Solana’s Many Red Flags

Solana is a $45 billion cryptocurrency and the 5th most valuable cryptocurrency in the world. I can’t figure out why because every time I look at Solana all I see are red flags.

If you have any comments for this essay please put them in this post on Reddit.

You can also read the Twitter thread version of this essay.

Why am I doing This?

I believe that cryptocurrencies and blockchain technologies are some of the greatest forces for improving the quality of life for humans. I plan to spend the rest of my life building and teaching in this space to spread this with others. While I originally wanted to only focus on the positive aspects, I've seen a lot of people get put off from entering this space due to the number of scams and fraud. To make the ecosystem healthier and more inviting for newcomers, I think we need to hold bad actors more accountable.

I think Solana had a lot of potential but greed and short-term thinking have ruined what could have been a very exciting project. Maybe they can still turn it around or maybe someone can learn from their mistakes and create something even better. But first, the following points need to be addressed.

Lying about Total Supply

In April 2020, the Solana team stated that the total circulating supply was 8.2 million tokens. An independent 3rd party found an unlocked wallet with 13 million tokens. That means the entire supply of Solana tokens essentially just doubled overnight. Solana claims that the 11.3 million of those tokens were loaned to a “market maker”.

They never actually identify this mysterious “market maker”. In the article, they say, “After speaking with Binance and our market maker…”. I find it curious that they mention Binance by name but not the market maker. Why is that? Who is this market maker? We’ll get to that later. 

Also, I’m genuinely curious, why does a cryptocurrency need a market maker? Wouldn’t the exchange be the party responsible for sourcing the market maker? Do Ethereum and Bitcoin have a market maker?

So anyway, they say they’re going to remove and burn the additional 11.3 million tokens that they loaned to this “market maker”. Fast forward to May 2020 and they release another statement saying that they were only able to get about 3.4 million SOL from the market maker. No explanation of what will happen to the other 8 million. They essentially just doubled the supply of SOL and just carried on with business as usual.

Justin Bons has a great Twitter thread that explains this issue.

There’s an even earlier blog post from June 2020 showing the confusion in the Solana Telegram chat regarding Solana’s supply.

Lying about Transaction Count

They inflate their transaction counts by including validator votes which make up 90% of transactions. 

Most other blockchains would only count the remaining 10% as the actual user transactions. This lie is peculiar because even without including the validator votes, they still would get about 300 transactions per second which is 10 times faster than Ethereum and slightly faster or about the same speed as Cardano. So why lie? 

Lying about Censorship Resistance

On Solana’s website, they claim to be censorship-resistant, yet in Solana’s Github README they have a disclaimer that says you can’t deploy, integrate or use the Blockchain if you live in any of the countries that have been comprehensively sanctioned by the United States Government. 

Looking at the Git blame and Pull request for when the disclaimers are added, there is absolutely no context on why a blockchain would need such a disclaimer. I’ve tweeted at the commit author for an explanation, so far no response.

Compare this to the README for Bitcoin, Ethereum, and even Binance Smart Chain which is run by a for-profit company, none of them have a disclaimer.

I know from talking to many people in the crypto space that most people will probably gloss over this disclaimer and say, “I don’t live in any of those countries, who cares?”. But the inclusion of this fine print cannot be underestimated. 

I’m not even the type to get political so sidestepping the debate of if countries should sanction regular citizens from other countries. Purely from a strategic perspective, building a blockchain protocol that tries to exclude people based on the country they’re from is a fatal flaw.

A blockchain is supposed to be a decentralized technology like the internet. Once you start picking and choosing who can and can’t join your club, you’ve already lost. This seemingly inconspicuous detail shows me that the core foundation of their protocol is completely flawed.

Finally, the very first page of the Solana whitepaper is a 2 paragraph legal disclaimer. I’ve read many academic and cryptocurrency whitepapers and I’ve never seen a legal disclaimer on a whitepaper before. Why does a blockchain white paper need a legal disclaimer?

VC Investments are Problematic

There’s been a lot of debate on if Venture Capitalists (VCs) are net-positive for the web3 ecosystem. I think it can go both ways and Tom Shaughnessy has a good thread about how VCs can invest in web3 in a good way.

Solana has decided to ignore all of that and raise VC funding in the worst way possible.

In March 2020, Solana had an ICO where it sold 8 million tokens for $0.22 each and raised  $1.8 million (alternate source 1, alternate source 2). As of January 14 2022, that’s a 654 times return on investment. Sounds good right? Until you realize that they’ve already had multiple private rounds where at least 36% of the total supply was raised. For comparison, they raised 1.64% of the total supply in their public auction on CoinList.

In June 2021, Solana raised $314 million in a private sale to venture capitalists. Reading this press release, you’re confronted with another list of red flags.

