Web3 is doing great, it doesn't need a Messiah
15 min read
Remember the "Lehman-Brothers" moment? A little over a decade ago, the bankruptcy of one of the largest investment banking firms in the US nearly brought the world to its knees at the climax of the subprime mortgage crisis. And from the ashes of the many traditional banking institutions which fell during this crisis in 2008, Bitcoin arose. A promise of a new world order. An anti-Lehman-Brother system was set to change the old system. Built on revolutionary blockchain technology, Bitcoin ushered in a new global financial system. One that is democratic, transparent and decentralized. With these fundamental characteristics, the Lehman-Brothers incident was never to happen again. The irony is that since the emergence of Bitcoin and blockchain technology, the Web3 industry has, however continued to witness what many would call the "Lehman-Brothers'' moment over and over again. There was the Mt. Gox crash, the QuadrigaCX crash, the Terra-LUNA crash and now,, in what might be the most significant crash the industry has ever witnessed, the FTX collapse. So much for the promise of a new world order, suitable? With so many scams, drifters and malicious actors endemic in web3, it is easy to dismiss the industry and conclude that web3 is a joke. But is web3 the problem?
In 2009, an entity named Satoshi Nakamoto shared a vision with the world. They called it Bitcoin, a new electronic cash system fully peer-to-peer and requires no trusted third party to function. This new technology showed so much potential and offered a lot of opportunities. It was what the world needed to escape the damage caused by too much control being concentrated in the hands of a selected few. It promised a system where freedom and autonomy take precedence. A system without the need for trust.
The blockchain technology on which web3 is built no doubt has the potential to help shape the future of finance and the growth of society, just like Satoshi wanted. But it is safe to say that the web3 industry has Bitcoin's original promise of Bitcoin. What we have today is an industry that talks about freedom and autonomy but ends up using this language to mislead the masses. Web3 is now riddled with grifters and mercenaries who are looking to make a quick buck. This get-rich-quick culture has created an environment where these grifters are revered and elevated to god-like status; incentivized money making schemes over the willingness to commit to the long and gradual real-worldbuilding real-world value; giving rise to complacency, lack of discipline and the blatant disregard of true web3 values. The community-centric dynamic of web3 is supposed to be a positive thing, but unfortunately, "Community" is one of the most used terms in web3 space and has become a byword for pushing bad investments and scams. People now conflate network effects with pyramid schemes. Rampant speculation and leverage have become the biggest affliction. The result is an industry that has been corrupted by the human factor and ends up breaking over and over again, just like the traditional system. This is far from what Satoshi Nakamoto had in mind when he shared his vision with the world.
Crypto's ill-fated heroes
Barely 6 months after thethe collapse of Terra-LUNA ecosystem which cost the industry over $300 billion in losses, web3 is again going through another catastrophic wealth destruction event. This time the FTX collapse is considered even more damaging given the sheer size and reach of the exchange and its sister trading firm, Alameda Research, both of which are owned by one man, Sam-Bankman Fried (SBF).
The web3 space has continued to witness the rise and fall of so many projects and ecosystems, many of which had so great potential but failed to live up to it. One unfortunate but striking observation is that these epic failures can be attributed to one single thing, centralisation. It is deeply ironic that an industry which seeks to change the top-down structure of traditional institutions, now increasingly leans towards trusting a central entity or individual. This has inevitably created the messianic culture now common within the web3 space. This is why characters such as Danielle Sestagalli, Andre Cronje, Do Kwon and others. For some reason, over the years, web3 communities have adopted this culture of making an individual the epicentre of a project or ecosystem's success. The end result of this has always been catastrophic.
