“an entirely preventable tragedy” • TechCrunch

If you want to better understand how big of a deal the recent collapse of cryptocurrency exchange FTX is, you could do worse than talk to venture capitalist-turned-entrepreneur David Pakman. After 14 years at investment firm Venrock, who led Venrock’s investment in digital collectibles company Dapper Labs and even mined bitcoin at home years ago, Pakman leaned on his passion for digital assets and joined the now seven-year-old last year. -old cryptocurrency company CoinFund.

His timing was either very good or very bad depending on your view of the market. Indeed, in part because CoinFund was an early investor in the collapsed cryptocurrency exchange FTX, we asked Pakman to join us on the phone today to talk about what has been a very wild week, one with FTX flying high on the ropes. ended with bankruptcy filings and the resignation of FTX founder Sam Bankman-Fried as CEO. Portions of the conversation continue, lightly edited for length and clarity. You can listen to our long conversation here.

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

DP: I think it’s absolutely terrifying on a number of levels. First, it was an entirely preventable tragedy. This failure of the company was not caused by a failed business, but by many wrong human decisions. The core business is doing great. Actually, he is [was] Highly profitable and growing even in a bear market. It is one of the most used cryptocurrency exchanges not in the US and with a large derivative business. He wrote a very good program. It’s not like he’s running out of capital or a victim of the macro environment. But his leadership, with almost no oversight, made many terrible decisions and got it really wrong. So the tragedy is how avoidable it is and how many victims there are, including employees and shareholders, and hundreds, if not thousands, of customers who will be affected. [by this bankruptcy].

No more “Isn’t this a crooked place with crooked people?” There are also those that have tarnished the reputation of the entire cryptocurrency industry, suffering from questions like This kind of Enron-esque collapse of one of the most highly regarded and arguably most successful companies in the space is really bad and will take a long time to pull off. But there are also positive aspects.

The positives?

Well, what positive technology is not failing; blockchains have not failed. Smart contracts are not hacked. Everything we know about the technology behind cryptocurrency continues to work brilliantly. So it would be different if it was a crash due to flawed software design or blockchains not scaling or major hacks that hurt people. The long-term promise of software and cryptocurrency-related technology architecture is intact. It is people who keep making mistakes. We’ve had two or three pretty big man-made mistakes this year.

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

I have no firsthand knowledge of what they actually do or don’t do. But it seems FTX and [the trading desk also owned and run by Sam Bankman-Fried] Alameda Research had relationships that were not known to all shareholders, employees or customers. And it appears that FTX took the FTT held by Alameda in large sums and they pledged it as collateral and made large loans against it by fiat. So they took a highly volatile asset and pledged it as collateral.

One can imagine that if the corporate board of directors or investors knew this, someone would shout, “Stop. What if FTT drops by 50%? This happens in high-frequency cryptocurrency, doesn’t it? So why are we promising this highly volatile asset? By the way, half a billion dollars worth of assets are in the hands of our biggest competitor [Binance]. What if they put it on the market?’

Therefore, it was not advisable to simply borrow against him. And after It appears that they have also taken the proceeds of this debt and invested it in highly illiquid assets, such as bailing out BlockFi or all the other private companies that FTX has recently bought. But they won’t be able to sell quickly if they need to pay back the borrowed proceeds. Apparently they also used customer funds and loaned it out or even gave it to trading arms. So all these things, I think if a council knew about it, ‘No, no, these are completely uninitiated people, we’re not doing any of these things, it’s too high risk.’

But considering VCs poured $2 billion into this company, there was no real mind-blowing board. Your company is among those companies.

I joined CoinFund a little over a year ago, so the firm’s investment in FTX was long before my time, and it’s a tiny, tiny amount. We’re almost at the cap table. We did not hold any FTT tokens.

But I will address your big question about the management of this company. I come from a traditional tech investment background, where maybe 99% of the time, there’s a standard set of governance that every entrepreneur agrees to when they take on venture capital, which is: there’s going to be a board of directors; the board will consist of investors and employees and possibly outside experts; control set will be; controls usually say things like, ‘You need to disclose any related party transactions so you don’t mix up the coconuts between one company and something else we don’t know about.’ The board also needs to approve things so that when you pledge assets as collateral to borrow money, you can’t issue new shares. [the board] to know about.

It’s mind boggling that none of these are here. And I hope that what comes out of this Enron-like moment in cryptocurrency is that any loose norms about not being given this level of oversight and governance as part of an investment are quickly dispelled.

Everything is at a very high rate. Crypto investor Digital Currency Group has reportedly given a $140 million capital infusion to its portfolio subsidiary Genesis Global Trading, as Genesis has about $175 million locked up in its FTX account. How bad will it be? What percentage of your own investment portfolio is affected here due to the failure of FTX?

How much does it affect us at CoinFund? This is irrelevant because we have such a small investment in this company from one of our funds, and we do not hold any assets in FTX* either in the US or in the international business. [As for broader implications], I don’t think any of us know the full, long-term impact of what’s going on here, because there’s some contagion, right? For example, when companies and investors have assets in FTX, how many other funds are there and how long will it take to redeem these funds? It must be assumed that everything goes into a massive bankruptcy process that lasts for several months or years. So there’s going to be that uncertainty, not just when you’re going to get the money back, but how much you’re going to get.

The vast majority of startups we invest in do not trade on FTX and therefore were not clients. But FTX was very useful in providing a launching pad for liquidating tokens and then either creating a market for those tokens or at least providing a place to trade and provide liquidity. A big part of cryptocurrency today is not only raising capital, but also the creation of tokens and the use of tokens as an incentive mechanism, which at some point requires those tokens to be liquidated and traded on exchanges, and FTX, it was one of the biggest places. tokens are bought and sold. Now you’re losing it.

How does this affect your day-to-day investing? I saw news that CoinFund is looking to raise a new $250 million fund, filing SEC filings on Nov. 1 after closing a $300 million fund three months ago. Are you going to have to put a pin on it now? I’m sure this failure makes LPs feel nervous.

We have spoken to many of our LPS over the past 48 hours. I think most people process. They also ask, as you asked, “what happened here?”.

I think the final capital will freeze a little here. The dust really needs to be cleaned. And capital is unlikely to be involved in such a tragedy.

It has a greater impact on initial evaluations. Valuing startups is an imperfect process seen by investors in illiquid markets, and one way to do this is to look at comparables. And one of the brightest star comps that almost everyone in cryptocurrency pointed to was FTX. If FTX is worth $40 billion, we are worth X. So you take the most highly valued venture-backed crypto company and it goes from $40 billion to zero, then who is the new cap on crypto value? It immediately affects the final stage evaluations.

* After our interview with Pakman, he learned that CoinFund was wrong when he said he had no assets on the exchange. It has a small amount of exchange assets in FTX International, which it is in the process of operating.

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