Unless you’ve been living under a rock this week you’ve probably watched the unfolding of the Lehman Brothers-esque insolvency and bankruptcy of the second largest crypto exchange in the world, FTX. It felt like nail-biting episodes of an award-winning drama series were dropped daily (I foresee a Netflix mini-series on the horizon). Just when I thought FTX’s bankruptcy filing represented the series finale the latest “episode” dropped Saturday after midnight, “FTX has been hacked”. What’s next? 👀
With billions of dollars at risk for a million users, this of course is no joke.
I’m no crypto nerd, nor am I “crypto native”. It’s not my area of expertise. With FTX blowing up on all my feeds I wasn’t planning on writing about it. There’s plenty of great coverage on the craziness from Kyla’s timely explanation of the events leading up to Tuesday to CoinDesk’s timeline of the events. I recommend going through them to get up to speed.
But as the events unfolded it became more and more clear that this wasn’t just about crypto. It’s bigger than that. It might shape the future of finance. And that’s something I have an opinion on. So here I am, glued to my desk on a Sunday, hoping to make some sense of what’s to come.
The promise of crypto
At my core I am a dreamer. I feed off the thought of building a better future. It’s why I am passionate about technology. The possibilities seem endless.
The world we live in was built by the few who dared to dream and take action to make it a reality.
Crypto is no short of a dream to build a better financial ecosystem. One built on trust, transparency, security and efficiency requiring no intermediaries. One that gives people control of their own money. A dream worthy of pursuit. To that end I am a believer. Crypto might be the biggest innovation in finance in our lifetime.
"At the most basic level, we believe blockchain technology and the crypto economy could represent the biggest innovation of our lifetime,"
JMP analysts Devin Ryan and Brian McKenna, Nov 2021
We tend to be skeptical of change, but adaptive at the same time. Any revolutionary change is first met with resistance. Over the last decade crypto has gone from resistance to preliminary adoption after some level of acceptance. Crypto’s market cap is now ~$830bn, a figure unimaginable a decade ago.
The journey has been choppy to say the least. There was a surge in 2017 that lead to a peak of ~$760bn in January 2018. This was followed by the first crypto winter when BTC dropped by more than 50% from its all-time high. The next crypto bull run started with the onset of the pandemic and peaked at ~$3tn in November 2021. Its been downhill since then.
We are now in our second crypto winter, partly driven by the global sell-off of nearly all asset classes, and deepened by:
The collapse of TerraUSD and LUNA resulting in $40bn in investor losses and domino effects throughout the crypto industry.
Frozen customer accounts and sudden bankruptcies at Celsius Network, Three Arrow Capital, and Voyager Digital.
And then there was FTX…
The impact of FTX’s collapse
FTX’s collapse has no doubt extended the crypto winter. User confidence is shaken and at an all-time low. The fact that the second largest crypto exchange can go belly up so quickly is beyond concerning.
This time, however, it’s not just about the fragility of crypto currencies or companies. It’s about the faith that crypto-believers put into FTX’s CEO, Sam Bankman-Fried (SBF), that was subsequently broken in a “Et tu, Brute?” fashion. A wound that cuts deep and that is going to be hard-to-heal.
SBF, a 30-year-old MIT grad whose office attire consists of shorts and T-shirts, had graced magazine covers, lobbied American regulators and Congress members, and emerged as a major Democratic donor. He was seen as the savior of crypto. The hero that crypto needed. He has been called the “J.P. Morgan” of crypto for his efforts to rescue crypto businesses like BlockFi. Forbes also posed the question of whether he is “the next Warren Buffet”.
FTX, and its balance sheet, was viewed as a fortress because of SBF. Why would FTX be insolvent if SBF was pushing for regulations, right?
The reality is that SBF did not hold himself to the standards that he was lobbying for. In fact, looking back it’s clear that he was downright deceptive. A series of lies to maintain his image as the savior of crypto.
We now know that FTX held less than $1bn in liquid assets against $9bn in liabilities. Still SBF tweeted “assets are fine” at the beginning of the week. That tweet was subsequently deleted. Unfortunately, his “I’m sorry, I fucked up” tweet does not change the fact that he was blatantly deceptive and will not undo the long-term damage that has been done to crypto.
On Friday FTX filed for Chapter 11 bankruptcy. Shortly thereafter FTX was reportedly hacked for more than $600mn. I just came to terms with SBF and FTX being dishonest, but still thought FTX was a “secure” exchange. Is crypto ever safe? Was this an inside job? What’s true? What should we believe?
CZ, Binance’s CEO, has since tweeted lessons learned, but they come nowhere close to solving the problems that have been exposed by the collapse of FTX. Sounds more like a CYA for Binance than in-depth introspection of what needs to change.
The bankruptcy of FTX has caused ripples in crypto. BTC is now ~$16,500 down from ~$20,500 a week ago, and ETH is ~$1,220 down from ~$1,570.
Any path to adopting something new oscillates between excitement and skepticism so this amount of volatility in crypto’s journey at this stage is expected. But not all changes result in widespread adoption. It takes a lot of strength to weather storms like this. The questions remain:
Is this a case of a few bad actors ruining it for everyone else?
Are these setbacks in crypto just “growing pains”?
Will crypto become truly mainstream or was this the last straw?
Will history repeats itself?
Is it the end of crypto now that we’ve lost its knight in shining armor (SBF), the second largest exchange (FTX), and the “trust” promised as an underlying feature of crypto? The answer isn’t obvious. But if history is any indication of the future we might be able to speculate.
What happened to FTX warrants urgent regulation of crypto. Crypto was born on the foundation of not requiring a central entity to guarantee “no foul play”, but might die if it isn’t regulated by a central authority. The irony.
It’s clear that user funds at FTX were at risk. There was a massive hole in their books. Customer deposits should not be lent out. This calls for, at the very least, increased transparency on sources/uses of funds and proof-of-reserves.
Historically, events like this have been a catalyst for regulation:
The 1907 a bank run struck trusts (bank-like associations) in New York City and then spread to traditional banks. At the time the U.S. did not have a central bank, but it was clear after the many bank runs over the 19th century that a central bank was needed. Led by J.P. Morgan, the savior of the banking system back then, the Federal Reserve was created in 1913.
In December 2021 Enron filed for bankruptcy after deceiving stakeholders by manipulating their financial statements. This resulted in the Sarbanes-Oxley Act of 2002, a federal law that established sweeping auditing and financial regulations for public companies.
The fall of Lehman Brothers sparked the 2008 financial crisis, which resulted in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).
FTX had elements of all these events:
Run on the exchange, similar to 1907
Deceiving investors and users on uses of funds, similar to Enron
Used a scheme involving overvalued junk collateral, similar to Lehman Brothers
Is this going to be the turning point in crypto regulation? Are regulators going to take serious actions to curb the issues that are plaguing the industry? Are we going to see an uptick in the speed of crypto regulations?
Crypto might require a central reserve. A central reserve would help pool resources of the nation reducing the reliance on large players in the industry, like Binance, to save systemically important firms. They offer, in times of need, liquidity to iron out the inevitable fluctuations in individual, regional, and industry-specific credit. It certainly warrants a central authority that can step in when there is foul play, back the system, and push for regulations to help guarantee the soundness of the system. In my opinion, it’s the only way of rebuilding trust with users. It’s what the industry will need to survive.
Or are regulators going to sit back and watch crypto burn? Only time will tell…
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