Capitalisn’t: The Capitalisn’t of Crypto—SBF and Beyond

Zeke Faux: If your company has created something that is really popular with Chinese gangsters and human traffickers, you ought to reconsider how your company does business.

Bethany: I’m Bethany McLean.

Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?

Luigi: And I’m Luigi Zingales.

Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.

Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.

Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?

Luigi: And, most importantly, what isn’t.

Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.

Luigi: Over the past few years, the world—well, a big portion of it—has been transfixed by the rise and fall, and maybe rise again, of cryptocurrency. We’re recording this just a few days after Sam Bankman-Fried was convicted in New York, all of which begs the obvious question, is crypto a capital-is or a capitalisn’t, or something else entirely different?

Bethany: Good question, Luigi. As an aside, my favorite bit of testimony was when Carolyn Ellison, SBF’s sort-of girlfriend, said she’d had to prepare seven balance sheets. She said, “He,” meaning SBF, “suggested I should prepare some alternative ways of presenting the information and send it to him.”

Then Matt Levine wrote, “Zero balance sheets is hapless fraud, seven balance sheets is calculating fraud.”

I guess the jury agreed. Anyway, SBF, of course, is the public face of the cryptocurrency industry, or bubble, or fantasy gone wrong, or whatever it is, but it’s provided us with the inspiration we needed to talk about crypto. And while Michael Lewis wrote the book on SBF, a lot of reviewers have said that the better book is Number Go Up by Zeke Faux.

“Number go up” is a phrase in the crypto industry that, as Faux puts it, means that the price of bitcoin will go up because it has gone up. It’s a gorgeous circular argument.

I guess I was always somewhat skeptical of crypto—not because I knew anything, I think mainly because I didn’t. And I’ve always felt a little bit guilty about not attempting to understand it. And then came the blowup, and I felt virtuous instead of lazy, which was nice.

I really like Jamie Dimon’s description at Davos last year. He said: “I think that’s all been a waste of time, and why you guys waste any breath on it is totally beyond me. Bitcoin itself is hyped-up fraud. It’s a pet rock.” I love that, pet rock.

Anyway, I’ve never really been able to tell whether crypto was an ideology, an ultra-libertarian desire to move beyond sovereign currencies and central banks, a means of speculation, a way of democratizing finance, a real asset class, or all of the above. I still am not sure I know.

Luigi: It’s a little bit all of the above. But let’s get to some fundamentals because very often, the discussion is complicated by jargon. But if you strip away the jargon, the facts are relatively simple.

First of all, you’ve probably heard the term blockchain. Blockchain is a fancy name for something that looks very much like a Google spreadsheet. Imagine that in a Google spreadsheet, we keep track of who owns what between the two of us. That’s a ledger.

Imagine that both of us keep a copy of that Google spreadsheet. The problem is that we can try to go and modify it. So, it is written there that I owe you $100, but I go back and say, “Actually, I only owe you $50.”

Now, the beauty is—and this is an innovation that took place, actually, in the late ‘90s—cryptography found a way to basically make it, let’s say, impossible to modify that Google spreadsheet, particularly linking every change in the Google spreadsheet to one another, and in the process adding a seal, which is a cryptographic seal.

Think about the blockchain as a ledger that is, number one, secure, so it cannot be changed in the past, and, number two, is shared by everybody. You know, I know, and everybody knows what is in the ledger.

Now, you say, “OK, but what does this have to do with money?” And this is a small step, a logical step that is dramatic, that was the idea of Satoshi Nakamoto, who invented Bitcoin. The idea is that money is nothing else than trusted memory.

There is a population in Micronesia called the Yap that used to write all their transactions on a gigantic piece of stone. And, of course, this piece of stone could not be carried around and traded because it was too big. However, you didn’t need that, because in a small community, where everybody sort of trusts each other, what was written on the piece of stone was enough to determine who owns what.

In a sense, what Bitcoin is trying to be is this immutable ledger that everybody trusts because of the cryptographic characteristics. The beauty of it is that it’s naturally digital. In a world that is digital, we desperately need digital money. And the clever component, which is also its limitation, because then we go into how this is guaranteed . . . is that you could, in principle, say you have all the systems without a central authority.

Every form of money, in one way or another, relies on some superior form of authority that gives legitimacy to that money. The idea here was that technology would substitute the need for governance. That, to some extent, is the false element because this money is in fixed quantity. If we really want to all adopt it, we’re going to have a deflation, a massive deflation, of the price of everything in bitcoin. And deflation is very costly in all our transactions. We don’t want this to take place. So, this is a kind of money that can only be created by some computer scientists who don’t know monetary history.

Bethany: That’s a very interesting line, that it could be money only created by a computer scientist who doesn’t know monetary history. And also, it’s a fascinating example of the value of being interdisciplinary.

