This blog is not about answering “What happened at FTX” or “Why did SBF do wrong”. The internet is filled with root causes and insightful analyses where opinions are on the entire spectrum from “oh, he was a well-intentioned kid who made innocent mistakes”, “this was the biggest fraud in history”, and “it is a political conspiracy”. Form your own opinions, please.

Instead, here are two critical common-sense based insights from the episode

1) Low Risk with High Reward is a myth

2) Decentralisation is essential but inconvenient

Life 101 - there is nothing called low risk with high return.

Low-Risk assets provide low returns in the long term, and high-return assets have high risks. Also, it is only common sense that taking a high risk but not getting compensated with high returns is just plain stupidity.

However, most humans' most common aspiration (for centuries) is to find that ‘hack’ in the system, where the risk is low and returns are high. How often have we heard someone telling us, “Mate - found a scheme just for you - no risk, but the return is high”? This always turns out to be one of two things.

Case 1 - Ponzi Scheme. Someone is trying to fraud you; the best thing to do is just run! The more you try to engage in a conversation, the higher the chance that you will be trapped. While this is most commonly highlighted, there are other reasons besides this.

Case 2 - Lack of understanding of Risk. This is the most common reason. It indicates the human mind's limitation to thinking through risks and acting accordingly. Once one thinks through all the risks in a given scenario (first, second and third order), the investment opportunity will move to one of the other quadrants of either high risk or low return (because of the investment required to hedge the risk). Try running this through various examples of assets. Empirically, it is apparent that people who can make consistent returns in the long term focus on risks methodically: identify, quantify, define appetite and hedge.

Arbitrage opportunities do exist but are almost always short-term. Some people can identify such opportunities regularly, and the investment to find such limited options is relatively high.

Lesson - “low-risk high-return” should be a trigger word for everyone - a big, bold red flag and should always create curiosity about what risks we are unaware of. This will typically help you understand the risks better and consider whether you are willing to take the risk and even how you hedge such bets.

Did this happen in FTX - indeed, yes! Potentially there are other reasons for fraud and mistakes. And hopefully, the judicial system will find the answer honestly. But they did lure investors through higher returns on cryptos (which happened at a different scale in the crypto bubble).

The fundamental premise of blockchain is decentralisation and the non-existence of central trusted parties. How ironic that FTX was a centralised exchange. Its failure highlights an important aspect: even though we talk about decentralisation, we still think of centralisation as a key enabler. Primarily because decentralisation is very inconvenient for an everyday user. And the platforms that make it convenient then centralise the trust.

So, what do you think is the solution?

Firstly, Blockchain is not spelt as C R Y P T O

Secondly, before making the system convenient, let’s understand what services are required in this permissionless, distributed, and trustworthy blockchain system.

While there is a layer-based approach to thinking about components and service providers in a blockchain ecosystem, the diagram above provides an alternate quadrant-based visualisation of the ecosystem, viz a viz,

• core technology providers

• tooling and upskilling providers

• application builders

• real-world data integrators

As you can see, diverse players and personas are providing various services. This diversity, while significant, fundamentally causes inconvenience and, inevitably, migration to central trusted parties. There is no definite answer yet, but there seems to be a general direction of progress, i.e.

• We must stop thinking about “one platform which will do it all”.

• Incentive structure designed to move away from central and opaque platforms and towards decentralised and transparent networks.

• Blockchain entrepreneurs make convenience their priority #1.

Blockchain is still in the infancy stage, and there is a lot of ground to cover. We have to think about service and solution providers differently so that we don’t need central trusted parties but have a trusted network.