010, joined AirBnb in 2011, and took on a few side projects, including a way to buy and sell crypto online. That project got admitted to Y Combinator in 2012. This meant $150K in funding, and the start of what would become Coinbase.

Over several rounds of funding, Coinbase’s final private valuation was around $8B, and when it IPO’d in 2021 its end of day valuation was $86B. Along the way, Armstrong became a tech superstar, appearing in ranked lists from Fortune, Time, and Forbes. At 40 years old, he’s one of the richest people in crypto, with a net worth around $6.5B.

What’s good

He’s taken the Giving Pledge (launched by Warren Buffett and Bill Gates, it encourages the wealthiest people in the world to give away the majority of their wealth). As we know from SBF, there’s no way to be 100% confident this is for real (his effective altruism was all talk and no walk), but at a minimum Armstrong is signaling the right things. Also, he’s taken an interest in helping build things outside of crypto that will help humanity moving forward. Specifically, he funded ResearchHub, which is a visionary way to revolutionize research. Rather than the beaurocratic processes, opaque funding, and slow-moving progress that characterize most scientific research today, ResearchHub takes a different approach. It’s a tool for open publication and discussion to make research more collaborative. Lastly, he helped incubate GiveCrypto.org, which lets users make donations to help people living in poverty.

What’s bad

Like other tech CEOs, Armstrong has sometimes failed to think ahead to how people will abuse this new tech (cough, Facebook). As we know from Part 2: The Good, he failed to prevent insider trading, which was finally flagged by crypto Twitter legend “Cobie”. Coinbase launched an investigation, and in July 2022, a former Coinbase employee and two others were arrested and charged. This breach of customer trust was unexpected coming from such a well-established player, especially since they had the technical know-how to prevent something like this. For legacy financial services companies, regulation and employee trainings hammer home the penalties for insider trading, and companies put in safeguards to avoid those penalties. 

Beyond missing those simple safeguards, Coinbase actively thumbs its nose at regulators. In their 2022 Annual Report, they added some new language saying they might choose not to comply with SEC or other regulators’ orders. Exact words:

This isn’t really a hypothetical. The SEC has already made it clear they think that staking (locking-up crypto assets in exchange for a yield – like a bond) is an area of concern. In February 2023, they announced that Kraken (another crypto exchange) needed to cease all staking activity. Kraken not only complied, but they also paid $30 million to the SEC as a settlement (more here from Reuters). But Coinbase still supports staking, and so does Binance. When regulators are cracking down, and your industry has just suffered a huge fraud, it seems like a really stupid time to be a rule-breaker.

On the other hand, it’s worth taking Armstrong’s perspective for a second. Staking is a relatively safe crypto asset class for customers (not subject to the same level of volatility as others). Staking is also important to Coinbase’s bottom line – it was 8.5% of revenue in the US for the year, totaling $275M. In a tough economy, when they’ve already had two rounds of recent layoffs (18% Jun 2021 and another 20% in Jan 2023, total of 2,050 fired), protecting that revenue is critical to staying afloat.

When crypto prices were high in 2019-2020 – and retail and institutional investors were getting involved – regulators were silent about specific regulation. But as it stands, prices and sentiment are down in every possible way, and regulators are active. Maybe they can afford to be active since those investors got burned and won’t stand in the way. If that’s the case, Binance and Coinbase might feel a responsibility to stick to their guns, defending their products where it makes sense. If Armstrong is legitimately worried about regulators over-stepping and taking advantage of timing, maybe his view is that a few rebellious teenagers are exactly what the industry needs.