In order to help us and our listeners understand crypto, we thought we would have Zeke on our show. He’s way more skeptical about the industry and his characters than some other authors are. He writes this: “From the day I started digging into the crypto world, I had seen nothing but red flags. Well, why were all these companies based in infamous offshore regulatory havens? What was up with all these random virtual coins that were supposedly worth tens of billions of dollars? Was that just maybe a precarious foundation for the future of finance? Were they all scammed? From the beginning, I thought that crypto was pretty dumb, and it turned out to be even dumber than I imagined.” Take that, Jamie and your pet rock.

Welcome, Zeke.

Luigi: It’s worth starting with SBF. Were you surprised by the verdict or not?

Zeke Faux: No. The fraud here was pretty clear. Customers had gone to withdraw their money, and it was gone. There was $8 billion missing. I listened to him talk in circles about this. He tried to tell me that he’d screwed up, that he just wasn’t paying attention. He lost track of things.

But here was a guy who had dedicated his whole life to making money, who spent every day thinking about how to get as rich as possible. To believe him, you had to believe that he didn’t even have a basic mental estimate of how much money was going in and how much money was going out. Once the trial began, you had three of his top lieutenants and best friends, in order, testify: “I did fraud. I’m really sorry. And I did it with that guy, Sam, over there.”

Bethany: Was there even anything very complicated about this fraud in the sense that . . . When I was thinking about it, I was thinking of that old line about Russia: an enigma, wrapped in a something, wrapped in a something. And I was thinking that this is just a straight-up basic fraud. He stole people’s money wrapped in a new business with complex language and jargon around it and a somewhat complex set of rules. But in the end, he just stole people’s money. Is that too simple of a way of thinking of it?

Zeke Faux: Basically, no. And what was at the core of it was something that you will be familiar with. All the customer money that was sent to FTX was kept off balance sheet. It was not audited. It wasn’t looked at by the venture capitalists who invested in FTX, who should have known better.

And what we learned at the trial is that things were even worse than I had imagined. Within a few months of starting FTX, Alameda Research, Sam’s affiliated hedge fund, was treating it as a piggy bank and was taking the customer money and gambling it on another stuff.

If you’re a listener, and you’re not that familiar with this, basically, it was an exchange. You can think of it like E-Trade. Let’s say I sent in a thousand dollars to FTX, and I would buy a million Dogecoin. I’d open my FTX app, and I would see that I had 1 million Dogecoin. But, in reality, FTX had taken that money, had taken those assets, and lent it to the hedge fund, which had gone and made all these bets with it.

And for a few years, while everything was going great, when people went and took out their Dogecoin, they got their Dogecoin. But at the end, when a lot of people tried to take out their money all at once, it was revealed that FTX did not actually have the money that it was telling everybody was in their accounts.

Luigi: The shocking thing, if I understood it correctly, is that SBF had a very profitable business that was the business of the marketplace. If I got it right, it was making half a billion a year. And then he had attached to it a hedge fund that was taking too much risk. Generally, people don’t get in trouble when they have a very profitable business that they can detach and save. So, what went wrong?

Zeke Faux: Before I answer you, I’m going to tell you that one of the first times I spoke with SBF, this came up. He explained his crazy philosophy about effective altruism and how he was just making money so that he could give it away. He didn’t really care about how he made the money.

And I had said to him: “Sam, this sounds great. You have so much credibility in the crypto world. You could probably run a scam right now and make several billion dollars. Why don’t you? All you have to do is run this scam. And we could do it tomorrow, which is obviously better than waiting decades.”

And he said, “No, charities don’t want dirty money,” but also what you’re saying, which is like: “I have this profitable business. I’m going to make more money in the long run.” That made sense to me, and it was part of the reason why I did not think that Sam was running a scam, other than just having a crypto exchange where all the cryptocurrencies themselves were scams.

This is the misconception. FTX was not as profitable as he said. He claimed that FTX had this cutting-edge risk-management system. Part of FTX’s profitability and popularity was because it gave leverage to big traders. It would allow traders to trade with borrowed money. And it claimed it had this great system for preventing losses because it was risky to let people trade with borrowed money. But that was not true.

And, in fact, there was one incident where a trader took a huge loss on something called MobileCoin, something like $800 million. The risk-management system failed, and FTX should have eaten that loss, which would have erased almost all of its profits from inception.

But instead, they shifted the loss to Alameda, the hedge fund. Alameda was able to absorb this loss because it had infinite access to the customers’ money. I don’t think this was the only example, but just that one example, had FTX revealed that, it wouldn’t have been able to raise more venture capital because it would have shown that their risk-management system was no good.

But rival crypto book author Michael Lewis said in his 60 Minutes interview that FTX was a real, profitable business and sort of put this idea out there that Sam had sort of unnecessarily ruined it by taking these risks that he didn’t have to take. I don’t think that’s right. I think it’s closer to it was a fraud from the start.

There was this surreal moment for me at Bankman-Fried’s trial. He made the risky choice to testify himself. This opened him up to cross-examination. The prosecutor could then press him on anything he’d said in the past, including in all of the interviews he gave making excuses once FTX failed. And she said something like: “Do you remember saying anything about the relationship between Alameda Research, your hedge fund, and FTX, your exchange? Did you ever say that Alameda didn’t have to follow the rules in FTX?”

