David Pakman, a venture capitalist turned entrepreneur, can help you better understand the magnitude of the collapsed cryptocurrency exchange FTX. After logging 14 years with the investment firm Venrock, Pakman — who led Venrock’s investment in the digital collectibles company Dapper Labs and even mined bitcoin at his own home years back — leaned into his passion for digital assets and last year joined the now seven-year-old crypto venture firm CoinFund.
Depending on how you view the market, his timing was either very well or very poorly. Because CoinFund was an investor in the collapsed cryptocurrency exchange FTX, Pakman agreed to talk to us today. We discussed the wild week that began with FTX at its peak and ended with FTX founder Sam Bankman-Fried resigning as CEO. Below are excerpts from that conversation, which were lightly edited for length.
TC. The NFT wave was just starting to get underway when we last spoke almost two years back. Now, we’re talking on a day where one of the biggest cryptocurrency exchanges in the world just declared bankruptcy. Actually, it’s declaring bankruptcy for 130 additional affiliated companies. What do you think of this development?
DP: I think it’s absolutely terrible on a bunch of levels. It was an entirely avoidable tragedy. The failure of the company was caused by poor human decision-making and not a failing business. The core business is doing well. In fact, it’s highly profitable and growing, even in a bear market. It’s not like it was running out of capital or a victim of the macro environment. Its leadership made some terrible decisions and did things really badly, apparently with little oversight. It is shocking how easily it could have been avoided and how many people were affected, including shareholders and employees. [by this bankruptcy].
There’s also the reputational harm to the entire crypto industry, which already suffers from questions like, ‘Isn’t this a scammy place with scammy people?’ This sort of Enron-esque meltdown of one of the most highly valued and arguably most successful companies in the space is just really bad, and it will take a long time to dig out of it. There are some positives.
Positives?
Well, what’s positive is the technology did not fail; the blockchains did not fail. Smart contracts were not hacked. Everything we know about crypto technology continues to work flawlessly. So it would be different if this was a meltdown because of flawed software design, or the blockchains aren’t scaling, or big hacks that injured people. The long-term promise of crypto software and technology architecture is intact. It’s the people who keep making mistakes. We’ve had two or three pretty big human-generated mistakes this year.
There are many news stories out there that explain what happened in broad strokes. How can you explain this?
I don’t have firsthand knowledge about what they really did or didn’t do. However, FTX appears to be able to do both. [the trading desk also owned and run by Sam Bankman-Fried] Alameda Research had a relationship with Alameda Research that may not have been known to all shareholders, employees or customers. It sounds like FTX took FTT. This token was held in large amounts by Alameda. They pledged it as collateral, and took out large loans in fiat against it. They took a volatile asset and pledged it as collateral.
One could imagine if a board of corporate executives or investors knew about that, someone would say, ‘Hang on. What happens if FTT falls by 50%? It happens all the time in crypto. It is a highly volatile asset, so why are we pledging it? And by the way, half a billion dollars’ worth of the asset is held by our biggest rival [Binance]. What happens if they dump it in the market?’
The act of borrowing against it was not wise. The proceeds of the borrowing were also taken by them and they invested them in highly liquid assets, such as BlockFi or any other private companies that FTX has recently bought. But it’s not like they could quickly sell out of those if they needed to return the proceeds of their borrowing. They were also reportedly using customer funds and lending it out, or even lending it to their trading arm. All this stuff is stuff that a board would not know about if it was known.
There was no board. This is amazing considering that VCs invested $2 billion in this company. Your firm is one of those firms.
I joined CoinFund a little bit more than a year ago, so the investment that the firm made in FTX was a long time ago, before my time, and it’s a tiny, tiny amount. We’re barely on the cap table. We didn’t hold any FTT tokens.
But, I will address your main question, which is about the company’s governance. I come from a traditional tech investing background, where maybe 99% of the time, there’s just a standard set of governance that every entrepreneur agrees to when they take venture capital, which is: there’s going to be a board; the board is going to be made up of investors and employees and maybe outside experts; there’s going to be a set of controls; the controls usually say things like, ‘You have to disclose any related party transactions’ so you don’t shuffle coconuts between one company and something else that we don’t know about. The board also has to approve things, so that whenever you’re going to pledge assets as collateral for borrowing, you can’t issue new shares without [the board] It is worth learning about.
It is amazing that none of this was possible. I hope that this Enron-like moment in crypto will bring an end to any loose norms that were put in place about investing not giving the same level of oversight and governance.
Everything is so closely linked. Digital Currency Group, a crypto investor, is reportedly giving a $140m equity infusion to a business called Genesis Global Trading. Genesis has approximately $175 million dollars in its FTX account. How bad can this get? What percentage of your own investment portfolio is being impacted here because of FTX’s failure?
How much is CoinFund affected? It’s negligible because we had such a tiny investment in this company from one of our funds and we held none of our assets at FTX, either its U.S. or international business. [As for broader implications], I don’t think any of us knows the full, long-term impact of what’s happening here because there’s like some contagion, right? How many funds are available to investors and companies that have assets at FTX? How long will it take to recover those funds? The entire thing is subject to a massive bankruptcy proceeding, which can take months or even years. And so there’ll be this uncertainty, not just about when you’re getting money back but how much you’re getting.
The overwhelming majority of the startups that we invest in aren’t trading on FTX and so they weren’t customers. FTX was a great platform for tokens becoming liquid. It also provided liquidity and a market for them. Today, crypto is more than raising equity capital. It also involves creating tokens and using them as an incentive mechanism. FTX was one place where tokens could trade on exchanges. Now you can’t do that.
How does this impact your day-today investment business? CoinFund filed SEC paperwork on November 1, after it closed a $300 million fund three month ago. Is that the pin you will need to enter? I’m sure this debacle has LPs feeling nervous.
We’ve talked to a lot of our LPS in the last 48 hours. Most people are processing. They’re asking, like you’re asking, ‘What happened here?’
Late-stage capital may freeze up here for a while, I believe. The dust must be cleared. And it’s unlikely that capital is attracted to a tragedy like this.
Startup valuations have a greater immediate impact. Valuing startups is an imperfect process done by investors in non-liquid markets, and one way it’s done is to look at comparables. FTX was the star comp that almost everyone in crypto pointed out as one of the most brightest stars. If FTX is worth $40 billion, we’re worth X. If you take the most valuable venture-backed crypto company and it goes from $40 Billion to zero, who then is the new ceiling for crypto value? It immediately affects late-stage valuations.



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