Luna guy: “There is a difference between failing and running a fraud!” You don’t say!

by Edmund Yong

This article was first published by Smart Investor Magazine at the following link:

https://www.smartinvestor.com.my/ms/how-does-hanlons-razor-apply-to-crypto-investment-risks/

How does Hanlon’s Razor apply to Crypto Investment Risks?

In the wake of the massive crash of the Luna stablecoin that brought the crypto industry to its knees, people everywhere are demanding justice. There are memes comparing it to the notorious Bernie Madoff, right next to McDonald’s job ads for those who lost their life savings.

Blame it on Stupid!

The creator of Luna which lost almost 100% of its US$40 billion value at one point, told the Wall Street Journal that it’s not a scam: “I made confident bets and made confident statements on behalf of UST because I believed in its resilience and its value proposition. I’ve since lost these bets, but my actions 100% match my words.” He emphasized: “There is a difference between failing and running a fraud” (italics added).

There is an age-old wisdom called the Hanlon’s Razor which states: ‘Never attribute to malice that which can be adequately explained by stupidity’. What this means, reductively, is that not everything is a fraud. People can and do make dumb mistakes. So don’t automatically assume that everyone is evil. The world is not out to scam you. Sometimes sh*t happens! You just have to accept that as a part of life.

If the Hanlon’s Razor is applied to the context of Luna, it suggests that stupidity is to blame: Not everyone is smart enough to manage a multi-billion-dollar crypto fund. Sorry to the investors who lost everything. Do you buy that?

Law enforcement investigations are now underway. Unfortunately for Luna, stupidity is not a great legal defence. There might not be an intent to defraud investors, but failure could mean negligence which is punishable by law. Were proper measures taken to safeguard investor monies? Was there a duty of care to do the right thing? Did they fail to do so, chose not to react in time, or were wilfully ignorant of the fallout?

Stupidity is a Big Risk

What is not obvious to most investors, and which Hanlon’s Razor elucidates, is that that the risk of stupidity is as serious as the risk of scams! But investors tend to mix up the two even though incompetent or dumb management is a much more outspread problem than perceived. While scams are intentional, stupidity is not and generally can’t be helped (‘if you are dumb, you are dumb, so help you God’).

One reason is because so much of the crypto DeFi space is unregulated. DeFi or “decentralised finance” with their anonymous operations and offshoring structures are still beyond the reach of national laws. Furthermore, in a traditional financial firm, the management has to be ‘fit and proper’ with deep requisite experience and board oversight. But with most DeFi projects, you are stuck with the founding team. Even if they can’t perform, you can’t fire or remove them. And while they claim to be decentralised, their decision-making flows often indicate otherwise.

We created a quadrant to illustrate this. In a very simplistic world where investment projects are ranked on two factors – only 1 in 4 (or 25% chance) have the rare combination of competency and virtue (green area). There is a possibility th at 2 out of 4 projects (50% chance) are led by those who are incompetent, or by those with malice (red area). In other words, there is an equal chance of project failure due to either stupidity or scams.

Each quadrant can be profiled by these fictional ‘straw men’:

  1. Smart + Evil: For instance, pure villains such as Gordon Gekko (the fabled Wolf of Wall Street) or Hannibal Lecter.
  2. Stupid + Evil: This could be like the Dr. Evil and Mini Me characters, or the bumbling burglars in Home Alone movies.
  3. Stupid + Good: A classic case is Forrest Gump, or when Mr. Bean tries to save the world.
  4. Smart + Good: The most relatable is Ironman, a genius and philanthropist, in the Marvel Universe; or Dr. Manhattan in the DC Universe.

For the Smart Investor, there are two things to take away from this. First, while there is moral hazard or malice everywhere, it particularly thrives in an unregulated environment. Second, never underestimate the power of stupidity. Dumb management can do a lot of damage. If you want to invest your life savings with a bunch of college dropouts and young punks who genuinely want to make the world a better place, please don’t cry fraud when you lose.

Disclaimer: Contents above are for educational purpose only.

 

Edmund Yong is the managing partner of Celebrus Advisory and appointed by MDEC as part of its Talent Expert Network (formerly known as Digital Expert Panel) for blockchain technology. He is also the resident consultant for GLT Law, a multi-award-winning legal practice with specialisation in digital assets.

References:

Do Kwon Interview Explains He’s ‘Devastated’ by LUNA Collapse, Says ‘There’s a Difference Between Failing and Fraud’ – Bitcoin News

https://www.nytimes.com/2022/05/18/technology/terra-luna-cryptocurrency-do-kwon.html ($40B)

https://en.wikipedia.org/wiki/Do_Kwon (Stanford, Apple, Microsoft) (even though it was led by a Stanford graduate and former Big Tech engineer)