And he said, “I don’t remember.” She pulled out a hard copy of Number Go Up, walked it over to Sam, and was like, “Turn to page 242. Does this refresh your memory?” And she pulled out this part where he had said to me that Alameda did not have to follow the same rules as everyone else on FTX. “There was more leeway.” That was his exact quote.

It had struck me at the time that that was a pretty big thing to admit. That’s almost admitting to fraud right there. I didn’t hear this happening because it was in a sidebar, but the defense was like, “Judge, we would like to introduce our own book, Going Infinite by Michael Lewis.”

And the judge was like, “Well, what part do you want to use?” It was something that made Nishad [Singh] look bad. And the judge said: “That doesn’t sound very trustworthy. No.” And he didn’t allow them to introduce the other book.

Bethany: Wow. It is actually very Enron-esque, because in the same way, Enron took bad assets and shifted them off its balance sheet in order to avoid recognizing the losses, by using money from investment banks that it had basically forced the banks to give them. There’s an interesting parallel there.

Did it surprise you that so many people were so credulous when it came to SBF, from Sequoia to perhaps Michael Lewis, who you just mentioned? And if it did surprise you, what do you think it is about you that made you look at this whole industry from the beginning and just say, “What?”

Zeke Faux: Well, thank you for giving me so much credit in that question because I wish that I had been the one who had said, “Hey, this FTX thing is a scam.” But I was kind of won over by Sam, too, for, I think, the same reasons as some other people who liked him.

In his personal appearance, he looked like a college kid. But when he talked, he actually did sound like a grownup, and he spoke the language of Wall Street. He’d worked at Jane Street Capital, a very highly regarded trading firm. He never said bitcoin is going to the moon. He didn’t sound like one of these crazy crypto true believers. If you were a venture capitalist or investment banker, you knew there was a lot of money to be made in crypto, and you wanted someone who you could trust. He seemed like that person.

He had a great story, which made a lot of sense. He said: “At Jane Street, we would do all these trades just to pick up fractions of a penny. And the crypto markets are very inefficient,” which is true, “and we can just go and take that kind of Wall Street knowledge, and we can earn much bigger spreads on our trades.”

Similarly, he said that the other crypto exchanges had outdated technology, and FTX could come in and create this better product, gain market share, and that it would not have to take big risks. It could just earn fees. Sam would acknowledge a lot of crypto was a scam, but he’d say: “I’m going to still be here. I’m going to collect these fees. And if anybody survives in crypto, it’s going to be me.”

Luigi: But what is wrong with that logic? Because I have to say, it sounds very reasonable to say, I’m an expert arbitrageur at Jane Street, and then I apply this technique to a world of crypto that institutions are afraid to touch because of all the other aspects we’re going to discuss later. This seems like a no-brainer, so what did go wrong?

Zeke Faux: Even as you say it now, it kind of makes sense, and you think that it should work. Almost everyone that I looked into in crypto, what they would say to me was some version of that. “We’ve come up with this good trade. We’re very responsible.” Then, I would investigate, and I would find that they just could not resist the temptation to bet it all on prices going up and up and up. I think for a while, you could just make so much money doing that, people thought, why not?

I think when Sam got started in crypto, like in 2018, it really was easy to earn some reliable profits with these Jane Street techniques. But a lot of people came in and started doing that, and it became more difficult. It became tempting to just bet on the prices going up, because for a while, they were.

Bethany: It definitely does sound, from reading your book, that all cryptos are a fraud, if not an outright criminal enterprise, and you mentioned earlier that the things traded on Sam’s exchange were fraudulent, even if the exchange itself wasn’t, at least at the beginning.

Is that your view, first of all, that these things are all, essentially, fraud? And can you build a real business off the back of something that isn’t real? Was that ever a possibility, or was the fundamental flaw in the fraud of the whole thing?

Zeke Faux: I’m sure there are some decent ones hidden in there, but I think that if you have to round it off, saying that they’re all scams is not the worst assumption. Start with that assumption, and then let them prove to you that theirs actually has some sort of point.

I think that you could compare FTX to DraftKings or FanDuel or something like that. An honest FTX would just be promoting gambling, and most of the customers would lose their money, but for some reason, they just keep coming back, for fun or something. Casinos do make money.

Now, I think that the crypto casino was awesome for a couple of years because everyone was making so much money. And then once everyone started losing, I think people would stop coming to the casino. They’d say: “This casino’s terrible. Everyone just keeps losing all their money. And the people running the casinos, half of them stole all the money out of the back of the casino.” This is why I think that there will be no new crypto bubble to match this last one. But, yeah, the bull case is online casino, which is a real business.

