Notes on Sam Bankman-Fried interview with Matt Levine on Bloomberg (25 April 2022)
One of the most extraordinary conversation about DeFi and Crypto we've seen. Sam Bankman-Fried (SBF) of FTX is in conversation with Matt Levine of Bloomberg. He appears to straight-up describe yield-farming as a Ponzi scheme.
Here's Matt Levine concluding after SBF's description:
I think of myself as a fairly cynical person. And that was so much more cynical than how I would've described farming. You're just like, well, I'm in the Ponzi business and it's pretty good.
Can you comment on the sustainability of that? Because, on the one hand you're: 'well, a trillion dollars of institutional money is going to come into Bitcoin'. And on the other you're: 'basically there are a lot of Ponzis that have done really well.'
To which SBF essentially agrees: i.e. no intrinsic economic value or cash-flow to these "boxes" i.e. DeFi protocols and they are essentially greater-fool endeavours (aka meme stocks).
You can sort of get a market cap either because of cash flow ... Or you could see something get market cap in the way that Doge coin or SHIB coin have where people are just like ‘ha ha’ and then they buy it.
See also the twitter thread version:
Yield farming in 6 steps
Here's the ever-sharp Matt Levine starting it off (fairly generously):
Can you give me an intuitive understanding of farming? Like to me, farming is you sell some structured puts and collect premium, but perhaps there's a more sophisticated understanding than that.
Then SBF describes the following steps:
1. Start with a "blue sky" enterprise
You start with a company that builds a 'box' ... dress it up as life-changing, world-altering protocol that's replaces all the big banks in 38 days or whatever but in practice this box ... [may do] literally nothing. [emphasis added]
2. People deposit "money" into it (bitcoin / ether etc)
and you take a token (e.g. ethereum) and you can put it in the box [the DeFi pool/company] and take it out of the box. [you get an IOU for putting it in and then you can redeem IOU back out for the token]
With remarkable frankness SBF states:
So far what we've described is the world's dumbest ETF or ADR or something like that. It doesn't do anything but let you put things in it if you so choose.
So how on earth does this go anywhere? Well we add another twist (or obfuscation?)
3. Protocol issues governance tokens
And then this protocol issues a token ... ‘X token.’ And X token promises that ... holders of the X tokens ... can vote on what to do with any proceeds or other cool things that happen from this box.
But why would this governance token be worth anything given the "box/protocol" is blue sky enterprise producing absolutely nothing and acting at best as an inefficient ETF?
The DeFi entity is a "blue sky" enterprise which SBF acknowledges:
of course, so far, we haven't exactly given a compelling reason for why there ever would be any proceeds from this box, but I don't know, you know, maybe there will be, so that's sort of where you start.
4. Yield, the essential enticement to attract dumb money
So how do we keep it going? Now we come to step (4) yield. This has two parts:
- X tokens have +ve price: Because in delusional bubble governance X tokens have +ve price even though they should be 0 (see previous point)
- Why do X tokens have any value? SBF states: "Well, X token has some market cap, right? It's probably not zero. [maybe should be zero but] In the world that we're in, everyone's like, ‘Ooh, box token. Maybe it's cool. ... appears on Twitter & it has $20m market cap."
- And we can juice our tokens total "market" value by using notional metrics and low floats. Again SBF straight up acknowledges this: ".. of course, one thing that you could do is make the float very low ... $20 million is mark to market fully diluted valuation ..."
- And acknowledges there is no reason X token (aka protocol equity) should have any value: "... but I acknowledge that it's not totally clear that this thing [the protocol's token] should have market cap". ("not totally clear" is fancy way of saying no reason at all!)
- Can use X tokens as yield to depositors to incentivize deposits (like interest at a bank) Thus, we can use our X tokens to pay out to people who deposited in step (2) above.
[SBF words] So anyone who goes takes some money puts in the box, each day they're gonna airdrop, 1% of the X token pro rata amongst everyone who's put money in the box.
This system creates yield for depositors. It's yield in the made-up X tokens rather than yield in cash (or bitcoin or ether or whatever they put in). But as long as X tokens appear to have some actual value it can work (for a while).
5. Speculative ponzi bubble in action
And finally in step (6) that starts a ponzi-like cycle in both deposits and the price of the governance/yield token X.
There are three parts to make the cycle
1. Ponzi take-off as first people are attracted by yield
In SBF's words:
So, X tokens [are] being given out each day, all these sophisticated [?] firms are like, huh, that's interesting. Like if the total amount of money in the box is $100m then it's yielding $16m in X tokens ... that's 16%"
Note the sleight of hand about "sophisticated firms" -- these are not sophisticated firms but often unsophisticated, vulnerable retail investors.
