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Sam Bankman-Fried reveals how DeFi works like a Ponzi scheme

As the Commodity Futures Trading Commission (CFTC) debates whether or not to allow FTX to settle algorithmic margin trades, its founder and CEO, Sam Bankman-Fried (SBF), recently revealed how DeFi works in a similar way to a Ponzi scheme.

In an insightful episode of the Odd Lots podcast, Bankman-Fried explained how yield farming works. The hosts weren’t the only ones stunned by the digital currency billionaire’s explanation of how this shell game works under the hood.

SBF explains yield farming with a box analogy

To explain how yield farming works, Bankman-Fried asks viewers to imagine a box. He says, “You start out with a company that builds a box,” and that the marketers of that box will try to sell it as some kind of world-changing protocol. He explains how to put digital currencies like Ethereum in the box and get a promissory note.

The next step is for the developers to issue a token. Holders of this token often have control rights over what happens in the box. For example, they could say what happens to the newly minted tokens that come out of the box. This token is then gifted or bought, giving it a larger market cap, leading other market participants to notice it and see it as valuable.

“I’ll admit that it’s not entirely clear that this thing should have a market cap, but empirically I’m arguing that it would have a market cap,” Bankman-Fried pointed out.

The FTX boss then describes how the high returns on these boxes are enticing new speculators to put more money into them. The fact that there is now a large amount of money in the box leads others to believe it must be legit and put more in it. This can cause the token price to increase rapidly, and the whole process is amplified when the total number of tokens available is low.

Matt Levine intervenes at this point in the conversation, describing it as “cynical” and likening it to an open Ponzi scheme. Bankman-Fried says that above all, these boxes value the perception of market participants.

Bankman-Fried and FTX sell these boxes

Although Bankman-Fried admits that it is unclear whether these tokens should have a market cap, he is happy to sell them on his FTX exchange. Many of them can be traded using leverage. To name a few, FTX lists LUNA, CURVE, and YFI, all of which have seen dramatic price increases at various points in the recent bull market. Many of them have emerged alongside the printing of large volumes of Tether, a controversial stablecoin of which Bankman-Fried’s Alameda Research is one of the largest recipients.

However, FTX is not the only exchange guilty of selling largely worthless tokens. Binance, Coinbase (NASDAQ:COIN) and others have listed meme tokens like Shiba Inu, ApeCoin, CumRocket and others. Of course, in doing so, they have been extremely careful to “protect” investors from Satoshi’s native Bitcoin (BSV).

So if Bankman-Fried is unsure whether these tokens should even have a market cap, why is he willing to sell them? And if he agrees that the whole process could be seen as cynical, why is he even getting involved? Maybe the next podcast moderator will ask him.

Should FTX be allowed to algorithmically clear leveraged trades?

The first paragraph of this article links to a story describing how the CFTC is currently deciding whether to allow FTX to algorithmically delete margin trades on their platform. Bankman-Fried touts this as a financial innovation, but it really is ultimate control over his firm’s operations.

If the CFTC allows it, all third parties involved in the trading process today, including brokers, would be barred and would have no way of calling what is going on inside FTX a foul. It would also give the FTX algorithms the ability to automatically liquidate traders, which should be viewed with concern as it has been accused of making counter trades with its clients.

In Bankman-Fried’s own description of how defi works, it’s one of the greatest Ponzi schemes in history. Perhaps the CFTC should proceed with caution before giving any of its figureheads unchecked power.

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