Luigi: Yeah, but actually, reading your book, it seems that the casino is the right example because the fraud is the good-case scenario. The worse scenario is the criminal enterprise. You describe that some parts of the crypto world are actually very much interconnected with criminal enterprise, from scamming to even human trafficking. Can you tell us about that?

Zeke Faux: Yeah. I kept a file of these mentions of crypto in other criminal cases. There was a bust recently of Chinese fentanyl traffickers. There was a great story in the Wall Street Journal about a crypto exchange that helps Russians evade sanctions and move their money. Hamas had raised some money with crypto. And one that had gotten my attention was a Russian oil-for-arms trade. There was an intercepted message that was published by prosecutors, and this money launderer was trying to convince his customer they should use a cryptocurrency called Tether.

He said: “It’s awesome. You don’t need to give your name. It moves the money instantly, just like an email. You should try it. Everybody’s doing it.” This is clearly an important part of this crypto world. I wanted to investigate it, but my contacts in this Russian sanctions evasion were limited. But then, I came across a scam called pig butchering.

Basically, it’s those text messages that we all get that come from some mysterious stranger who says, “Hey, David, did you get the milk on your way home?” If you answer, they say, “Sorry for the wrong number,” and then, they try to befriend you. They reveal themselves to be an attractive person of the opposite sex, and then, they drop hints about how great they are at crypto trading and eventually get you to use crypto to send your savings to them. You’re hoping they’re going to teach you some great trading strategy, but in the end, they’re just going to take your money. Crypto experts estimate that billions of dollars are lost every year to these.

Now, if a crypto person was listening to this, they’d say: “Hey, that sounds a lot like Nigerian prince scams, romance scams. These have been around. Is this really crypto’s fault?”

They sort of have a point, but also the scammers have switched to crypto because it was way better for them. I played along with one in the book, Vicki Ho, who even talked me through it. She was like: “Oh, you don’t know much about crypto. No problem. Sign up for an account at Crypto.com or Coinbase, and you can use your credit card to buy some Tether coins.” And then she gave me a 32-digit address to send them to. And once I did that, there’s no refunds. The address isn’t associated with a name. I was able to instantly send my money to what I believe is a group of Chinese gangsters in Cambodia.

If I used a credit card, there’s chargebacks. The credit-card company will close your account if they figure out that you’re getting a lot of customers complaining about your scam. People use banks for scams, but you need someone to go open an account at the bank and accept your dirty money, and that person can get in trouble.

To the crypto people that say this existed before, I say, well, you have supercharged it, and the dark side of these scams is that the people sending the spam messages are often victims of human trafficking who work out of these giant office towers in southeast Asia, Cambodia, also Myanmar, and there’s thousands and thousands of people who are forced to spam people, forced to run these crypto scams, and who can’t leave unless they pay a ransom.

One of the themes in my book is that I never see crypto in use in the real world, and it appears to be good for nothing, but I get to the human-trafficking compound in Cambodia, and right at the entrance, there’s a closed money-exchange business advertising right on the billboard that they will trade Tether for dollars. And I’m like, this is some coincidence. This is the first time I’d seen Tether’s logo outside of a crypto conference.

If your company has created something that is really popular with Chinese gangsters and human traffickers, you ought to reconsider how your company does business.

Bethany: You mentioned Tether a couple of times. I think we share your disbelief in it, me mainly just because people have emailed me over the years saying, “You need to look into Tether.” Can you explain what it is and why you’re surprised it’s still standing, and what role Tether plays in the creation of this whole, at one time, $3 trillion industry? Is it the linchpin?

Zeke Faux: If I go and write a story about a hedge fund or something like that in the traditional financial world, I identify a couple red flags, like their top trader had actually lost a lot of money in the past at his last job and no one knows it, or their auditor is a one-man shop, and it’s not like the normal auditors that hedge funds use. With Tether, there were just so, so, so many red flags that it was hard to imagine that anybody did business with them.

It’s the one cryptocurrency that doesn’t go up. The coins are supposed to be always worth a dollar because they’re backed by real money in the bank. When I started looking into it, there were 50 billion Tether tokens floating around, and that meant that Tether was supposed to have $50 billion in the bank somewhere. But they were not saying where. They had been sued for fraud by New York’s attorney general, who had quite credibly shown that they had misrepresented their holdings in the past.

The CEO . . . Nobody had ever seen this guy. In crypto, usually the CEOs go to every conference, and they talk a lot about how great their coin is. This guy was never there. Some people speculated he didn’t even exist. I was told pretty quickly early on that the real power behind Tether was the CFO, Giancarlo Devasini. He’s from Milan, a former plastic surgeon who had had a checkered career in the electronics industry. He’d been accused of counterfeiting by Microsoft.

The company was . . . You couldn’t even tell where it was supposedly based. And they’d suggested they were regulated by the British Virgin Islands. I asked the regulator there. He was like, “No.”

So, Tether was sitting on this big pot of money. And at the time, interest rates were zero, so it was hard for Tether to earn money with its reserves without taking some risk. And I found that they’d invested a lot of the reserves in Chinese commercial paper in order to earn a slightly higher return, and also that they had lent big amounts of Tether to other crypto traders.