Take, for example, Danielle Sesta of Wonderland Money project. A protocol that managed around $1 billion of assets in total value at its peak. Dani built an ecosystem of DeFi projects, including Wonderland, Abracadabra and Popsicle Finance, and rose to become the de facto leader of the "Frog Nation" community. There's only one problem, these money leggos all depended on the community's trust in Dani Sesta. Which is why it all came crashing down the very moment that trust was questioned. A similar case is seen with Andre Cronje and the Fantom ecosystem. Cronje is quite notable for his prolific contributions to the DeFi space. However, his failure comes from his inability to dissociate himself from his creations. Cronje has left DeFi on two occasions, and each time, his departure has had significant negative effects on the entire Fantom ecosystem. Also significant is the Terra ecosystem collapse, which can be attributed to a single man, Do Kwon. In all of these cases, it is always the same pattern. There is a central point of failure, an entity of trust. The most glaring is the recent FTX collapse. Again, the same playbook is at play.
The rise and fall of SBF
SBF (Sam-Bankman Fried) was the poster boy for crypto and all things web3. He was adored and looked up to by many. At 25 years old, SBF founded Alameda Research 2017, a crypto trading, and made millions through Bitcoin arbitrage between Asia and US markets. Two years later, he launched the crypto exchange FTX in 2019, a venture Binance was heavily invested in amongst other reputable investors such as Sequoia Capital, Paradigm, and Ontario Teachers' Pension Plan. The exchange quickly rose to the top 3 global exchanges valued at $32 billion. As a result, SBF's personal net worth rose to $26 billion and subsequently became a major player within the web3 space. He would go on to host conferences with big-name celebrities like Tom Brady, Gisele Bundchen, and others, buy arenas and go on a branding spree, plastering FTX all over cities. He also played a significant role during the Terra collapse, bailing out crypto firms that were affected by the contagion.
In 2021, Binance opted to divest from FTX during its $900 million funding round. The leading exchange was rather paid in $FTT for their shares, FTX's exchange token. One could say that the move by CZ, the CEO of Binance, to divest was because of the rapid growth of its direct competitor and, more so, SBF's grand ambition in the polity. As the second largest donor to the Biden campaign, SBF was in bed with the regulators, an affiliation that would maximize FTX potential. This affiliation would make any competitor anxious, especially with links to China. CZ understood this very well and wouldn't go down without a fight. Then following a series of events, CZ made a play that would ultimately crumble the SBF empire.
Shortly after SBF published the highly controversial proposal on crypto regulation, CoinDesk published a story revealing that $14.6 billion in assets on Alameda's balance sheet was, in fact, its $FTT token that the company prints itself. This meant that if the price of $FTT dropped, FTX itself could be at risk. Soon after, CZ revealed that Binance would be selling all of its $FTT tokens, causing a free fall in the price of $FTT, and it all went downhill from there. FTX became insolvent, and a deal was made for Binance to acquire it and bail out the exchange, but it turns out FTX had too many skeletons in the closet, and Binance was not going to touch it.
We now know that FTX was a poorly managed company with no real organizational structure. Just SBF and his friends are betting big and taking risks with customer funds. Apparently, SBF secretly moved $10B in customer funds from FTX to Alameda. After withdrawals were halted, the exchange was reported hacked, and millions of customer funds were drained. FTX has filed for bankruptcy, and SBF has stepped down as CEO, with his net worth going from $26 billion to 0 in just 48 hours. Billions of dollars of customers' funds have already evaporated, but the FTX story is far from over. How will this affect the rest of the crypto space?
The great contagion
The story of Alameda and FTX can best be summarized by SBF's philosophy of betting big. Every major decision he and his friends have made is related to acquiring more leverage through deceptive fund-raises, financial engineering, and, ultimately, outright fraud. This will ultimately have a major impact on the web3 space, given the sheer size of SBF's empire. FTX and Alameda are associated in virtually every project in crypto and reach across every corner of the crypto space.