1. The biggest red flag is that they only mention how much money was raised, not a word about how many Solana tokens they sold. It’s like when startups announce how much money they raised but don’t mention the valuation. Probably because these tokens were sold to investors at a steep discount to the current market price and they don’t want people to know how many tokens were sold to investors.
   
    
2. We’ve already seen that Solana is very centrally owned, this sale just further centralizes an already very centralized token.
   
    
3. There is no clarity on if there’s a lockup period for any of these investors and if there is one, how long is this lockup? How do we know they won’t just dump it on retail investors?
   
    
4. Why are they even doing a private sale anyway? It’s extremely suspicious that a cryptocurrency that has already done an ICO would raise another round of funding to a private group of investors instead of selling those tokens to the public.

Compare this to SushiSwap’s proposed venture capital raise. The entire conversation was transparent, the whole community was involved and they insisted on a lockup period.

They ended up not going through with the VC round because they probably realized that if the VCs really wanted to invest in them they should just buy it in the public market like everyone else. Solana should take notes.

Proof of History Blockchain is Flawed

One of the reasons why Solana has such high transactions per second is because it uses a consensus mechanism called Proof of History (whitepaper). Their core “innovation” is adding a clock, which makes it possible to mathematically derive the next validator. The problem with this method is that anyone can calculate the next series of validators so if someone wants to DDOS attack the network they only have to attack one node as opposed to 51% attacking the entire network. This is one of the reasons why the network has suffered an outage 3 times in 6 months. This means that such outages will keep on happening unless they change the very core of their blockchain consensus mechanism.

Here are some interesting Reddit threads with more information on the problem with Proof of History.

Lack of Academic Research is Worrying

I’m also skeptical about Solana introducing a completely new approach for consensus mechanisms that aren’t being used by others. If proof of history is so great, why are so few people using it? Not only are so few people using it, barely anyone is researching or citing proof of history. 

Compare the Google Scholar results for proof of work, proof of stake and proof of history. Also, note that in the Google Scholar results for Proof of History, the only result that has anything to do with blockchain and consensus mechanisms is Solana’s whitepaper. All the other results are about topics that have nothing to do with the blockchain, the other results refer to “proof of history” in the social science sense.

This matters for two reasons: First, the lack of academic interest is an indicator that researchers in this field don't find the ideas proposed in proof of history worthy of researching any further. If implementing proof of history makes your blockchain better, implementing it would be low hanging fruit, since someone has already done the research and written the code for you.

The other problem can best be described by Linus's Law: "given enough eyeballs, all bugs are shallow". Which usually means, if enough people are looking at a certain code, security and quality issues will be discovered. Considering how much money has been lost to hacks in smart contracts and blockchain protocols,you want to have as many people as possible reviewing your blockchain design and making it better.

Fixing their blockchain is possible but they’ve dug themselves into a hole

Changing consensus mechanisms is a solvable problem and other blockchains have done it before. For example, Ethereum is in the process of migrating their consensus mechanism from proof of work to proof of stake. Even the new Ethereum proof of stake Beacon chain has a similar problem where block producers are known in advance which also makes it susceptible to being DDOS attacked, however, that chain hasn’t been merged yet so it’s still in testing. Solana on the other hand essentially shipped a beta product that is now worth  $45 billion and does $2 billion a day in volume.

Although there is a precedent for changing consensus mechanisms, I think the Solana team has dug themselves into a hole by becoming ideological and overemphasizing their proof of history technology. 

Solan could have taken a more “technology agnostic” approach similar to Ethereum’s open roll-up centric endgame and said, “We’re going to try proof of history but if a better method comes out we’ll switch to that instead”; then they could have got themselves some flexibility and “permission” from their community to switch to a different mechanism.

Instead, Solana has promoted their proof of history “innovation” so aggressively that if they changed their consensus mechanism now, it would be admitting that proof of history is flawed and many people in the community might lose confidence in Solana’s technical decision making ability.

Suspicious FTX, Alameda, Solana Connection

Source

Sam Bankman-Fried (commonly known as SBF) is the founder of FTX, the world’s 3rd largest cryptocurrency exchange. SBF also owns 90% of Alameda research, a crypto investment company. Alameda invested in Solana during the $314 million private fundraising round we talked about earlier and is the single biggest recipient of Tether, an unbacked stablecoin.

This means that the same person who owns a major cryptocurrency exchange and has the ability to see their user’s trades, also owns an investment company that can invest in those same cryptocurrencies, and is potentially the same market maker for one of the largest cryptocurrencies.By the way, all of this is being funded with non-existent money (alternate non soft paywall article).

To put in context how big of a conflict of interest this is, imagine if Robinhood, the popular stock trading app, also owned a market maker and hedge fund (Citadel or Melvin Capital) and could see how their own user’s trade and front-run using money they got directly from the Federal Reserve.