To me, this was like, wow, this doesn’t seem like a risk-free asset. I wonder if people will continue to trust it. And I was very surprised that they did. The crypto world didn’t seem to care. Even as almost every other company in crypto collapsed one by one, Tether held up pretty well. And now, their business model has been saved by rising interest rates.

Tether has grown to more than $80 billion. They still haven’t shut up those critics by providing the financial details that everyone has been looking for. But if you believe the numbers they are putting out there, they have most of their money now invested in US Treasuries. The Italian plastic surgeon’s shoestring operation is earning $4 billion a year in profit. It is one of the top-200 most profitable companies in the world.

Luigi: Yeah, it really seems to defy reality. In class, I have actually used in the past a statement from Deltec, which is a bank where they have some of their money deposited. There is not even the name of the person signing it. There is a scribble, but without a name underneath. And they say, “Oh, we testify that you have $1.8 billion in this account,” but they don’t say, what are the liabilities? You don’t know how they get to it. It’s the most bizarre thing. And this was 2018. So, it was five years ago, and they’re still standing. It’s unbelievable.

Zeke Faux: Yes. That letter, when I went to look into it, I called the chairman of Deltec, Jean Chalopin. He became wealthy from creating Inspector Gadget. And he was not, like, the money man who invested in the company that created Inspector Gadget. He literally did create Inspector Gadget. With his Inspector Gadget money, he had bought a mansion in the Bahamas, which you can see in the Bond movie Casino Royale. It’s the villain’s house.

I emailed him and said: “Hey, how about this letter? Would you be willing to talk about it?” And he said, “Sure.” And then I got to the office. He’s making a cup of tea, and he takes this book down off his shelf that’s about financial fraud, called Misplaced Trust. And he’s like, “Hmm, people do such strange things for money.” And I’m like, “Are you trying to send me some sort of signal?”

I actually do not think he was, but there were a lot of times investigating this crypto world where I just felt like, do you realize what great characters you are? Are you playing this up for my benefit? Jean was always great in that regard. He introduced me to Tether’s mysterious CEO and facilitated an interview.

We were in the Bahamas a different time. This book required a lot of travel to the Bahamas. I was standing there with Jean and with Jean-Louis van der Velde, the mysterious CEO of Tether. Jean said to me, “If you screw this up, I’ll kill you,” but with a big smile, and no killing will be done. He’s a gentleman. I was like, “Oh, great to meet you . . .”

Jean-Louis cuts me off and says, “The man who doesn’t exist,” since he was the mysterious CEO. And I was like, “Oh, you guys are great.” But he was not great in terms of answering any of the questions about Tether’s balance sheet or where it was keeping its funds.

Bethany: Is there a way in which the story you’ve laid out for Tether, that it kind of has become a real business with real profits, does that provide a roadmap forward for the industry? As goes Tether, does there go the whole industry? Is it too soon to write crypto off, or would you make a different argument?

Zeke Faux: It seems like they have built a popular business. And given that they pay no interest on the tokens, it’s a great business and very profitable. I question whether it is sustainable because there’s other examples of payments, new kinds of payment networks, that became popular for crime. Eventually, the operators of those networks get in trouble.

Just the other day, Cynthia Lummis, a senator, who actually is very pro-crypto, wrote a letter to the Department of Justice urging them to hurry up and charge Tether and also Binance, which is the biggest crypto exchange, for facilitating crime and money laundering.

It is hard to say what will happen to crypto if Tether and Binance get into trouble. I think that the crypto world is underestimating the potential problems this could cause, because hypothetically, if Tether did face criminal charges . . . Tether still depends on American companies to hold its assets because its liabilities are in dollars, so they need dollar assets.

It’s been reported that Cantor Fitzgerald is holding money for them now, and I wonder if Cantor Fitzgerald would still be willing to do that if the company got indicted, which is a possibility. Tether, of course, says it does nothing wrong in that it checks its customers and follows the rules, but I think they’ve created this system of essentially numbered accounts, and they’ve got this sort of . . . By saying it’s crypto, it seems kind of more acceptable. But I think the regulators might not buy that argument if it keeps coming up in all of these criminal cases again and again.

Luigi: Let me play the devil’s advocate. Because as my name and accent give away, I grew up in Italy with Giancarlo Devasini. I don’t know him, but we are contemporaries, actually. He’s a year younger than me. I remember, as a kid, calling the United States over the phone was a very expensive proposition. It was very complicated. You had to book in advance, and you would pay a fortune. Today, you speak for free. WhatsApp is the closest thing to a free lunch you can imagine.

Let’s move to the world of money. It was complicated and expensive to send money back then, and by and large, it has remained the same way. In 50 years, we have seen very little evolution in sending money across borders. And so, the idea, the vision that Facebook had of Libra, in which you could send money back and forth as easily as you can send messages, wasn’t that crazy. If the US authorities had let Facebook start Libra, today maybe we would be in a very different world.