Just like Do Kwon and the fall of the Terra ecosystem, the resulting ripple effect of the FTX collapse will definitely shake the entire crypto space. BlockFi, one of the firms bailed out by FTX, has already paused withdrawals due to a liquidity crunch. More significant is the effect on Genesis, which recently paused withdrawals. For context, here is how bad things could get. Genesis is a crypto full-service prime broker owned by the DCG (Digital Currency Group), Barry Silbert's holding company which also owns CoinDesk, Foundry, Genesis, Grayscale, and Luno. Similar to a brokerage firm, Genesis plays a critical role in enabling large institutions to access markets and manage market risk. They are crypto's largest lending desk. At the height of the crypto market, Genesis was moving huge numbers. For example, $50B in loan originations, $12.5B in active loans, $31B in spot volume traded, and $21B in derivatives trading in Q4 of 2021. This means that Genesis impacts nearly every aspect of crypto. They sit at the direct centre of crypto capital markets. They custody funds. They help institutions earn yield. They are the yield product for CeFi platforms. Several companies like Gemini use Genesis to help their users earn yield. This is how it works:
You give your crypto to Gemini → Gemini gives your crypto to Genesis → Genesis lends your crypto to a fund → the fund borrows from Genesis X+2% → Genesis gives Gemini X+1% → Gemini gives you X%.
However, this also means that Genesis is exposed to counterparty risk. If Genesis can't get back the crypto they lent out, they can't give it back to Gemini (or any other crypto CeFi platform), which means Gemini can't give you your crypto. Also, institutions and crypto whales use Genesis directly, which means they can't also get their crypto back. The collapse of 3AC (Three Arrows Capital) and Babel Finance following the Terra collapse drastically brought down Genesis numbers in Q3 of 2022 to $8.4B in loan originations, $2.8B active loans, $18.7B spot volume traded, and $9.6B derivatives traded. The FTX counterparty risk might be the last straw that broke the camel's back. And the resulting effect could ripple across several projects within web3, including institutions like Grayscale, whose $GBTC is now highly volatile.
CeDeFi is not a thing, DeFi didn't break
There is centralized finance (CeFi), and there is decentralized finance (DeFi). For some reason, people have come to believe that there is something called centralized DeFi, a concept that involves using centralized rails to access decentralized finance. The aim here is to lower the barrier to entry and facilitate adoption. But this is a fallacy. You can not centralize DeFi. A centralized DeFi is simply a CeFi because introducing a central point of failure at some point in any DeFi protocol automatically defeats the purpose of DeFi. DeFi is non-custodial, decentralized, transparent and permissionless at all levels. If it is not DeFi, then it is CeFi. There are no in-betweens. The CeDeFi narrative is why several centralized platforms, such as Celsius, BlockFi etc., have managed to market themselves as DeFi services but have all gone kaput in times of market downturns while true DeFi ticks on.
Regulation is coming
CeFi is regulated by the government, while DeFi is regulated by code. This is why real regulation is needed to protect users from shady dealings associated with CeFi platforms. It’s a misnomer to associate VC cheques with due diligence. Otherwise, we wouldn’t see heavily backed entities like FTX blow up in split seconds. Strong revenues on paper are not enough to back a project, questions need to be answered. The VCs that backed FTX didn't care to know if the revenues were sustainable. Was it all predicated on an untenable self-dealing setup, frontrunning clients, and misappropriation of user funds? This is why regulation is needed to keep these centralized exchanges in check. And no, it is not regulation by enforcement by going after U.S.-based companies for not following the rules without actually establishing what those rules are or sanctioning a piece of code and cracking down on developers who build these tools, e.g., Tornado Cash. What is needed are clear regulatory guidelines for crypto.
Like Brian Armstrong said, Crypto regulation in the U.S. has been hard to navigate, and regulators have so far failed to provide a workable framework for how crypto services can be offered in a safe, transparent way. This causes many crypto operations to set up shops outside the U.S., where regulation and enforcement are often weaker. FTX's collapse results from risky, unethical business practices, including conflicts of interest between deeply intertwined entities and decisions to lend customer assets without permission. This isn't about aiming high and missing. This is about recklessness, greed, self-interest, hubris, and sociopathic behaviour that causes a person to risk all the hard-won progress the web3 industry has earned over a decade for their own personal gain. There's an urgent need for smarter regulation that protects consumers and makes the U.S. a more attractive place for crypto companies to operate.
