Bankchain Briefing: FTX — implications, impact, and the way forward

Sam Callahan, Bitcoin analyst at Swan Bitcoin:

The FTX collapse is an important event not simply because of its overall impact on the industry, but also because it highlights the kind of fraud that is enabled when an individual or group of individuals have the ability to print worthless cryptocurrencies out of thin air and pump these illiquid tokens to enrich themselves at the expense of others. It highlights a playbook that has been adopted by the broader cryptocurrency industry where insiders and development teams create these tokens at zero cost, pump the price, and then dump their holdings on retail investors without any proper disclosures around their token vesting schedules. If FTX was not able to create tokens like FTT, OXY, and SER, it would not have been able to inflate its balance sheet, raise copious amounts of money based on this inflated balance sheet, and grow to the massive size it did.

Alex Adelman, co-founder and CEO of Bitcoin rewards app Lolli:

FTX’s overnight implosion highlights the danger of highly centralized, opaque operations that continue to govern the crypto ecosystem. The revelation that one of the most trusted, powerful players in crypto was gambling with customer funds has served as a watershed moment for crypto, wherein the industry now needs to rebuild trust and unify to ensure that this doesn’t happen again.

FTX over-leveraging its own native token as collateral bears a startling resemblance to the 2008 financial crisis. In both settings, the irresponsible business practices of centralized powers put everyday people’s assets at risk.

2. Overall impact on the industry

William Quigley, co-founder of Tether and WAX:

In the near term, crypto prices will fall, but the crypto markets are resilient. Within 6 months, most of the negative impact from the FTX collapse should dissipate. Nonetheless, I don’t believe we will see another big run up in crypto prices until the second half of 2024, post the next Bitcoin halving event.

Investors will be asking crypto companies more questions about their debt, their internal risk management controls, and their use of collateral pledged against loans.

Wall Street will move away from crypto, at least in the short term. Its short-lived foray into the crypto market began in mid-2020. The past 18 months have been painful for them. The fact that even major crypto companies can collapse overnight is not something Wall Street investors signed up for. They will be more cautious moving forward around the crypto space.

Binance clearly comes out stronger from all of this. CZ claims Binance has no debt, and doesn’t use its BNB token as collateral. Both of these are good practices in the highly volatile crypto markets. More institutional trading and custody will be shift to Binance. 

Kent Halliburton, president of sustainable Bitcoin mining platform Sazmining:

So long as FTX is not bailed out by either the government or private actors, other blockchain and crypto firms will be more reluctant to engage in the same shenanigans as FTX. They are witnessing the financial collapse and social humiliation of FTX’s fallout and will not want to experience either for themselves.

The industry is already taking steps to mitigate the likelihood of this happening again. Many exchanges – such as Huobi, Crypto.com, OKX, and Kraken – are either openly preparing to display proof of reserves for all to see or have already done so. And Binance’s CEO, Changpeng Zhao, recently announced a bailout fund for crypto projects that may face liquidity issues in the future.

3. Regulatory considerations

William Quigley, co-founder of Tether and WAX:

Calls for more “regulation” don’t mean much unless we properly focus on what risky business practices need to be curtailed, or what information needs to be provided to crypto customers. The biggest and least controversial move on the regulatory front would be to require centralized crypto businesses holding customer deposits to report on the safety of those assets. I could get behind regulations that required reporting around how customer funds are protected, whether or not the business is using customer funds for any purpose they have not approved (i.e. hypothecating customer assets as collateral for loans, which is what Celsius allegedly did).

The risk from the FTX collapse is that regulators will move swiftly and without much forethought to impose a regulatory framework similar to US banking rules onto crypto businesses. That move would be a mistake, because it would fail to account for the fact that US banks have to be tightly monitored and constrained since the customer deposits they hold are guaranteed by US taxpayers. Crypto businesses do not hold government-guaranteed customer deposits, and so should not be subjected to the same level of controls.

4. History repeating itself?

Griffin McShane, head of insights and communication at MPCH Labs:

While I’ve seen comparisons on crypto Twitter comparing SBF to Bernie Madoff, I don’t think that comparison works when looking at the crypto industry as a whole. Instead, I think there’s greater parallels between the FTX saga and the evolution of venture capital in the ‘80s.