Zeke Faux: I think you make a good point. Cross-border money transfers are cumbersome, but I think part of the reason comes from the need to comply with all these different international banking regulations. Even if crypto has created some shortcuts, the regulators might frown on that.

I would also say that there’s more fees involved in crypto transfers than you might imagine. You always have to put in your real money somehow and take it out somehow. There are usually fees on both ends, and you might pay a fee for moving the crypto as well. Once you do all that, it may be pretty competitive with the existing methods.

But I see your point that this makes sense in theory. You can certainly invent uses for crypto that sound pretty cool. I think what I’m trying to argue in my book is that we should judge crypto by what it has done and not what people say it might do.

Again and again, I would look into the claims made by these crypto companies and see that the companies were not living up to what they claimed. One example that’s relevant to what we’re talking about is in El Salvador, the president started promoting bitcoin. He made it a legal currency, and he invested a lot of money into creating this infrastructure that would allow Salvadorans to use bitcoin to make remittances.

Despite this official push and this big investment, very, very few people are using it for remittances. It’s something like 1 percent of remittances. And even though it kind of makes sense why you might want to use bitcoin for remittances, it just has had no adoption. What I think is that if the technology were really good, people would use it. It’s been around for years and years, and the adoption is still really low.

Bethany: Do you think crypto offers any larger commentary on the state of capitalism, in the sense that you could see it very much as a good thing? Capitalism is supposed to be creative, and much of what has happened in crypto is definitely creative. Or you could see it in a much darker way, that it’s very dystopian, that capitalism has become empty, and it’s very difficult to create anything productive, so we’ve created this whole made-up world of illusion and fraud out of some kind of desperation. Or neither of the above. What do you think?

Zeke Faux: Well, it’s definitely an argument for regulation. When left to their own devices, people do very unproductive things. I think it’s bad for so many people to spend so much time thinking of scams, pump-and-dump schemes, ways to knock off monkey pictures and create other monkey pictures that will lure in new, get-rich-quick monkey buyers. It’s sad just how much effort was wasted on all this stuff and how little came from it.

And the crypto industry right now is still arguing . . . Their lobbyists in Washington are saying Congress needs to pass a law that will create new regulations for crypto and enable the industry to grow in a productive way. But I do not think that’s necessary because simultaneously, the Securities and Exchange Commission is finally getting around to enforcing the existing securities laws and has been filing a number of lawsuits telling different crypto companies: “We have securities regulations. You cannot offer people investment contracts without making all these financial disclosures.”

Similarly, FTX was an exchange that was based in the Bahamas, so that it didn’t have to follow the rules. And I thought it was because they wanted to offer cryptocurrency trading and that they were in the Bahamas because so many of the coins they wanted people to trade wouldn’t have been legal to trade if they’d been in the United States. But also, it proved that it was a way for them to get out of all the rules about asset custody and financial disclosure for brokers. So, yes, I think it’s all one big argument for our hundred-year-old system of securities regulation.

Bethany: I think I’m all set. Luigi, do you have any more questions?

Luigi: No, thank you very much.

Bethany: Thank you.

Zeke Faux: Thank you.

Bethany: Luigi, did you hear anything from Zeke that made you think differently about his book or his views, or crypto as a whole?

Luigi: Actually, the most interesting thing I learned is that Michael Lewis was wrong in his book writing about the fact that the FTX component was profitable, and Alameda was not. Everything was unprofitable, at least because it was hiding some losses. I think that that was a very interesting insight.

The other insight that I got is that SBF’s idea to move standard arbitrage into the world of cryptos was a good idea initially, but it is something that a lot of people can replicate pretty fast, and he lost that hedge pretty quickly. Now, when you have a big apparatus and you have lost your hedge, you’re trying to find another one at all costs, and sometimes even at the cost of breaking the law.

Bethany: Yeah, I totally agree with you. I thought that was really interesting, too, because you’re always looking for the why’s of these things. And you’re right, it was a fundamental, gaping hole in the why. If you believe this idea that FTX was a solid, profitable business, then why? And so, this idea that maybe it was at one point, but as the arbitrage went away and he increasingly—or they increasingly—took risks and had losses, it wasn’t such a great business, makes a ton of sense to me.

It does, to me, make this fraud just like every other fraud, in the sense that, yes, it’s wrapped in this complicated language of cryptocurrency, but in the end, that’s always the story. Somebody doesn’t intend to commit fraud. It’s just that business becomes a little harder, and they figure out a way to plug a hole or a way to pretend to make the money that they’re supposed to be making and that they had made before.

And then something goes wrong with that, and then there’s a big hole and they think: “Well, I’ll make it back. If I just make the right gamble, I’ll be able to make it back.” The thing I really like that Zeke said, we do so often . . . and there is a great glory to our world in belief. Because if we didn’t believe and use our imaginations and have these grand ideas about the future, nobody would ever do anything. But I really like his core idea that, at this point, crypto has to be judged on what it is used for rather than these hopes about what it might be used for in the future. I think that’s a really interesting point. At this point, maybe it was always true, and we wouldn’t have gotten to the place we are now if it had been treated that way. But I think, for sure, now, going forward, it’s true.

