The collapse of cryptocurrency exchange FTX has put the entire cryptocurrency industry on edge.
The latest in a series of bankruptcies of multi-billion-dollar companies this year, it raises questions around sound financial management and sounds an alert that some business leaders are willing to gamble people’s investments on their own success.
As law enforcement agencies in the Bahamas investigate the organisation led – until Friday’s bankruptcy filing – by Sam Bankman-Fried, Binance CEO Changpeng Zhao told Indonesia Fintech Summit 2022 that the industry has “been set back a few years”.
Zhao, who pulled out of an emergency rescue deal for FTX following due diligence concerns, said: “Regulators rightfully will scrutinise this industry much, much harder – which is probably a good thing, to be honest.”
He said that while crypto regulations focus on Know Your Customer (KYC) and Anti-Money Laundering (AML), they should also focus on exchange operations such as business models and proof of reserves.
Torsten Dueing is head of ETC platforms (exchange-traded commodities) at the London-based HANetf investment platform. He questions why investors pumped billions of dollars into a company “sustained by reputation instead of a sound capital structure”.
Frankenstein of Enron and Lehman
“This feels like a Frankenstein of Enron and Lehman, only in part aided by the unregulated nature of crypto markets, the decentralised structure of its players and the lack of safety that comes with the sort of laws and regulations to which most of finance is subject,” he says.
“Unfortunately, this episode has led to further erosion of trust in crypto. As we know, trust takes years to build and seconds to lose. And when you are actively looking for flaws, you will find them.
“There will be more questions around the balance sheets of stablecoins and other lending counterparties. We suspect this will make the market less liquid and lending terms less favourable. This seems like another case of the ‘smartest guys in the room’ blinded by the light.”
Nick Saponaro is CEO of Divi Labs, a decentralised payment ecosystem which aims to accelerate the mainstream adoption of cryptocurrencies. He agrees that the debacle is crypto’s Lehman Brothers moment.
“In fact, it’s worse,” he adds. “In ’08, investors would have had some protection. FTX’s investors will not and if history teaches us anything, they will lose everything.
“Inevitably, global regulators will see this as their cue to step in and crack down hard on the industry, making it very difficult for DeFi providers to operate without the oversight of a third party. The polar opposite of why crypto was created.
“DeFi now has a very small window of opportunity to stand out and demonstrate its value before the regulator gets its claws in.”
Sacrificial lamb
The crisis was triggered by reports that a notable portion of FTX’s sister investment fund Alameda Research’s balance sheet was made up largely of its native FTX Token (FTT) and Solana’s SOL token. Zhao subsequently revealed plans to liquidate any remaining FTT on Binance’s books – reported to be worth more than $500m.
“When Binance CEO Changpeng Zhao speaks, the industry listens, and this time he has exposed FTX’s weak points,” says Suneet Muru, analyst in the thematic intelligence team at GlobalData.
“FTX is the crypto industry’s latest sacrificial lamb. Its bankruptcy will be a classic example of ‘short-term pain, long-term gain’. It will deflate the crypto market cap over the next few months, but will force exchanges to realign their business models toward effective risk management.
“Now, more than ever, exchanges must demonstrate how they differ from banks and keep far less of their own cryptocurrencies on their books. These same exchanges must also continue diversifying their revenue streams away from transaction fees and towards subscription-based products to limit exposure to market downturns.”
Daria Y, CEO of Cometa on the Algorand network, said that the FTX bankruptcy only further underlines the case for financial decentralisation.
She says that as centralised platforms continue to prove they are as untrustworthy as banks, the DeFi industry must work harder to attract users into a safer ecosystem.
“The FTX bankruptcy is going to affect a great many users and investors, which is a real tragedy for people already hurting,” she says. “It has also again reminded us of the problems that come with centralisation in cryptocurrency: where assets are not properly owned by the users themselves. In decentralised finance, where users are in full control of their assets, this situation simply could not happen.
Gambling on the customer dime
Nick Jones, CEO of Zumo, a Scottish decentralised finance platform, says it is a tough time for the crypto industry and “the people who gave their money to a business they thought they could trust”.
“Crypto businesses like FTX have been gambling on the customer dime. It has to stop,” he insists. “As an industry, it’s about time we now got serious about how we treat our customers and how we show – through targeted action – that this is an industry worthy of people’s trust.
“Wherever a crypto business is entrusted with the care of customer funds, it must be held to the most stringent standards of regulation and good governance. And those who have publicly failed in that endeavour should take a long hard look at themselves and the consequences of their actions.
“The losses and breach of trust engendered by the events of this week are deeply damaging and painful, and nothing we can do can change that. Today it’s on us to show the world a different face.”