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Jon Bradshaw & Peter Harris

We cover what FTX's crash mean for Venture Capital and specifically for Crypto Startups.

FTX’s Crash and It’s Affect on Venture Capital

Learn what FTX’s crash means for VC. We are sure there are a lot of memes that also show this.

Join us on this podcast to see what we think!

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Episode Transcript

Jon: What should be the perfect title of this episode.
Peter: Now, Jon lost his life savings in FTT.
Jon: It was FTT or FTX.
Peter: FTX FTT as the coin token.
Jon: FTX is the token price FTT. All right, so I have a text message from a friend who's a founder. You have a friend. A friend who in the FTL FTT space. So I just said, Hey, how's your startup doing? And it's kind of crazy because they're preparing for their next round. They're in the blockchain space, blockchain crypto space.
Jon: They're one of the few actually crypto startups that I appreciate because what happens with most of these crypto startups is they're like, Hey, we're a product, but they end up launching a coin. These like, but I feel like our scammy crypto startups and I'm like, If you're really building something, just go build a product. Although maybe it's a cash.
Peter: Machine like an MLM, it's like, Hey, we sell these great products, but really you should buy the business, right?
Jon: But if Codebase had a coin and I could get millions off of printing.
Peter: My bitcoin base coin.
Jon: The Codebase, not Coinbase, then we would that would be in business. But I think this has been kind of does that disastrous? Do you want to first talk about what's happening in the news with FTX and FTT? I'll talk about what's happening confidentially at the startup and then we can talk about the implications on venture capital, on startups in the space right now.
Peter: Yeah, let's just give a quick high level on, on what's happened. So yeah, there's some context.
Peter: So basically there's a lot of details left to come out. So, you know, we'll see what the truth ends up happening. But essentially FTX. Well, yeah, okay.
Jon: There's like 15 hours old. The story, you.
Peter: Know, I know.
Jon: Super, super early. Sam Bankman-fried Founder.
Peter: Yeah. Okay. So essentially. Sam Bankman-fried, Right. Founder of RTX, second or third largest crypto exchange, depending on, you know, what numbers you're looking at. FTX basically is collapsing in real time. Sequoia just came out and announced that they are writing down their 200 plus million dollar investment to zero, and there are a lot of venture funds. I mean, the company raised over $2 billion and basically every venture fund paradigm, IVP, Sequoia, I mean the list goes on and on of funds that were in there probably at this point basically saying our investments were zero.
Peter: lot of controversy around how, you know, there are rumors that sound was like going to the government to complain about Binance and saying put pressure on Binance and then seizing his at a Binance was like fine, we're just going to dump all of our FTT and cause the market to collapse. And then there was all of this, these rumors about like Alameda, which is like the sister organization that probably has too much overlap and too much sharing of assets, like always losing a ton of money and it was collapsing.
Peter: And then that dragged off with it and then by it. And like then there are all these conspiracies that like Binance did that because they just wanted to crush their competitor and then buy them for pennies and then they like made overtures to buy them and then they pulled out. I mean, and now they're like hoping that like Kraken will come in.
Peter: I mean, they're just like desperate. And my friend just said the FTC's just reopened the ability to withdraw because they cut off everybody from withdrawing their assets and they just reopened it. But you have to be in the Bahamas. And so now everyone's like trying to figure out how do they get to the Bahamas or how do they get a Bahamian ID so that they can actually withdraw their money.
Peter: And like, the whole thing is crazy, right? And we'll see. Like we don't even know all the rest of the stuff that's happening right behind the scenes. Because to your point, this happened like 15 hours ago and it's fresh and people are still trying to figure it all out. And frankly, I don't think Sam had really knows what's going on.
Peter: Right. I don't think anybody like has a full grasp of the full picture.
Jon: Yeah, I don't think I think the crypto winter's been cold and then it just dropped to, like -20 overnight.
Peter: Yeah.
Jon: And we're trying to see what's happening in our. Is the orchard still around? The trees die because it got too cold. Yeah. Now is Granny's house you know. Is our heater still on. Who knows. Yeah. But I think in the space, you know, I think startups are, are seeing founding team members leave because they see that the space is not as hot as they thought it was.