Luigi: I agree, but I think there is something more sobering here because I think that the entire world of venture capitalism comes out terribly from this. They’ve thrown a lot of money to a kid who might be a genius, but he did not have the most traditional rules in place.

If you read the Michael Lewis book, it comes out that even early on, there were like half a billion dollars of Ether missing, and they said, “Eventually, we will find out where they are.” And, eventually, they did find them out, but how can you operate a business with that level of disregard for controls? And how can you get a lot of people giving you money for that?

If you are crazy, you might run that business, but how is it possible that sophisticated venture capitalists give you money without any due diligence? It’s a bit like Elizabeth Holmes all over again. You know that many people gave a lot of money to Elizabeth Holmes without any audited financial statements.

Bethany: Yeah, that’s why I’ve never been sympathetic to the investors who lost money in Theranos because they put money in without getting an audited financial statement.

I think it is one step even more cynical than that, though. I think I worry that venture capitalists gave SBF money because he fit the right stereotypes rather than being the wrong stereotypes, that sort of rumpled founder who doesn’t appear to care, and who flouts the rules and is so confident in himself and his idea that he doesn’t even wear the right clothes, and he shows up in shorts, and he’s disrespectful of people’s time. People now take that as a sign of brilliance, and it just shows how shallow our world is, and how driven by these perceptions that have nothing to do with whether the person is actually smart or not. And you can bet that if SBF had been a person of color, those things would not have accrued to his advantage, but he met the right marks.

I spoke at Stanford last week, and one of the rules that I’ve come up with over all this time is don’t ever outsource your due diligence. Because in story after story, from Valiant now to FTX, it turns out that the people, the very smart people who had put their money into these things, who you may think, well, they did the work, I don’t have to do the work, that it turns out they either weren’t so smart, or they had a different set of incentives than you might have.

Luigi, I googled the definition of money, and I got that in economics, there are three definitions for money. Money is a liquid asset used to facilitate transactions of value. It is used as a medium of exchange between individuals and entities. It is also a store of value and a unit of account that can measure the value of other goods. That actually sounds like four to me, not three, but anyway. Maybe I’m struggling to count today. Does crypto meet any or all of those criteria?

Luigi: First of all, crypto is not really a very effective medium of exchange. In order to be a medium of exchange, you have to maintain a relatively stable value. And if we set aside stablecoins—and we’ll come back to that—and focus on bitcoin, Ether, or the major cryptocurrencies, they fluctuate like crazy. They’re not a good medium of exchange, so much so that it became famous a few years back that even a conference about cryptos was not taking bitcoin as payment for the fee to access the conference.

Now, certainly, they’re also not a very useful unit of account. If I want to have my profit and loss in bitcoins, it would be very large or very small, depending on what happens in the world with the price of bitcoins. It’s going to be very difficult to see what’s going on in the underlying business because of the fluctuations.

The only function of money that bitcoin is playing is, to some extent, a store of value. Now, I would say it’s more a speculative form of store of value because it’s not a way to make sure that when you put a thousand dollars there, you’re going to have a thousand dollars tomorrow. It could be $2,000, it could be $500, with almost equal probability. So, it’s not a very safe store of value, but it has been a very attractive instrument of speculation.

Bethany: I guess, during the bubble, the idea that it was a safer storm—maybe storm is the operative word—a safer store of value than sovereign currencies that were being debased by central banks made a kind of sense to me. Did that argument ever resonate at all with you, and did the blowup affect your views at all? Or do you think now that we are where we are, just, of course, that was what was going to happen, it was inevitable?

Luigi: First of all, ironically, when Bitcoin was launched and for the first 10 of years of its life, inflation was not an issue in the Western world, so I think that there wasn’t this massive risk of debasement.

The other aspect that, as an economist, it is natural to be suspicious of is that there is a reason why we economists don’t like gold as a medium of exchange. It’s very simple: gold is very finite, and the economy grows. You cannot maintain a stable currency with a growing economy and a fixed amount of gold.

Bitcoin is even worse, because at least with gold, you can try to dig for more of it. But for bitcoin, the total quantity is fixed in advance, so there is no way to increase it. So, you have this paradox that if everybody were to accept bitcoin in the future, the price of bitcoin would skyrocket. As a result of that, the price of everything in units of bitcoins would drop tremendously.

But if that’s the case, if I expect Bitcoin to be adopted, I don’t want to use it as a medium of exchange. The first transaction on Bitcoin was for a couple of slices of pizza. At current prices of bitcoin, those slices of pizza had cost the purchaser something like $100 million. This is the pizza most difficult to digest that you ever ate, because having eaten $100 million dollars is really hard.

