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#29 - Well, that escalated quickly …

Two thoughts come to mind as I reflect on the past week’s crypto happenings. The first is a Vladimir Lenin quote:

There are decades where nothing happens;

and there are weeks where decades happen.

The second is a tweet from @netcapgirl :

one of the laws of financial physics:

any institution immune to a bank run will engineer a way to make it so they are exposed to the risk of a bank run

Both apply to crypto exchange FTX:

“Things Go Wrong™: FTX meltdown edition”

FTX was – yes, “was”; I’ve kinda given away the ending there – one of the larger players in the cryptocurrency space. It had earned a reputation for bailing out failed crypto groups and making those customers whole.

And then … FTX blew up this week.

Many say it collapsed due to a bank run. I think that’s sort of what happened. But sort of not.

It helps to understand how retail banks work. You convince people to give you their money for safe-keeping. They trust that the money they hand you today will still be there tomorrow, next week, and next year when they want to withdraw some of it. So far, so good.

But you’re not content to just hold the money. You want to make money. Lots of it. So you loan depositors’ cash to someone else and charge them interest for the privilege. As Jacob Goldstein explains in Money: The True Story of a Made-Up Thing:

That money – your money – is now in two places at once. It’s your money, in your account at the bank. It is also the borrower’s money. The borrower can deposit her money at another bank, which can then lend some of it out to yet another borrower. The same dollar is now in three places at once.

This act of defiance against the laws of physics sleight of hand works for two reasons:

  1. The money people give you is fungible. Every dollar is interchangeable, indistinguishable from the next. People don’t need their specific dollars back.

  2. It’s unlikely that all depositors will want all of their money back at the same time.

The first point makes your scheme possible. The second point puts you at risk of a bank run. That’s when depositors all rush in at once to withdraw their money. Money that you don’t have, because you played chicken with the laws of probability. Now that you’ve hit this negligible-but-still-entirely-possible chance that everyone wants all of their money, right now, you’re in trouble.

(Let’s take a second to appreciate how the equivalent of a bank run would be absurd in any other venue. Imagine the calamity of, say, a baggage carousel run. Or a parking garage run, where they’ve loaned your car out for the day so it’s not there when you happen to leave work early.)

But if you insist on accepting other people’s money and moving it around when they’re not looking, there are ways you can reduce your exposure to a run. For example, you could lend out only a tiny amount of the total deposits. Or lend only to very trustworthy, stable entities.

You most certainly would not want to:

  • Hand it to someone whose entire business model is based on only maybe paying you back. Like a hedge fund. They tell you up-front: “we may give you back your money and then some. But we may also lose it. This is not a place to put money that you absolutely, positively need to see again.”

  • Hand it to someone who most certainly will not pay it back. Doubly so if that someone is … your alter ego.

All of that takes us back to FTX. From what I’ve read, it went down something like this:

  1. People gave money to FTX, retail-style.

  2. [scene missing]

  3. Somehow several billion dollars of that money wound up in the hands of FTX’s sister hedge fund, Alameda Research.

  4. [scene missing]

  5. That money is now gone.

  6. Last week, rumors spread that FTX had a lot less money than they claimed. The growing loss of confidence led depositors to (try to) withdraw their funds.

  7. Friday afternoon the company formally filed for bankruptcy.

  8. Did I mention, the money is now gone?

(I’ve oversimplified for brevity. There was a lot more going on here, including some nonsense with their FTT token, but this is the gist.)

So does this count as a bank run?

In the pure textbook sense, yes: people went to pull their funds from FTX and FTX said “yeh I don’t have that.”

In a realistic sense, no: it’s not as though the company had put the money into stable investments that just happened to overlap with people making untimely withdrawals. As far as the world can tell, the ten billion dollars is just … gone. Which leads to the question of how (“whether?”) FTX had planned to honor withdrawals. And what would be the proper term to describe the money’s disappearing act.

Some writers have compared this to the Lehman Brothers or Bear Stearns meltdowns of 2008. Others say it’s more Enron-style, due to the alleged misallocation of funds. (Surprisingly enough, I didn’t see any LTCM comparisons.)

But no. Lehman and Bear collapsed due to exposure to mortgage-related instruments. Enron was playing accounting games with a splash of mark-to-theoretical. What happened last week was, quite simply, FTX. Not “crypto.” FTX. The FTX collapse will go down in history as its own deal, and will no doubt serve as the foundation of countless PhD theses in economics and finance. (And maybe, criminology?)

What next? It’s tough to say. Crypto collapses are becoming increasingly common – this is the third major one since this newsletter launched, just six months ago – but how many more could there be? Sooner or later we’ll run out of players big enough for us to notice when they fall apart.

(Maybe, after “speedrunning the 400 year history of modern trading firms,” DeFi will eventually learn about risk management? Unlikely, but maybe.)