Ponzi take-off part 2 as we have growth on social media
maybe that happens until $200m in the box. So, sophisticated traders &/or people on crypto Twitter etc, go & put $200m in the box collectively and they start getting these X tokens for it."
Ponzi take-off part 3: it's valuable because everyone thinks it's valuable
... now all of a sudden everyone's, wow, people just put $200m in the box. This is a pretty cool box, right? This is a valuable box [because] all the money people have decided should be in the box."
And SBF adds a classic cynical trader point:
And who are we to say they're wrong about that?" [about that obvious bubble almost certainly fueled in large part by unsophisticated investors]
Ponzi bubble part 4: line goes up
And so what happens now? All of a sudden people recalibrate: $20m, that's in market cap for this box? It's been like 48 hours & already it's $200m, including from sophisticated players. Come on, that's too low.
Ponzi bubble part 5: full mania
X token price goes way up. Now it's $130m token b/c of bullishness. Now ... there's 60% yield in X tokens. ... So [people] pour another $300m in & you get a psych and then it goes to infinity. Then everyone makes money."
"Then everyone makes money" ... Really? Given his general sophistication difficult to imagine SBF is being that naive. What happens when people try to cash out their X tokens yielding 60% a year ...
Matt Levine: (21:17)
Can you give me an intuitive understanding of farming? I mean, like to me, farming is like you sell some structured puts and collect premium, but perhaps there's a more sophisticated understanding than that.
Sam Bankman-Fried: (21:28)
Let me give you sort of like a really toy model of it, which I actually think has a surprising amount of legitimacy for what farming could mean. You know, where do you start? You start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that's gonna replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box. So what this protocol is, it's called ‘Protocol X,’ it's a box, and you take a token. You can take ethereum, you can put it in the box and you take it out of the box. Alright so, you put it into the box and you get like, you know, an IOU for having put it in the box and then you can redeem that IOU back out for the token.
So far what we've described is the world's dumbest ETF or ADR or something like that. It doesn't do anything but let you put things in it if you so choose. And then this protocol issues a token, we'll call it whatever, ‘X token.’ And X token promises that anything cool that happens because of this box is going to ultimately be usable by, you know, governance vote of holders of the X tokens. They can vote on what to do with any proceeds or other cool things that happen from this box. And of course, so far, we haven't exactly given a compelling reason for why there ever would be any proceeds from this box, but I don't know, you know, maybe there will be, so that's sort of where you start.
And then you say, alright, well, you’ve got this box and you’ve got X token and the box protocol declares, or maybe votes by on-chain governance, or, you know, something like that, that what they're gonna do is they are going to take half of all the X tokens that were re-minted. Maybe two thirds will, two thirds will offer X tokens, and they're going to give them away for free to whoever uses the box. So anyone who goes, takes some money, puts in the box, each day they're gonna airdrop, you know, 1% of the X token pro rata amongst everyone who's put money in the box. That's for now, what X token does, it gets given away to the box people. And now what happens? Well, X token has some market cap, right? It's probably not zero. Let say it's, you know, a $20 million market …
Wait, wait, wait, from like first principles, it should be zero, but okay.
Uh, sure. Okay. Completely reasonable comments.
I mean, that's not quite true, but, like, when you describe it in this totally cynical way, it sounds like it should be zero, but go on.
Describe it this way, you might think, for instance, that in like five minutes with an internet connection, you could create such a box and such a token, and that it should reflect like, you know, it should be worth like $180 or something market cap for like that, you know, that effort that you put into it. In the world that we're in, if you do this, everyone's gonna be like, ‘Ooh, box token. Maybe it's cool. If you buy in box token,’ you know, that's gonna appear on Twitter and it’ll have a $20 million market cap. And of course, one thing that you could do is you could like make the float very low and whatever, you know, maybe there haven't been $20 million dollars that have flowed into it yet. Maybe that's sort of like, is it, you know, mark to market fully diluted valuation or something, but I acknowledge that it's not totally clear that this thing should have market cap, but empirically I claim it would have market cap.
It shouldn't have any market cap in theory, but it practice, they always do. Okay.
That's right. So, and obviously already we're sort of hiding some of the magic impact, right? Like some of the magic is in like, how do you get that market cap to start with, but, you know, whatever we're gonna move on from that for a second. So, you know, X tokens [are] being given out each day, all these like sophisticated firms are like, huh, that's interesting. Like if the total amount of money in the box is a hundred million dollars, then it's going to yield $16 million this year in X tokens being given out for it. That's a 16% return. That's pretty good. We'll put a little bit more in, right? And maybe that happens until there are $200 million dollars in the box. So, you know, sophisticated traders and/or people on Crypto Twitter, or other sort of similar parties, go and put $200 million in the box collectively and they start getting these X tokens for it.
