The recent collapse of FTX is about more than a deepening bear market and marks an important inflection point in the future of the industry in terms of regulation and education.
So much has been said about the unfolding FTX saga over the past month that it's hard to know what part of this mess to be most outraged over. The one thing that can be said with certainty is that the demise of the third-largest cryptocurrency exchange by volume, which saw the total cryptocurrency market cap slump below $900 billion for the first time since January 2021, marks a major inflection point for the future of "crypto" as an asset class.
Not only has the collapse yet again exposed the folly of investors' blind faith in crypto platforms, but the industry's very own 'Lehman moment' has also shown how fallible and corrupt individuals succeeded in using the false promise of "decentralisation" as cover to engineer the very same financial mis-selling and overleveraged practices that bitcoin and blockchains were meant to safeguard against.
Crypto's ongoing Chapter 11 wars
In a year that has already seen the demise of Celsius, Voyager, and other major lending platforms following the implosion of Terra Luna in May, FTX's collapse has unleashed a second contagionary wave which saw the likes of Gemini, Genesis, and Galaxy halting withdrawals overnight in order to keep as much collateral in their custody and stave off the margin calls. On November 28, BlockFi became the latest to file for chapter 11 bankruptcy, and given ex-FTX CEO Sam Bankman-Fried's web of investments through FTX's various corporate structures (Figure 1), it is unlikely to be the last.
Figure 1: The expansive web of Sam Bankman-Fried's investment
When looking at the numbers, however, none of this is particularly surprising. According to the Financial Times, FTX held just $900 million in easily sellable assets against approximately $9 billion of liabilities the day before it went down (Figure 2). Among the many victims of the collateral damage were hedge funds (pun very much intended). Crypto Fund Research estimates that between 100 and 150 crypto hedge funds, or around 25 - 40% of the total number of such specialist funds still have direct exposure to FTX Group or to FTT.
In hindsight, no one can be surprised that the CEO of Binance, Changpeng Zhao, made the decision to renege on the in-principle agreement for a rescue deal, citing that they “under-appreciated the solvency risk with holding our funds at FTX”, and has gone on record saying that it could take years to recover “some percentage of our assets” still held in FTX.
Figure 2: The numbers behind FTX's toxic balance sheet
Big question marks remain around regulation
As if it weren't obvious enough before the FTX implosion, there is an urgent need for crypto regulation in order to avoid future systemic failures of this kind. Gary Gensler is said to want the SEC to have jurisdiction over the whole industry, justifying this goal by categorising every crypto token as a security.
But at the same time, if he is indeed the man to oversee the introduction of regulatory frameworks for "crypto" via the SEC, it begs the question of why Gensler himself had such close links to Sam Bankman-Fried, a man now facing criminal charges over the circumstances behind FTX's collapse?
The very fact that so many in the industry were pinning their hopes on Gensler to formulate favourable legislation conducive to the flourishing of the digital assets is concerning if we consider his spectacular failure to foresee the FTX crisis even despite the firm's new chief recently describing its collapse as a 'complete failure of corporate control'.
But let's not pretend this is a mystery.
Much of it can be explained by Sam Bankman-Fried's campaign contributions to the Democratic party in the run-up to the US primaries (donations were also allegedly made to the Republican party but in the dark). Money buys influence in Washington, it's that simple. In this context, it is not hard to see why Gensler, himself a Democrat, had such a cozy relationship with the individual who would soon bring the industry to its knees and why it's absolutely no coincidence that Bankman-Fried was seen as the 'chosen one' to be 'instrumental' to the process of formulating crypto industry regulations.
Sam Bankman-Fried's silver linings
There is no doubt that Sam Bankman-Fried's mismanagement – or outright criminality – with respect to running FTX has significnalty worsened the already battered confidence in crypto, with the huge theft of customer funds adding insult to the industry's mounting injuries.
And though it's too early to know the extent of the skullduggery that went on behind the scenes in the run-up to FTX's collapse, it isn't too early to see that this latest and largest exchange blow-up will have a few silver linings. Here are just three:
The implosion of the FTX is likely to speed up the formulation of cryptocurrency regulation, including reporting and auditing requirements. This will bring more adoption from both retail and institutionals while offering a framework of protection to all investors.
FTX and other crypto platform collapses (Voyager, BlockfFi, Celsius) all had one thing in common: they have all been centralised industry players, not decentralised protocols. This could be a real positive for the DeFi sector.
The growing number of exchange failures is (hopefully) leading to a wider understanding that "crypto" ≠ bitcoin. Yes, bitcoin continues to be pressured due to the panic in the markets but it continues to operate as the distributed, peer-to-peer electronic cash system it was always intended to be. Self-custody trumps all, or as the saying goes, not your keys, not your coins.
Again, the FTX disaster has shown that like others in the past, the root causes of the present cryptocurrency crisis are human fallibility and centralised points of failure, with the very people entrusted to oversee its regulatory health being bought and paid for by some of the worst actors in the industry. But by flushing out the excess and zeroing back in on the utility of distributed systems, the industry and all of its participants can ensure these events become the teachable moments needed to build a foundation for a future of mass adoption.
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