Jon: I think it's really shaky in founders to the core. But I think the other trick is that I believe EFT is FCX Yeah, is investing in a lot of these other these VC funds.
Peter: Yeah. So that.
Jon: Investor though.
Peter: Yeah. And so well not only are there investors in other crypto funds, they're investors and they're the investors that are invested in them. So they're investors in Sequoia, they're investors in Paradigm.
Jon: Which means it will affect capital calls coming up because capital calls are going to come.
Peter: FTX is not going to have the money because they don't exist. Right. And those funds are going to implode because. Yeah, because FTX was their anchor LP.
Jon: So maybe Baby Angel.
Peter: Or maybe they want implode. I mean, it depends on on how big of an anchor FTX was for them. If they represent half the fund, they implode. If they represent 10% of the fund now, they're probably survivor, right? and there are mechanisms within limited partnership agreements that when somebody can't fund you basic, I mean, depends on how the LPA is written.
Peter: But I mean there are very harsh penalties all the way to like basically dissolving all of their prior investment and holdings and redistributing that out to other LPs. So there are mechanisms that will unless FTX is like, you know, massive part of your fund, you'll probably be okay. But it's definitely I mean, you just you just your management fee, you get cut by whatever percentage they were of the fund.
Peter: You just saw your carry get cut. I mean you just Yeah. And your ability to continue to support crypto start ups which you know in a lot of cases these crypto this crypto startups, they're in like the worst period ever right this winter and they're probably going to be in the most need of capital. So sorry I don't mean to go on this long, but if you're a crypto fund you should probably be like conserving capital at all costs just to keep your current portfolio companies alive, right?
Jon: Or a crypto startup.
Peter: Or a crypto startup. Yeah, you should be. You should be lengthening runway as much as you can. Or maybe, maybe you do just hang up the Spurs and say, You know what? Maybe I should look at something else like generative AI maybe.
Jon: I don't know. I don't know. What do you think? Do you think something like this big will embarrass Sequoia because they're an investor in FTI?
Peter: Like, I think they already are embarrassed, right.
Jon: Because they're so down to zero.
Peter: They wrote it down to zero. Now, look, I mean, this article is like very broadly shared at this point, but the letter that, Sequoia sent to their peers, they basically said yes, like, you know, they were writing it down to zero, but don't worry, because the fund it's in, you know, is already, you know, valued at $7.5 billion and you're going to be okay.
Peter: so on the one hand, is Sequoia embarrassed? They're absolutely embarrassed that they put money into this company and $36 billion of value disappeared overnight. And it doesn't look good whether they did their diligence or not, like it just doesn't look good. The other thing is that don't look at that are potentially embarrassing to the venture funds that we're in is none of them have board seats there effectively wasn't a board.
Peter: None of them had much oversight. None of them had much control. And it was just kind of like, if you want in to this rocket ship, you want to get on the same bandwagon like this is the cost of playing ball. Like you just kick in money. And and so, you know, what do you do right. Like there's and so they're probably going to be LP is a push back and be like well if you can't get the control and don't have the oversight like you shouldn't be doing these types of deals And so there's probably some fall back or fallout and pushback from that regard if you're the venture partner.
Peter: I mean, here's the other thing that a lot of people don't really appreciate, I don't think, is that like it's not Sequoia alone that lost this money. There was a partner at Sequoia, right? There's a partner at IVP, there's a partner at Paradigm, there's a right. And that partner was probably the partner that led that investment and so on there, like Sequoia overall is probably and we find like a lot of these big funds are probably gonna be okay.
Peter: That partner, that's going to be a tough that's a tough situation to have like you know, 100, $200 million zero in your track record, right? especially on the growth stage, because it's just so hard to come back from that. And, and when we say 200 million, that's cost basis, like that's capital deployed into the company, not, not what it was worth.
Peter: That's, you know, I mean it was probably were some multiple of that. Right. So you're taking like a double whammy if you invested that $200 million in that $200 million became like $1,000,000,000 of value. You're seeing $1,000,000,000 markdown on your books, right? Not a $200 million markdown.