Actually, you don’t have to imagine, this is what the entire r/Wallstreetbets Reddit, Gamestop, Robinhood, Citadel situation was allegedly about. Some people think frontrunning was involved, and it’s illegal. Citadel has already been fined for frontrunning before. 

Sidenote: Alameda is also a market maker and while I have no proof, my guess is that Alameda is Solana’s mystery “market maker” we talked about earlier.

Time will tell how this type of activity will be regulated in the cryptocurrency markets, but we can get a sense of what will happen to Solana by looking into FTX and Alameda’s history.

The history of FTX and Alameda

In November 2019, a lawsuit was filed against FTX Trading and Alameda Research for manipulating the price of cryptocurrencies and the sale of its FTX token, FTT.

The case was dismissed with prejudice and Coingeek has two articles that cover a lot of these similar points in more detail. Coingeek mentions that the dismissal usually means the plaintiffs were paid off and that another suit was filed with SEC accusing FTX and Alameda of paying plaintiffs off and then claiming the case was without merit. 

I couldn’t find any evidence of the SEC suit and since the case was dismissed with prejudice, I’m not alleging any wrongdoing, but it’s still interesting to see what the lawsuit says.

There are multiple allegations in the lawsuit but the two I want to focus on are the manipulation of cryptocurrency prices and the private sale of FTT tokens. These two are the most relevant to what I think will happen with Solana.

In page 11-17, they’re accused of manipulating the price of Bitcoin through activities like pump and dumps, Barts, spoofing and other forms of market manipulation. Page 59 highlights how FTX tried to manipulate the price of Bitcoin on Binance but Binance’s use of an index price instead of future’s price prevented them from doing so.

In page 43-45 of the lawsuit, they allege that FTX sold its own cryptocurrency, FTT, to investors in a private sale at a steep discount of $0.16. FTX then sold FTT to the public for  $0.80, five times more than what they sold to the investors.

I give all this context so we can see that there’s a precedent for FTX allegedly manipulating the price of cryptocurrencies and fundraising a cryptocurrency in a private market sale and then selling to retail at a high markup. I think we’re seeing history repeat itself with Solana.

Present: FTX, Alameda and Solana

Since the events in 2019, FTX and Alameda are in a position to pull the same thing again but this time they can do even more effectively. Here’s why:

Compared to Bitcoin, Solana has a smaller market cap, is more illiquid (less trading volume), and is more centrally owned. Three things that make it easier to manipulate the price. 

Second, FTX’s exchange is more developed now and more popular than it was in 2019. FTX was founded in May 2019 and the lawsuit was filed in November 2019, just 6 months after the company was founded. Back in 2019 when they were trying to manipulate the price, they had to use other exchanges like BitMex and Binance to do it and we’ve already seen how Binance prevented them from market manipulation. By owning their exchange, they have more freedom and capacity to potentially manipulate prices. They also have more users now (25 monthly visitors) which means more data on their customers’ order flow.

When you take a popular exchange (FTX) that also owns a trading company (Alameda), combined with a centrally owned asset that’s backed by fake money (Tether), you have a scenario that makes manipulated prices more likely.

Serum DEX has Frontrunning Risks

To put the cherry on the cake, in July 2020, SBF announced his team would be releasing a Decentralized Exchange (DEX) called Serum. Serum uses an on-chain order book (SBF tweet about order book) instead of an Automated Market Maker that’s more common amongst most DEXs. This begs the question of why even create the DEX if you’re going to use the same order execution mechanism as your centralized exchange? 

The point of decentralized exchanges is that there is no central intermediary so the risk of front-running is reduced. By using a fully on-chain order book in your DEX, you re-introduce the risk of frontrunning. I see now why they created a fully on-chain order book DEX. It’s a big club and you ain’t in it.

Conclusion

The world of cryptocurrency is a crazy and exciting place and markets can stay irrational longer than you can stay solvent. I wouldn’t be surprised if Solana went down by 90% but I also wouldn’t be surprised if it went up by 300%. 

So I won’t offer any financial advice, but my opinion is that if you’re considering buying this token or you’ve already bought some, you might as well own a rug.

Further Reading

• Luca Land’s Twitter thread visualizing where Tether’s $1B mint went
• Hacker News Discussion about Solana’s Fundraise: Solana Labs completes a $314M private token sale led by Andreessen Horowitz | Hacker News
• I heard about the FTX lawsuit from this thread on Reddit
  • Ironically the poster was wrong about the Youtube video being the evidence of frontrunning but was right about the case being strong evidence of frontrunning, however, like I said earlier, it was dismissed so no one knows what actually happened
• Journal of Finance Paper on Tether’s Backing
• Deep dive on who received newly printed Tether
• An interesting case for why Tether can still work: Tether USDT is possibly a scam but it can remain valuable
• Hacker News Discussion about Tether giving USDT to Alameda: Tether minted most USDT to just 2 firms – Alameda and Cumberland | Hacker News