Separate the man from the protocol
It is worth noting that true DeFi has consistently proven resistant to these human factors and has continued to work just fine. Aave, Uniswap, Compound, Curve etc., all these protocols have stood the test of time. There's a reason why Hayden Adams of Uniswap DEX and Michael Egorov of Curve finance, founders of the two most prominent DeFi primitives, keep a low profile. They understand the importance of dissociating the man from the protocol. It helps to prevent tying the success of the project or an ecosystem to an individual. This is critical because conflating the two creates a central point of failure that is capable of bringing down an entire ecosystem. A typical case is a dynamic seen with Andre Cronje and the Fantom ecosystem. Even Sushiswap understood this dynamic clearly. The Uniswap fork would have been destroyed if it had continued to leverage on the profile of the Master Chef, a single entity that controlled the minting of new tokens. Instead, the protocol has since transitioned to a 9-person multi-sig and is looking to further decentralize. Bitcoin is unbreakable because no one knows who Satoshi Nakamoto is.
The future is non-custodial DeFi
The FTX situation further shows the importance of returning to the foundations of true DeFi. We must start embracing core web3 values such as trustlessness, non-custodial and permissionless as our guiding principles. This is the best way to protect against the dangers of centralized entities. But to do this, DeFi needs to be seamless to use and scalable. Until users can use their funds and own their funds, regardless of location or chain, much the same way that data roaming has unlocked communication over 4G/5G service providers, we have not accomplished the necessary steps for mass adoption. To do this, there's a need to connect more and more blockchain ecosystems to allow for the seamless transfer of an increasing number of tokens across various chains regardless of the chains each token is native to. This is crucial in unlocking mass appeal. By increasing user affinity to DeFi and DeFi solutions and subsequently removing the pressure on developers to integrate or deploy projects on specific chains for exposure, even when it is not convenient, we can significantly facilitate mass adoption. The goal is a future of a completely interoperable and user-friendly DeFi industry with no boundaries or limitations.
Imagine having to move your crypto assets, swap different tokens native to different blockchain ecosystems and routing transactions on multiple chains without having to sign each transaction execution at every touchpoint individually. All you need to do as a user is to tap a button, and every other thing happens in the background. This is made possible by infrastructures such as the Cross-chain virtual machine (XCVM), Centauri and Inter-Blockchain Communication (IBC) protocols. XCVM allows for cross-ecosystem communication enabled through cross-chain smart contracts. This means that smart contracts are chain agnostic, allowing them to interoperate with one another without limitations seamlessly. This abstracts complexity on the application layer, allowing applications to be natively cross-chain. Even more, interactions between EVM and non-EVM chains can become straightforward, further abstracting the user experience for users and developers alike.
XCVM adopts a top-down approach to interoperability and composability rather than connecting different pre-existing pieces together. This alleviates the major pain point dApp developers face in deploying their applications. Centauri is a cross-chain trustless bridging tool which leverages highly efficient light client technology to facilitate the transfer of assets across ecosystems without compromising security and decentralisation. IBC is the string that ties it all together through state sharing. By acting as the mechanism to share states between chains, IBC provides a robust execution layer for all connected chains. Together with a workable and seamless UI/UX, users can be able to move any assets of their choosing from any chain to anywhere they want, on and off chain. Achieving this successfully means improving user appeal and alleviating the pressure on projects or devs to deploy or integrate dApps on specific ecosystems. This eliminates the existing borders and ecosystem fundamentalism in DeFi and Web3 in general, thus allowing DeFi to return back to its roots of ultimate composability and hence addressing the fundamental problems that have barricaded DeFi from scaling to the ultimate goal of mass adoption.
The web3 dream is not dead, but hopefully the delusions are
What this recent carnage actually reveals is that most blockchain-enabled crypto businesses need to be rethought and rebuilt from top to bottom. In the long-term, the web3 industry will be able to build better systems using DeFi and self-custodial wallets that don't rely on trusting third parties such as exchanges. Rather, users will be able to trust code, and everything can be publicly auditable on the blockchain. As we wait for regulators to establish clear rules and guidelines, we all have a responsibility to humanity to protect and propagate web3 values. We can do that by being good crypto advocates, self-regulating, and attacking the cancers among us and leading by example.