Are We Taking the Wrong Lessons From the Crypto Implosion?
No other emerging technology has faced so much disdain and misunderstanding as blockchain.
The technology, the foundational pillar of nouveau vocabulary additions like DeFi and Web3, is always seen as a solution looking for a problem. Yet, cryptocurrency, the most successful use case of permissionless open blockchain, gets a lot of scorn.
So, it’s no surprise when on Nov. 2, 2022, CoinDesk reported that SBF (Sam Bankman-Fried) founded trading firm Alameda Research was flushed with FTX Tokens (FTT). The naysayers came out of the woodwork. And boy, did they come out in droves!
But are we missing the point?
FTX x SBF - CZ = 0
The FTX story is not about the fallacy of cryptocurrencies. Nothing of that sort happened. It was really about bad oversight and management by SBF et al. We had the wrong guy with the wrong intention to run a public project.
The way it happened was like a major Hollywood movie. Its major competitor, Binance, whose chief executive officer CZ (Changpeng Zhao), said on Nov. 6 that they would liquidate its significant FTX Token position because of the CoinDesk revelations. Alameda’s then chief executive officer Caroline Ellison quipped over a tweet that her firm will “buy it all at USD22.”
Things very much went into a downward spiral after that. FTX’s SBF tweeted on Nov. 7 that a competitor was coming after them with false rumors and said FTX has USD 1 billion in cash. On Nov. 8, FTT prices dropped 30% to USD15.40.
On Nov. 8, in a complete turnaround, SBF revealed FTX faced a liquidity crunch and said CZ’s Binance had been asked to cover it “1:1”. A few hours later, SBF deleted his previous Nov. 7 accusatory tweet. After a quick look at the bank books, CZ backed out of the deal on Nov. 9.
Nov. 9 also saw SBF asking for USD8 billion in emergency funding from investors. The FTX website discouraged deposits and said it could not process withdrawals. VC firm Sequoia Capital, a major investor in FTX, decided to mark down its USD214 million stake to zero on Nov. 10, the same day SBF publicly said, “I fucked up twice.”
Regulators around the world started asking questions and halted operations. SBF filed FTX, FTX US and Alameda for bankruptcy and subsequently resigned. Since then, we’ve uncovered unexplainable holes in the balance sheet. We had suspicious hacks, further investigations by regulators, claims of “on-chain spoofing,” and finding out that SBF received USD1 billion in loans from his bankrupt companies.
It led to SBF’s eventual arrest and being brought to the U.S. (after resisting extradition until he saw the inside of the Bahamas prison cell, which was not the same as the beach properties).
The fraudster’s balance sheet
2022 was a lousy crypto year. The genesis of FTX’s eventual bankruptcy was laid out in another USD60 billion collapse in the same year. That was the USD60 million wipeout of stablecoin TerraUSD.
SBF came to the limelight because of the stablecoin collapse in earlier 2022. In a white knight move, his Alameda stepped in to lend to crypto firms such as Voyager Digital and Celsius. He became known as the crypto bro, who became the altruistic savior.
No one saw that Alameda’s balance sheet was full of FTT (the token FTX issued). Out of its USD14.6 billion of assets, USD3.66 billion were unlocked FTTs and USD292 million of locked ones. Equally suspicious was the USD2.16 billion FTT collateral (whatever that was).
“It’s fascinating to see that the majority of the net equity in the Alameda business is FTX’s own centrally controlled and printed-out-of-thin-air token,” said Cory Klippsten, chief executive officer of investment platform Swan Bitcoin in another CoinDesk report.
The crypto market subsequently imploded. Other well-meaning crypto exchanges saw withdrawals like never before; NFTs became boring; crypto bro no longer was a claim to fame.
No time for wisdom
The often-cited argument against cryptos is that it attracts the wrong investors. This is partly true because no one thinks about stable investment income when investing in a quasi-regulated digital asset.
But private equities are now part of the crypto game. And they were supposed to add additional oversight and business acumen.
Yet, the FTX implosion showed there was no such oversight. That the likes of Sequoia Capital and Temasek invested so much without asking for better oversight and audit trails yet require it for other equity investments is beyond me. Maybe, we can leave it to FOMO.
The regulatory disregard
Yet, while the attention is on SBF, we should be looking at why regulators were not there. The dragging of their feet is understandable from a centralized regulatory point of view. There are two significant reasons.
First, and the most obvious, is the loss of centralized control. Central banks and regulators are there to bring order to chaos. Their market principles and guidelines are shared, agreed and followed. A technology built on decentralization goes against the very centralization ethos of financial regulators; they also lose control of a significant economic lever.
The second issue is that not all cryptos are the same. It may be tempting to lump all cryptos as a single asset, but you cannot.
Bitcoin began as a proof-of-work where bitcoin miners append blocks and mint new currency by solving more complex mathematical puzzles. Ethereum takes a different proof-of-stake route where validators stake their participation and are penalized if their nodes go dark or validate a “bad” block. Both have pros and cons.
Then you have tokens that crypto exchanges offer (like FTT) that can be converted to other more tradeable cryptos or fiat currency and are used as a utility tool for luring investors with free rebates and discounts. Then, we all know about stablecoins with a fiat currency component to act as an investment counterweight.
Creating regulations for this field can be difficult. More so if this is a constantly evolving market and participants are always creating new blueprints.
But regulators are waking up — finally. After the FTX fiasco, the Fed is looking to better regulate cryptos, although it is still suggesting that their digital dollar project will be the main focus.
Other failures show lessons not learned
FTX’s implosion was not the only major failure, although it did grab the most headlines.
TradeLens, a project led by IBM and shipping giant Maersk, closed because of a lack of traction. The reason behind this is changing fortunes, the proponents cited. The Australian Stock Exchange (ASX) also revealed that it no longer pursued the blockchain project for equity market clearing and settlement.
Despite these failures of permission-based approach to blockchains, governments are still talking about the Central Bank Digital Currency (CBDC), which like TradeLens and the ASX project, use private permission-based blockchains.
By issuing CBDCs (the so-called digital currencies), central banks may be improving their centralized control as they are now directly engaging with and managing the issuance of digital currencies to end customers (e.g., the citizens, traders, businesses, etc.) It can also alter the role of banks.
Many blockchain proponents don’t feel these are true blockchains. Instead of applauding the warped view of DeFi and blockchain, we should be relooking at what blockchain initially promised: decentralized, digitized trust. Don’t let crypto fraudsters who are hell-bent on destroying this promise sway us otherwise.
Winston Thomas is the editor-in-chief of CDOTrends and DigitalWorkforceTrends. He’s a singularity believer, a blockchain enthusiast, and believes we already live in a metaverse. You can reach him at [email protected].
Image credit: iStockphoto/Istoma
