- Chamath Palihapitiya is a billionaire venture capitalist and early bitcoin investor.
- On the “All-In” podcast, he addressed the two biggest problems he sees in the crypto market.
- Palihapitiya explained why governments must pay attention to crypto exchanges’ off-chain activity.
Chamath Palihapitiya’s name has become synonymous with SPACs — but while his investments in that arena have received a lot of attention in the past few years, he has also been investing in cryptocurrency for over a decade.
On a recent episode of the “All-In” podcast — a program he cohosts with fellow venture capitalists David Sacks, David Friedberg, and Jason Calacanis — Palihapitiya outlined the biggest problems he sees with the crypto industry right now, and what he thinks needs to happen in the digital-asset space to solve them.
The biggest problems with crypto
Palihapitiya expressed frustration with the current state of crypto on the podcast — a notable change in tone from the way he’s talked about the industry in the past.
Palihapitiya has been a longtime defender of bitcoin, first purchasing the cryptocurrency back in 2012. In fact, according to an interview with CNBC, in 2013 Palihapitiya and two of his friends reportedly owned up to 5% of the total supply of bitcoin at the time. That same year, he wrote an essay explaining why he thinks bitcoin’s strength is as a store of value and its potential for asymmetric upside.
Palihapitiya remains a staunch crypto bull, lending his frustrations with the crypto industry extra weight.
The first issue Palihapitiya pointed out is the lack of regulatory oversight in the crypto industry.
“This is a completely unregulated market, right? There are no market makers that actually have reporting requirements to any regulatory authority. There aren’t any clearinghouses. There isn’t a way for us to understand systemic risk as it builds in the crypto market,” Palihapitiya said on the podcast.
“The underlying principle around that is a common set of parameters, a clearinghouse, the ability to monitor risk — none of those things exist here. And I think that’s really what folks have to solve for now,” he continued, emphasizing the lack of traditional safeguards in crypto.
Palihapitiya also brought up the off-chain activity that crypto exchanges regularly engage in.
Off-chain activity is when crypto is moved from one account to another without a record on the blockchain. People engage in off-chain transactions for a variety of reasons — some legitimate, some less so.
Palihapitiya warns that off-chain activity could be used by bad actors looking to pump the price of a token that they themselves created, which, in turn, could hurt retail investors.
“You go and do some crazy round,” Palihapitiya said. “You mark up some phantom equity in a company, that company then issues tokens, you then list the tokens, not on a blockchain per se, obviously, but in a place where trades can happen off-chain, right? There’s a bunch of exchanges where these things happen off-chain because it’s one company, and then they have a bunch of segregated subaccounts.
“What happens is when these things initially get listed, retail goes crazy, the price goes up. And you know, you spin that loop as fast as you can, and you can extract an enormous amount of money.”
He also criticized the recent popularity of high-yield staking, in which investors enjoy spectacular returns in exchange for depositing their crypto with a particular network protocol. In practice, however, the pursuit of these returns can lead to both retail investors and crypto exchanges alike taking on too much risk.
“Along the way, all these things like DeFi all of a sudden popped outta nowhere,” he said, referring to decentralized finance, “and it’s like, ‘Hey, you can earn 15%, 16%, 17%, 18%, just deposit the bitcoin.’ And so folks would deposit bitcoin, but then what would happen is the places where those deposits were held would then need to obviously find places to make that. And so then they would go off-chain to some other random person who was offering to pay them even more than that.”
Terra luna — the cryptocurrency whose crash deeply impacted the broader crypto market — offered a 20% annual percentage yield in exchange for staking. Celsius, which is now refusing to let customers withdraw their crypto, offered 8.53% returns to investors who staked with them.
Palihapitiya continued: “And they would try to arbitrage the difference, but it all catches up with you because when something like a terra goes to zero, all the bitcoin that was used to run that DeFi process around terra vanishes, and then all of a sudden, the lender says, ‘Hey, can I have my bitcoin back?’ And the broker’s like, ‘Well, actually I don’t have it. I lent it to somebody else. Let me ask someone else.’ And they’re like, ‘I’m sorry, I don’t have it. But I have these terra coins.’ And it went to zero, and that’s essentially what we’re seeing right now.”
So what’s the solution to crypto’s current issues?
Palihapitiya expressed concern about the future of crypto if it continues to go down the path its heading.
“The big problem is obviously in the absence of any regulatory oversight, this stuff is gonna happen,” Palihapitiya said. “Systemic risks are gonna build up. That’s what we’re facing right now is an enormous amount of systemic risk, largely around bitcoin.”
His solutions to the problems he outlined in the podcast are simple: First, introduce regulation.
“I tend to think at this point, bitcoin probably has to be regulated like a security, even if it is not and it’s more of a commodity, only because of the volume and the sheer size of both the market and the secondary markets.”
Right now, regulation is a hot-button topic in crypto, and it is worth noting that both crypto believers — like the “Shark Tank” investor Kevin O’Leary — and skeptics — like the Duke fintech professor Lee Reiners — have called for increased regulation of the space.
In the US, Sen. Cynthia Lummis has proposed what many call a very industry-friendly bill. Meanwhile, in Europe, the Markets in Crypto-Assets, or MiCA, legislation aims to protect European consumers from crypto fraud.
As for curtailing off-chain activity, Palihapitiya’s solution is to get the justice system involved. “If you subpoena the exchanges, all of this gets turned over, because the exchanges are the honeypot of off-chain activity.”
Beyond subpoenaing exchanges, other solutions that experts like Reiners have suggested include having the Securities and Exchange Commission, which has an investor-protection mandate, regulate the crypto industry. Deloitte has also suggested that the government regulate the “access points” of cryptocurrency purchases in exchanges, through additional KYC (know your customer) provisions.