Sam Bankman-Fried is the Founder and CEO of FTX (a well-known crypto exchange) and Founder of Alameda Research (a quantitative cryptocurrency trading firm). Sam has been at the forefront of crypto’s surge to the mainstream over the past 5 years, and even detractors of the young billionaire can’t deny his influence on the space. The position Sam holds in the cryptosphere is particularly why we should be paying so much attention to his regulatory proposals, and why we should try to understand what he is proposing in practice.
Below, I break down the high level themes Sam wrote about in his recent post highlighting Possible Digital Asset Industry Standards, and explain why it’s so important the industry as a whole gets ahead of the ball here. Specifically, we’ll cover Sam’s views on (1) Hacks and Accountability, (2) What is a Security, (3) Consumer Protections, and (4) Stablecoins.
**I’ll cover Sam’s commentary on (i) Sanctions, Allowlists, and Blocklists, (ii) Tokenized Equities, and (iii) Defi in Part II of this blog post.
Hacks and Accountability
– “Binance Exchange Hacked for 570 Million” – “DeFi Protocol Wormhole Loses 325 Million” – “I didn’t want to post this, but got drained last night 😔” – “Help! Someone stole my Degen Trash Panda and it’s currently listed on Magic Eden DON’T BUY!”
The list goes on and on and on. These hacks aren’t new and they’re not going anywhere. Sam’s proposals on tackling this issue:
- Publicizing widely seen lists of “suspicious” addresses associated with security breaches — allowing centralized and decentralized protocols alike to freeze out those addresses.
- 5-5 Standard for bug bounties. Hackers often enter into negotiations with platforms they hack to return some funds, but keep the rest as a “bug bounty” and be granted immunity. There isn’t currently a market standard amount to keep, and that can cause very turbulent negotiations. The 5-5 Standard Sam proposes would allow the hacker to keep 5% of the hacked amount and return the rest, assuming that the amount they returned would be enough to make consumers whole (if it is not, then AT LEAST returning the amount to make customers whole is required). Sam stresses this must be done in the first 24 hours and not as a backup plan, if the hacker doesn’t comply, then they should be treated as a bad actor.
Both of these are reasonable suggestions, though I suspect some hackers may not go along with the latter suggestion so easily (unless law enforcement starts crushing perpetrators, immunity seems to carry low value atm).
What is a Security?
Ahhh the age old question that this blog and the crypto community loves (🤢🤮). Despite being reviled by this question and the complexities it brings, it’s one that will need answering, and need it soon.
Sam doesn’t really go into what he believes should or should not be a security, but he does give an inside look at FTX’s current analysis on the topic before they list. Essentially, FTX performs the Howey Test on each asset it considers, and if the test deems an asset a security they treat it is as such (refraining from listing in the US), and if not, then they treat it as a non-security commodity (think BTC, ETH, etc.).
Sam mentions they don’t want security classification to end up being a bad thing in the future, but that’s about it (a fair and neutral statement — I think we all do — but to what extent that’s a possibility, I’m not sure).
But Sir Esquire, WTF is the Howey Test!? The Howey Test comes from a case called SEC v. W.J. Howey Co. where the SCOTUS came up with a test to decide if a given asset is an investment contract and thus a security. The test basically says an investment contract is: (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit, (4) to be derived from the effort of others (I know what you’re thinking, if the SEC is watching BitBoy then everything is a security). If you want more detail on the case and the rules, Investopedia has a good write up here.
Customer Protections
Sam pretty much says it all in this snippet:
“Investors should be given clear, comprehensible information describing the asset they are considering, and regulators should crack down on any that misrepresent or make materially misleading marketing claims.”
I mean, hard to disagree with that — I think everyone is sick of the constant BS shilling. Veterans are used to tuning it out, but new entrants will continue to get fleeced, and as crypto gets more and more mainstream, that has potential to paint the community in an awful light.
Next, Sam goes on to disavow credit enabled leverage trading. He comments that systems should not allow retail investors to “lose more money than they have deposited on a platform and any credit extended to by a platform should be given extreme scrutiny if its failure could result in socializing losses among other innocent investors on the platform.” In theory, this makes sense (see the financial crisis of 2008). However, this will limit the feverish-upside-seeking-degenerates that do make up a healthy portion of the crypto genome (maybe not a terrible thing).
The other major theme of Sam’s notes here are on suitability. Simply, who should have access to certain financial products and why. This is where I think Sam will see, and probably has seen, most of his blow back. A lot of the reason people despise the SEC is because the SEC tries to “protect consumers”, but ends up enabling the rich to get richer, while simultaneously throttling the less affluent’s ability to make high risk/high reward plays (think accredited investor classification). Now, I know this isn’t what Sam is trying to do, and in fact, I agree with the basic principal that you should be educated on a product before you make a significant financial use of it. The question remains, though, is it your responsibility to protect your dollars, or someone else’s?
Well, if it’s regarding leverage on credit with no collateral, then it is probably the institution’s responsibly to prevent you from wrecking yourself so hard that you end up wrecking other innocent people as well. Sam goes on to say that there are different methods to determine suitability for certain products, listing: (a) net worth, (b) income, (c) knowledge testing, (d) product features (aka, not being a scam) and (e) platform discretion. He acknowledges the issues with net worth and income barriers (rich-richer, poor-poorer dilemma), and agrees that’s the wrong way to go. He goes through the other options as well, ultimately landing on (c), education assessed through knowledge-based quizzes, as the most appropriate determination of suitability.
I love this conclusion and I agree that if there must be a method to determine suitability, this is it. This will still annoy people, but the reality is it will make you a more informed market participant and will reduce the amount of people being scammed. A lot of people will have a knee jerk reaction to the suggestion of blocking certain people from using products and allowing others, but a further dive into Sam’s reasoning at least makes his conclusion rational, and not abhorrent on its face.
Stablecoins
*Cue flashbacks to UST with Do Kwon’s face fading to black*
But seriously, stablecoins offer invaluable upside to democratize payments, and Sam mentions this in bold and upfront. Sam’s major sentiment is that any true USD stablecoin should be backed by at least as many US Dollars or gov’t treasury notes/bills as there are tokens in circulation (not BTC LOL).
Sam also mentions that there should be KYC of traders participating in the on-ramp/off-ramp process (clarifying that this shouldn’t be necessary on minute transactions, but issuances and redemptions should be Bank Secrecy Act (BSA) level KYCed).
Conclusion/Why Should You Care?
Sam’s proposals here are suggestions for government regulation. Are they perfect? No, they’re not. Will they change over time? Yes, they will. Will I keep asking myself layup questions? 100%.
However you feel about Sam’s specific suggestions, we need to have this discussion and we need to establish norms as soon as possible. If governments can look at crypto and say “alright, it’s not the regulatory scheme our old wrinkled keisters would have come up with, but it’s working and there’s accountability” there’s a very high chance they won’t want to change it (mostly because fixing a non-broken thing takes too much effort). BUT, if they look at crypto and say “wow, this is an area rife with scams, enabling financial crime, and the average investor is over-levered and under-informed” they’re likely to come in and do something really realllllly stupid and regulate in a very painful way.
Agree with him or not, we need leaders in our space to start having these conversations and shaping the regulatory framework to our advantage.