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For people who have been in crypto for a few cycles, it’s not hard to separate out the most obvious scams and gambling from projects that aim to create real-world value. To identify projects whose developers and community and enthusiasts are there for the tech, and not for a get-rich-quick scheme. For people new to the space, it can be a bit harder to distinguish without the context to understand what the root causes of these scams and catastrophic events have been.
So if you’ve recently heard about staking and you’re wondering if it’s just another thing that could rug people of their life-savings with one founder-exit or exploit, I’m here to help you understand what happened in the biggest catastrophic crypto events you’ve heard in the news and also how to avoid them in the future.
Let’s split these events into three categories: traditional banks, centralized platforms, and crypto itself. These three categories will be about what kind of asset was involved (e.g. dollars or crypto?) and who had custody of those assets.
These events had nothing to do with and no impact on how crypto fundamentally works. They do have implications on and are symptoms of how crypto is treated by the government and financial sectors, but these events posed no risk at all to people who hold crypto themselves. Their biggest impact on crypto projects was de-banking them. No matter how much we believe in crypto, banks are the current reality, and one needs a bank account to be able to operate a business in order to pay for real-life services that don’t yet accept crypto. Bank mismanagement and subsequent government intervention will make other US banks think twice about providing bank accounts to businesses whose core product centers around crypto. This will play out in courts and you’ll see a lot of campaign material on supporting or fighting crypto in the next election. If the US wages a war on crypto, the outcome will be that tech innovation in that sector will move overseas and continue building there.
This is an illustration of the importance of self-custody. FTX was a centralized exchange (CEX) and functioned as a bank… but without the oversight and regulation of a bank. They were able to do that because the US government hasn’t provided any clarification on what crypto ‘banks’ need to be doing to be compliant with laws that are designed to protect investors. We desperately need these clarifications and new laws that will govern how these custodial entities operate.
In order to use FTX, you sent them your assets. Sending your assets to FTX meant that you no longer held the keys to those assets, you just trusted that they were keeping good records of the assets that you had sent them, were taking good care of them, and would send them back to you when requested. This is the opposite of onchain activity. It is antithetical to the ideals that created crypto.
These were also centralized entities - they weren’t made for trading (not a CEX), but they were entities that took custody of your assets and promised to hold onto them for you. They were marketed as ways for people uncomfortable with crypto to engage with it in a more recognizable way. They prioritized ease of use so that your grandma could figure out how to deposit money and get yield from crypto.
In reality, these entities were far more dangerous than investing in crypto yourself. Imagine the most risk-seeking person you can - that person is essentially who was generating the yield that BlockFi and Celsius were promising you. They took these extremely risky traders, bundled them together, and packaged them up as a product that would generate yield on the assets that you deposited. This worked great… when the market was up-only. As soon as these traders started to lose money with their risky bets, the product no longer worked - and your grandma found out that she was considered an ‘unsecured creditor’ - a phrase she had never heard before she learned that she wasn’t getting any of her money back.
A note on CEXs
So why do entities like this exist?
CEXs function as a way to turn government currencies into crypto on a platform that requires you to show your identity. This is an anti-money laundering, anti-tax evasion measure. CEXs will typically have you upload your government-issued ID so that they can, if necessary, report your activities to tax revenue services (e.g. IRS) or law enforcement agencies (e.g. FBI). This is known in the traditional finance world as KYC - ‘know your customer’.
They also function as a place for people to save on gas while trading. Because you’re not actually transacting onchain, the CEX can just record on their internal ledger “Bob traded 15 XXX for 1 ETH, so deduct 15 XXX from his account and add 1 ETH.” No funds move when you do this - the CEX just changes their internal records on their centralized database. So traders can trade back and forth without needing to pay onchain gas fees, which can be high depending on chain activity and what network you’re using.
This is why CEXs should only be used to buy and sell cryptocurrency. You should not be using a CEX to store your assets long-term. If you’re not actively trading, you should move your assets to an onchain, self-custodied wallet.