Jon: But it's part of the game. So how do you think this.
Peter: Part of the game.
Jon: How do you think this will affect founders? Do you see this issue with suggest, hey, the crypto market is still in its nascent stages, it's still highly unregulated and things like this will continue to happen as and it will happen less frequently as it becomes more mature.
Peter: I think that's true, but I think this is going to scare a lot of investors away. I think anybody that's not doesn't have a core thesis in crypto is basically going to say, you know what, if Sequoia got this wrong, I'm probably not going to get it right. I'm just going to stay away.
Jon: I guess we should make especially if Sequoia got this wrong, because they would all have a huge team and oversight and.
Peter: Look and Sequoia gets things wrong all the time, right? That's part of the game to your earlier point. Right? I really love this quote. Somebody said once in this versus other, like, you know, really well-known fan and he was like, venture is the game where, you know, you're wrong 70% of the time, but you're still like if you have the hit rate of 30%, right?
Peter: Like you are the biggest genius, wealthiest VC in the world, right? So yeah, people get it wrong. But I do think there are a lot of sees a we'll look at this and just say, you know what, this whole market is a mess and there are so many existential threats that like you just don't know what's under the bed is going to come get you right because FTX number two, player number two, number three, right $36 billion valuation gone, right?
Peter: I mean, that's kind of crazy to think about. Yeah. Like, you know, talking out of the other side of my mouth, though, is that financial firms are always in a tricky position. So if we think back to 2007, 2008 at Bear Stearns and Lehman Brothers, both large multibillion dollar investment banks that totally collapsed within a matter of days.
Peter: And the reason they collapsed and this is this is a real challenge with financial firms is that they are built fundamentally on trust. And when you lose trust, when that trust evaporates, your business evaporates almost overnight. And that's exactly what happened here with FTX, because Bear.
Jon: Stearns was still in a great financial spot. Just the perception I think we were talking about this a while ago. Yeah, the perception of trust was lost, collapses.
Peter: Everybody went and pulled their money back. Right. And now and then Bear Stearns can operate because they live on liquidity and the whole business collapse. Same thing with Lehman, same thing effectively with FTX. So what happened is Binance was an investor in FTX, and at some point FTX bought out by Nance. And part of that deal was that they gave them $2 billion worth of FTT, the currency for FTX.
Peter: And in in normal situations, you would think that would be a positive because now, Binance has a $2 billion incentive to make sure that it is successful. Right. They don't want to lose that $2 billion of value because of FTX fails. The FTT is worth nothing. Right. But what's interesting is you basically said, I don't care about this 2 billion.
Peter: Right. And I'm going to dump it on the market. And if I dump it, I'm effectively saying I have concerns and I don't trust FTX anymore. And I'm willing to basically take a donor on this $2 billion. Right. Or I'm willing to take whatever I can get at this point. Right. Because whatever I can get is better than zero, which is what I think it's actually worth.
Peter: And that basically evaporated all trust and everybody pulled out as much as they could and had a liquidity crisis and collapsed.
Jon: If you were on the board of FTX or a crypto startup today, Yeah. Is there a lesson that you would learn or take from this and say, hey, here's a policy that we should roll forward to prevent this?
Peter: I think one is just like radical transparency. I don't think there was good transparency based on the little that I've read there is, you know, like there's all these like crossovers, conflicts of interest between Alameda and others. You know, there wasn't oversight and there probably needed to be like really good oversight. And, you know, there's not a lot of regulation in this industry.
Peter: And, you know, some regulation is good, right? It provides that trust that is so, so important to these entities. So, yeah, I mean, I think I think all of those things are important. I think in this environment where we're in this, you know, this winter, it's being really thoughtful around your risk controls and your risk management. And so having people that understand risk really, really well and can help guide the company accordingly becomes become super important.
Peter: But at the end of the day, there's also a certain element of like, you can't you can't really control this sort of thing. What I think is unfortunate is that I don't think that FTA acts as collapse is indicative of crypto, the crypto market. Broadly speaking, I think, you know, we could look we could point to many examples, not just Bear Stearns, the Lehman Brothers, we get to point to long term capital management that collapsed in the nineties that almost took down the whole financial system.