The world also doesn’t know the full extent of the damage. FTX’s collapse has already brought about troubles in crypto lender BlockFi. A number of crypto organizations, to calm their users, have publicly denied any exposure to the company. Others, like investor Sequoia Capital, have acknowledged their investments in FTX and marked them down to zero. It’s likely there will be other such announcements in the near future.

As I write this, a number of film studios are no doubt scrambling to release documentaries on FTX’s demise. (Michael Lewis, of Liar’s Poker and The Big Short fame, is similarly scrambling to update the book he’d been writing on FTX. This was probably not the twist ending he was expecting.) Hopefully those don’t oversimplify the story as much as I have in this segment.

Making that paper trail digital

Supply chains are an interesting concept. In order to get from some distant farm or factory to your front door, goods pass through a variety of locations, vehicles, and warehouses. Many of these elements belong to different companies. Something is bound to get misplaced at some point.

It would be nice to track what’s gone where, so a company could catch problems in short order. Maybe ring up a carrier or a warehouse manager to understand why package XYZ didn’t make it onto that plane.

This calls for a tamper-resistant ledger, visible to all parties involved, to track the point-to-point movement of a specific item. That’s the textbook use case for blockchain. And TradeMark East, along with Kenya’s Institute of Export and International Trade, is running a pilot program to give it a try:

Rather than requiring dozens of paper documents to travel with the weekly shipments of flowers from Nairobi airport to [England’s Stansted airport], via Istanbul, they are being processed on secure distributed ledger software, the technology that supports crypto currencies, under a pilot scheme backed by the Cabinet Office. The initiative is saving farmers and shippers time and money and is eliminating the risk that local officials are offered chai, a local phrase for bribes, to fast track checks and paperwork to enable shipments to be loaded on time.

This is a great idea. Technology generally helps speed up manual processes. And blockchain’s transparency should reduce corruption along the way. This program therefore reduces paperwork while improving the paper trail. Win-win.

There is one catch. The article notes that while the Kenyan side of this is humming along, the pilot program does not extend all the way through the supply chain into the UK side. This is a common challenge with new technology – not everyone is ready at the same time – but hopefully the work with TradeMark East continues running, and the UK side eventually catches up.

Making the world a little more pixelated

A previous Block and Mortar newsletter raised a point about metaverse properties finding their identity:

The world is still sorting out what counts as a “metaverse” and what it’s good for, but metaverse properties are each starting to find their role and vibe. This is important for three reasons:

  1. While some properties will certainly want to become The Everything Place, they know deep down that they’ll develop a reputation for fulfilling a particular consumer interest and need. This is the same with restaurants and bars: you can’t be the sports bar and the upscale wine bar and the dive bar all at once.


Consider the big names in the metaverse properties. Roblox and Fortnite? People go here for events, like games or concerts. Horizon Worlds? This is where you pretend to pay attention to work meetings. The Sandbox? It’s feeling pretty retail-focused thus far.

It’s important for metaverse providers to think this through. They need to know what kind of venue they’re going to be, so they can build accordingly.

It’s equally important for the companies that want to set up shop in those properties. Brands currently treat these digital worlds as places to interact with people. And that means understanding what sort of people will be hanging out there when they arrive.

Burberry, for example, has established a presence in Minecraft. This may seem a strange mix but the fashion house definitely has a plan:

“Gaming is a super important channel for us in terms of how we engage our customer,” [Burberry director of channel innovation Phillip] Hennche says. “We know that it’s a very important passion point for our target markets and consumers. We know that they are there, they are present, and they’re very active in that community.” With this partnership, Burberry hopes to reach both its customers that it knows are already playing Minecraft, and users who might not yet have engaged with the brand.

Also of note is how Burberry has approached the project. They’re not just establishing a presence in this world; they’re blending in with Minecraft’s blocky feel:

“We’ve created something that feels very us: very elevated, very fashion, very luxury — but also very Minecraft,” Hennche says. Here, Burberry signals an openness to metaverse aesthetics that have not always been readily embraced by the fashion industry. The aesthetics of the metaverse and Web3 graphics have been critiqued as fashion has delved further into the space. Minecraft is famously blocky and pixelated — not an obvious choice for a luxury brand. To Burberry, this was another opportunity to lean toward the unexpected, opting for a less classically high-fidelity world in which to create designs and activities.

It’s tempting for businesses to try to bend new technology to the old ways. Hats off to Burberry for seeing itself through the Minecraft lens and building something that represents both companies’ distinct flavors.

One interesting note about Burberry’s choice of metaverse partner is that Minecraft formally banned NFTs earlier this year. Since brands lean heavily into NFTs to connect physical to digital, building loyalty through on-chain collectibles, working with Minecraft will require their teams to get creative. Or, at least, they will have to think outside the box and ask whether that particular digital-to-physical connection is even necessary.

The wrap-up

This was an issue of Block & Mortar.

Who’s behind Block & Mortar? I'm Q McCallum. I've spent the past two decades in the emerging-tech space. And I'm very interested in web3 use cases.

Credit where it's due. Big thanks to Shane Glynn for reviewing early drafts. Any mistakes that remain are mine.

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