Unfortunately, this is one on the list that actually was crypto. This is one of those ones that would have been difficult at the time for the untrained eye to identify for sure as a scam. Terra created a stablecoin, a coin whose value is pegged to the value of the US dollar, and called it UST. The stablecoins you might already be familiar with, like USDC and USDT (Tether) are backed by real-world assets that ensure their value. UST was an algorithmic stablecoin, which is to say that there was a complicated mechanism behind it that’s meant to ensure its value. UST maintained its peg by an algorithm tied to its cryptocurrency LUNA. An algorithmic stablecoin is very difficult to get right and risks a de-pegging event where it very quickly plummets to zero, as UST did.
The biggest red flags that personally kept me away from the Terra LUNA fiasco were its incredibly rapid growth, the high yields promised on its stablecoin, and the hubris of its founder. Stablecoins should be boring - they’re not meant to produce high yield, they’re meant to produce stability. And it’s a trope in crypto that, once a crypto founder becomes the ‘main character’, it’s doom from there. Arrogance, a god-like sense of self, and high social media engagement (instead of building) are signs that there might be just a bit more hubris in a project than there is actual product. These aren’t absolute, foolproof signs of a scam, but they certainly should make you wary.
Crypto is full of scams because there’s excitement about a tech disruption. Tech disruptions happen when everybody’s arguing about how to make some technology better while someone comes along and changes how that technology fundamentally functions in society. It happened to the telegraph when the telephone came along, to the radio when television came along, and to personal computing when the internet came along. We can see the disruption, but it takes a community of innovators to figure out what it makes possible, so people rush around trying to find which innovators are finding the best product-market fit for the new technology.
The problem is that the people running around with cash in their hands looking for the innovators don’t always know how to recognize those innovators. So grifters see the opportunity and LARP as an innovator while venture capital (VC) and retail pours money into their lap, hoping to get in on what’s fundamentally good tech - but the grifter isn’t actually building something innovative, they’re building whatever will keep money pouring into their laps. As long as VCs and retail have targets on their back by throwing money around without doing research, and as long as the government refuses to regulate who can hold assets for those VCs and retail investors, grifters gon grift.
The only reason the scams exist is because anybody who spends some time learning about it can sense that something very exciting is happening and that opportunity is lurking around somewhere, but not everybody has the time or resources to sift through the garbage.
It’s up to you to do your own research (DYOR), but staking on Ethereum is a sustainable yield generated by helping secure Ethereum. Yields are low, nobody custodies your assets, and everything is transparent. Staking is an agreement between you and a smart contract. Yield from this smart contract is dynamic to keep it sustainable - as more stakers enters, yield goes down. If stakers leave, yield goes up. This way, it finds an equilibrium based on what operators think is fair for their labor. Current yield is viewable on the Launchpad.
The deposit contract is audited, can be viewed here, and sits directly on the most decentralized network of node operators in the world. Meaning - no one can go in and unilaterally edit the contract or manipulate the validators. Every change to the protocol is proposed, meticulously discussed, debated, planned, tested, and implemented by hundreds of developers from different organizations - the entire process is transparent and you can even sit in on these meetings if you’d like.
Proposals are first drafted here: https://github.com/ethereum/EIPs/
They’re officially proposed here: https://eips.ethereum.org/
The EIP process is explained here: https://eips.ethereum.org/EIPS/eip-1
Discussion happens over months or years in the all core devs calls that you can watch live or even join in on: https://www.youtube.com/@EthereumProtocol/streams
It’s always safer to keep your funds in a cold wallet, but if you’re willing to put in a bit of research and effort, staking is, in my opinion, the best option if you want to put your assets to work in a sustainable way.
If a centralized entity is custodying your funds, they are at risk
If it feels like gambling, it probably is
If it feels too good to be true, be very wary: it probably is
If your trust in a product hinges on a famous influencer personality, be cautious
A cold wallet is always the safest place to keep your assets
Always DYOR: having context is key to understanding how a product works
As always, if you find any inaccuracies in these blog posts, please contact nixo and let her know so she can hastily correct them.