Peter: We look at, you know, companies like Enron and so forth that did a lot of financial engineering. And I think at the end of the day, like those have nothing to do with crypto and yet had huge impacts in not just their industries, but in the kind of broader world economy. And if you look at. FTX, Yeah, it's it's it's a tragedy for those that had their life savings and so forth and can't get that value back out of FTX.
Peter: But in the broader world, global ecosystem is probably not going to have much of an impact in the same way that a Lehman Brothers or a Bear Stearns and, you know, long term capital management collapse and some of these others had. So but it's going to be a cold winter for crypto and it's going to probably last a few years because this is the way this is like this is the way.
Peter: Right. But but this is the cycle, right. That keeps happening. And I think one of the things that you have to remember is that when we're in recessions, until it starts hurting, right. We're not quite in that recession yet. And you're right. And so we keep talking about like a recession is around the corner and all these companies are doing layoffs and that, you know, that's painful.
Peter: But until you see large companies start collapsing. Right. We're we're not there yet. Right. And it's like once you see those companies collapse, then, you know, like you're starting to hit the bottom now. And I don't think I don't think FTX is the last one to fall. I think it's the first of many, especially.
Jon: In the crypto.
Peter: Space, I think potentially kind of across the economy.
Jon: Okay.
Peter: I mean, there are a lot of bloated companies that are struggling to cut as much as they can so they can cut costs and and survive long enough. Right. I mean, Facebook today that today just announced like.
Jon: 11,000 layoffs.
Peter: 11,000 layoffs. Right. Right after not not that long after Mark Zuckerberg said that we were that he wasn't going to lay off anybody. Right. Including laying off a decent number of people in his beloved Medicare. You know, Metaverse group.
Jon: Snapchat had 10% layoffs. Twitter did 50% because.
Peter: They're trying to get some of them back now. They were a little too they're a little too aggressive on those cuts.
Jon: And anytime you that you come into a hostile takeover, it's always, always rocky.
Peter: So he's going to be rocky. Yeah, especially especially in the opinion that such.
Jon: By a company that's losing money every year and I've got an additional 1 billion plus of interest expense to pay for for Twitter.
Peter: And you just overpaid for it.
Jon: Did they overpay.
Peter: yeah. $44 billion for that company right now. No way. Twitter is worth that today.
Jon: I think it's on the high side. If you also look at the premium, you typically have to pay, it's like a 30% premium over value to do an acquisition, Right?
Peter: Yeah. But what's the true value of Twitter today? Like 20 billion maybe. So you're paying over a 50% premium that's rich.
Jon: Maybe.
Peter: Maybe in this market, everything is down. Everything all right? Well, not everything, but most things. Yeah. I mean, look, I will never bet against Elon Musk, right? I think he has consistently, his entire life proven everybody wrong.
Jon: Does that mean you got to buy Twitter blue?
Peter: That doesn't necessarily mean that I'm going to invest in his next next idea.
Jon: His next idea is Twitter. I know he needs money for it.
Peter: And he was out with his hand, his hat, asking for money from a lot of people.
Jon: because of this? Because of Twitter.
Peter: yeah. When when they went to buy it.
Jon: when I went to buy it, he got money ultimately for what?
Peter: The Saudis got money from like tons and tons and tons of different groups like I think. Marc Andreessen Right. Famously it was like, I don't even need to run the numbers. Here's here's my, you know, hundreds of millions of dollars. Investment. So, yeah, we'll see. I bet he pulls it off, but it's going to be rough.
Jon: But he's got to grow it to be $100 million company or he'll 100 billion or he'll look like a loser. Yeah, right. Yeah. And we'll see how he does as the CEO of a third or.
Peter: The three publicly traded the three large multi billion dollar companies.
Jon: Yeah. If he has a four to maybe a third one is not that hard. Yeah. Especially you already spent so much time on anyway. So anyways guys, thanks for watching. Go to venture capital that often if you want to scribe on Spotify, Apple, YouTube, all the links are there. Venture Capital FM and we will see you on the next episode.
Peter: Stay warm out there.
Jon: All right. See you guys.