Talking with David Pakman, a former entrepreneur turned venture capitalist, can help you better grasp just how big of a deal the collapse of the cryptocurrency exchange FTX is. After spending 14 years working for the investment company Venrock, Pakman—who oversaw the company’s investment in the maker of digital collectibles, Dapper Labs, and who once even mined bitcoin at home—leaned into his love of digital assets and last year joined the now seven-year-old cryptocurrency venture firm CoinFund.
Depending on how you interpret the market, you could say that his timing was either excellent or terrible. In fact, we asked Pakman to jump on the phone with us today to talk about this very wild week, one that began with high-flying FTX on the ropes and ended with bankruptcy filings and the resignation of FTX founder, Sam Bankman-Fried, as CEO. In part because CoinFund was an early investor in the collapsing cryptocurrency exchange FTX. The conversation has been lightly edited for length and clarity in the sections that follow.
Additionally, the reputation of the entire cryptocurrency business will be damaged, which already suffers from inquiries such, “Isn’t this a scammy place with a scammy people?” It’s just incredibly horrible, and it will take a long time to recover from this Enron-like breakdown of one of the most highly regarded and possibly most successful organisations in the industry. However, there are also advantages.
Positives
The good news is that neither the technology nor the blockchains failed. There was no hacking of the smart contracts. Everything we know about the technology underlying cryptography continues to function flawlessly. Therefore, it would be different if this breakdown occurred as a result of poor software architecture, blockchains that aren’t scaling, or significant hacks that resulted in injuries to humans. The software and technological architecture of cryptography still hold their long-term potential. It’s the individuals who continue to make errors. This year, we’ve experienced two or three quite significant human-caused errors.
There are several news articles available that provide a broad overview of what occurred in the crypto world. How would you describe it?
I’m not personally aware of what they actually did or didn’t do. However, it appears that FTX and [Alameda Research, the trading desk that Sam Bankman-Fried also owns and manages] had a relationship that maybe wasn’t disclosed to all owners, staff members, or clients. And it appears that FTX took FTT, their token that Alameda owned in significant quantities, pledged it as collateral, and took out huge loans in fiat against that. They so offered as collateral a very risky asset.
One might imagine that someone would say, “Hold on,” if a board of business executives or investors learned about that. What occurs if FTT decreases by 50%? It occurs frequently in cryptography, right? So why are we pledging this extremely risky asset, exactly? And by the way, our greatest competitor [Binance] owns the asset for $500,000,000. What will happen if they sell it cheaply?
Therefore, simply borrowing money against it was a bad idea. And it appears that they also invested the proceeds of this borrowing in very illiquid assets, perhaps in an effort to save BlockFi or any of the other private companies that FTX just acquired. However, it’s not as if they could easily run out of those if they needed to pay back the money they had borrowed. Additionally, they appeared to be borrowing money from customers and lending it to others or perhaps even to their trading arm. Therefore, I believe that if a board knew about all of this, they would say, “No, no.”
Everything has such a strong correlation. According to reports, cryptocurrency investor Digital Currency Group is apparently injecting $140 million into Genesis Global Trading, a derivatives company in its portfolio, because Genesis has roughly $175 million tied up in its FTX account. How terrible will this situation get? What proportion of your own investment portfolio is this failure of FTX affecting?
How much is CoinFund affected? It’s insignificant because we had no assets at FTX, either its domestic or global operations, and because one of our funds made such a little investment in this company. Because of the potential for contagion, I don’t believe any of us are aware of the full extent of the long-term effects of what is occurring here. For instance, how many additional money are there and how long would it take for investors and companies to recover those monies when they have assets at FTX? One must presume that everything is filed for bankruptcy in its entirety, which could take months or years to complete.
Startup valuations will be affected more immediately. Analyzing comparables is one method of valuing startups, which is an imperfect process carried out by investors in non-liquid markets. And FTX was one of the biggest star comps that virtually everyone in the crypto space mentioned. We are worth X if FTX is worth $40 billion. If the most valuable venture-backed cryptocurrency company drops from $40 billion to nothing, who is the new threshold for cryptocurrency value? The valuations of late stages are immediately affected.
Kokila Mishra
Priyanka Pareek