That, in a sense, is the paradox of Bitcoin. If you expect Bitcoin to be successful, you don’t want to use it as a medium of exchange because it’ll be worth more tomorrow than today. But if everybody does not use it as a medium of exchange, it will not be successful.

Bethany: That’s fascinating, that in a sense, its success depends on it not being money, at least according to that definition of money that I’d found. And its failure means that it could be money. There’s something very twisted in that. Can you address any of those problems by the creation of other cryptocurrencies, or is that just monkeying with the edges of a flawed system?

Luigi: I think stablecoins are a solution to the problem of fluctuation in the price of cryptocurrency. Stablecoins are basically a fancy and more modern version of checks or bank notes issued by banks, not by the government. Originally, bank notes were issued by banks, not just the central bank. To the extent that those are backed 100 percent by other fiat currencies like the dollar, I think that they could be a useful way to exchange value, or even a useful medium of exchange.

The real problem is twofold. Number one, a bunch of those stablecoins were not based on a 100 percent deposit but on some algorithm. Those are gone because they’re unstable. Even the ones that are based on a 100 percent fiat-currency backing, the issue is who guarantees that the backing is there. The real appeal of cryptocurrency is to have a currency that does not depend on any sovereign authority to make sure that you trust the currency.

Stablecoins do depend on somebody to check, maybe some auditors at the very minimum, that the money is there when you need it. And without those, they are very speculative and always at a risk of a run because you are always doubting whether there is enough to pay everybody back.

Bethany: Yeah. I always thought that that was the irony at the heart of stablecoins, that part of the romance in the story of cryptocurrency was that it offered freedom from sovereign currency. But if, in the end, its very legitimacy and reason for existence is that it can be converted into sovereign currency, then doesn’t that blow a hole in the romance?

But before we get to that, I was wondering, are there other times in history that you’re aware of where people have tried to redefine money, or tried to come up with another thing that could be called money, or is cryptocurrency a first?

Luigi: No, I think this is done all the time. I remember as a little kid, believe it or not, there was a shortage of coins in Italy because the government was not printing them fast enough. And so, the private sector, the banks, created some micro checks that were worth the correspondent probably today of 25 cents or 50 cents, not very much. But they were constantly exchanged until a legal scholar said, oh, that minors could not use them because they were checks. And so, eventually, they went out of circulation.

But people have tried to replace currency. You go to Disney World and there are Disney dollars, right? There is a big temptation to replace currency because there is a thing called seigniorage that you can earn interest on the money that you are printing, and that gives you some substantial value.

One of the things I always tell my students is that Milton Friedman was not in favor of a lot of government ownership, but there was one thing he thought must be owned by the government, and that was the printing of money. Part of the reason is because it does create some free lunch, if you want, which is called seigniorage. You don’t want that to be appropriated by somebody that earns the rent for nothing. You want this to be given to the government to use for proper public uses.

There is a constant tension of the private sector to invent substitutes for government money because you can get a slice of that seigniorage, and there is a constant fight of the government to fight back against this misappropriation of the seigniorage. This is a story that has been going on from the invention of money.

Bethany: I didn’t know that about Friedman. That’s really interesting. And do you subscribe to his line of thinking? Do you think he’s right?

Luigi: Yes, I do think he’s right. Actually, when I teach this in class, I always pitch him against Hayek because those are the two great thinkers of the 20th century. Hayek had a completely different view of money. He thought that money should be private, and it should be a competition across different currencies. In 1974, he wrote this article about the denationalization of money, and everybody thought he was completely crazy. And now, you look at cryptocurrency, and you see he had a vision.

I think it is the wrong vision. I think that what he misses big time is that he thinks that competition among currencies could take place in a perfectly competitive market, but that’s not true. It is actually an oligopoly. There is a lot of market power, and this market power is what gives stability to some of the currencies. In that situation, you don’t have the benefits of perfect competition, and I think having some form of government regulation is actually welfare-improving.

At the end of the day, I side with Milton Friedman, even if I think that Hayek was very creative in thinking something that today sounds reasonable but at the time sounded completely crazy.

Bethany: That’s fascinating. I didn’t know that Hayek was so prescient. And that really does provide a fascinating case study in the importance of ground rules and how oligopolies can form and the importance of competition. It’s really interesting. I’d actually like to write an essay or read an essay on the two competing views.

Anyway, Luigi, to wrap up, what would you say about the crypto industry, capital-is or capitalisn’t?

Luigi: I think it’s mostly capitalisn’t. I still have the hope that something will come out of there that is useful, but I think time is running out. They’ve been around for a while. It is the typical example of a solution in search of a problem. And we have not found the killer app yet. And, as I said, time is running out.

Bethany: I hate that I agree with you, but I do. I’m hoping that something will come along, and the crypto industry will surprise and delight me and prove that my skepticism has been wrong. But right now, I actually find it a deeply dystopian story about capitalism, the creation of something out of nothing and a whole giant multitrillion-dollar thing built on nothing but sand.