And now all of a sudden everyone's like, wow, people just decide to put $200 million in the box. This is a pretty cool box, right? Like this is a valuable box as demonstrated by all the money that people have apparently decided should be in the box. And who are we to say that they're wrong about that? Like, you know, this is, I mean boxes can be great. Look, I love boxes as much as the next guy. And so what happens now? All of a sudden people are kind of recalibrating like, well, $20 million, that's it? Like that market cap for this box? And it's been like 48 hours and it already is $200 million, including from like sophisticated players in it. They're like, come on, that's too low. And they look at these ratios, TVL, total value locked in the box, you know, as a ratio to market cap of the box’s token.
And they’re like ‘10X’ that's insane. 1X is the norm.’ And so then, you know, X token price goes way up. And now it's $130 million market cap token because of, you know, the bullishness of people's usage of the box. And now all of a sudden of course, the smart money's like, oh, wow, this thing's now yielding like 60% a year in X tokens. Of course I'll take my 60% yield, right? So they go and pour another $300 million in the box and you get a psych and then it goes to infinity. And then everyone makes money.
I think of myself as like a fairly cynical person. And that was so much more cynical than how I would've described farming. You're just like, well, I'm in the Ponzi business and it's pretty good.
Joe Weisenthal: (27:27)
At no point did any of this require any sort of like economic case, it’s just like other people put money in the box. And so I'm going to too, and then it's more valuable. So they're gonna put more money in, and at no point in the cycle, did it seem to like, describe any sort of like economic purpose?
So on the one hand, I think that’s a pretty reasonable response, but let me play around with this a little bit. Because that's one framing of this. And I think there's like a sort of depressing amount of validity…
Can you comment on like the sustainability of that? Because, you know, on the one hand you're like, well, a trillion dollars of institutional money is going to come into Bitcoin. And on the other hand you're like basically there are a lot of Ponzis that have done really well.
Right. So let me, okay, cool. I'll stay on the cynical route, think about like cynically, what could happen here? Well, okay. So you've got this boxes and it’s kind of dumb, but like what's the end game, right? This box is worth zero obviously. And like that, you know, you can't like keep this smart cap or something. But on the other hand, if everyone kind of now thinks that this box token is worth about a billion dollar market cap, that's what people are pricing it at and sort of has that market cap. Everyone's gonna mark to market. In fact, you can even finance this, right? You put X token in a borrow lending protocol and borrow dollars with it. If you think it's worth like less than two thirds of that, you could even just like put some in there, take the dollars out. Never, you know, give the dollars back. You just get liquidated eventually. And it is sort of like real monetizable stuff in some senses. And you know, at some point if the world never decides that we are wrong about this in like a coordinated way, right? Like you're kind of the guy calling and saying, no, this thing's actually worthless, but in what sense are you right?
Tracy Alloway: (29:15)
Can I just ask on this point, I mean, so are you saying that the value has to derive from everyone agreeing that it's worth something? And I know like on the one hand, that seems like a simple point about crypto, but on the other hand, throughout crypto's history, there have been these different arguments about how it actually gets value, you know, use cases for the underlying technology — for blockchain. Everyone's gonna start migrating stuff on blockchain, and then you're gonna have a real economic use attached to these assets. And that's where the value's gonna come from. But are you saying that it depends more on everyone just agreeing that these are worth something?
So really what I'd say is that it could come in theory from either. You can sort of get a market cap either because of cash flow and then Warren Buffett's like f*ck this. Like, I'm going to buy this if it's at too cheap of a price, because I'll just buy it and own it and get cashflow from it. And that's great. Or you could see something get market cap in the way that, I don't know, Doge coin or SHIB coin have, where people are just kinda like ‘ha ha’ and then they buy it. And if you're like, that's dumb, it has no cashflow flow. I'm gonna short sell it. You lose all your money. And, you know, those like, at least like over the last few years, those have both been ways that assets have gotten market cap. And I sort of like think that this starts to hint at like, at least some interesting angles on this, because it's not just cryptocurrencies that have had this dynamic, right? How about like, you know, AMC or Hertz or GameStop or meme stocks in general have like a very similar pattern to this and the sort of concept of maybe people will pay something for it even though it doesn't seem traditionally valuable, is not a crypto specific concept. Although it certainly has become like…
One takeaway from this whole conversation is that DeFi might be more similar to Bitcoin than a lot of people thought, deriving its value from collective agreement that the ‘thing’ (in this case the box, or yield-farming protocol) is worth something rather than deriving value from a fundamental usefulness.