The amount of money in venture capital from the late ‘70s into the ‘80s quadrupled, and the amount of cash committed skyrocketed 16x. The sudden explosion in capital led to heavy competition among firms, leading to earlier investments and less time to conduct diligence. Startup prices also skyrocketed as early VCs tended to make operational assumptions and conflated their own relative value to the startup.

I feel like FTX and other centralized crypto companies got caught up in a similar pattern to venture capital in the ‘80s. High valuations, rapid funding rounds and operational assumptions made SBF into the darling of Silicon Valley. As a result, FTX was operating internationally without a functioning board of directors and handling money in a way where making a true valuation of the company would have been impossible.

The FTX saga could very well impact the future valuations and funding for blockchain and crypto firms. But, like with venture capital in the ‘80s, this isn’t necessarily a bad thing. Returning to responsible investing, more focused diligence, and an elimination of assumptions can bring about a healthier environment for everyone.

Despite the decline in valuations at the end of the ‘80s, we still saw major VC-backed tech companies like Microsoft IPO. A shift toward responsible investing will not hurt industry-leading companies, but instead will distinguish them from those that are acting improperly.

5. The way forward

Griffin McShane, head of insights and communication at MPCH Labs:

In the aftermath of FTX, we’ve seen a mass migration away from centralized exchanges and into self-custody solutions. In the week following the collapse, Binance, Coinbase, Crypto.com, and other major centralized crypto exchanges experienced $6.33 billion in net outflows. At the same time, sales for cold storage solutions exploded – with Ledger sales reaching new all-time highs, and Trezor reporting 300% growth in sales revenue.

Moving forward, we’re likely going to see retail move to self-custody and institutions place a greater emphasis on policy. Self-custody ensures that even if an exchange is hacked or goes bankrupt, you will still be able to access your funds. While the self-custody crowd used to be primarily Bitcoiners, we’re now seeing an overall shift in industry practices toward self-custody. Even institutions, who are typically required to hold crypto with a custodian, are looking to implement MPC technology or other forms of self-custody safeguards.

Alex Adelman, co-founder and CEO of Bitcoin rewards app Lolli:

To even begin to rebuild consumer trust, there must be a holistic re-evaluation of how crypto companies operate. When companies rely on and collateralize their own alternative currencies to inflate their balance sheets, they undermine not only their clients’ funds but also the financial health and integrity of the crypto ecosystem at large.

Bitcoin was created to serve as a secure, independent store of value that is not reliant on any one centralized power. It could therefore solve the problems that countless companies like FTX continue to encounter by relying on their own tokens. We will continue to see this effect in crypto until companies recognize that they cannot secure their or their clients’ wealth in centralized assets that are ultimately baseless stores of value.

Derek Yoo, CEO of PureStake:

If anything, the FTX saga has underscored the importance of decentralization in the industry. The root cause of the FTX collapse, and the 3AC collapse before that, is a lack of transparency and a lack of proper risk management. It is exactly these things that DeFi does well, since the logic and assets controlled by smart contracts are on-chain and thus fully transparent. So while FTX is presenting major challenges right now and has caused significant reputational damage to the industry, I think it is long-term bullish for DeFi. DeFi protocols are chugging along right now, facilitating lending, borrowing, and other functions in a way that isn’t vulnerable to the same issues that brought down FTX.

Highlights from our recent coverage

Bankchain Briefing: MoneyGram deepens crypto push with crypto trading service

This week, we look at MoneyGram’s crypto expansion, and the potential role of digital currencies in the remittance industry. We also hear from Diogo Monica, the co-founder and president of Anchorage Digital, about why more FIs are starting to offer crypto services.

Steez Podcast #1: What financial services has learned so far trying to capture, delight, and retain the hearts and minds of today’s youth

Understanding what makes Gen Z tick is imperative for financial services firms in positioning themselves for future success.With a series of 3 interviews, Tearsheet's Steez Podcast explores how this generation is already impacting banking, investing, and payments.

What we're reading

• Nervous auditors re-examine crypto clients after FTX collapse (FT)
• Binance, other crypto firms line up bids for bankrupt Voyager Digital (CNBC)
• Apollo plans to offer a new fund on blockchain with fintech Figure (Bloomberg)
• US Senators ask bank regulators to 'review' SoFi's crypto listings (CoinDesk)
• FTX owes its largest creditor $226 million; top 50 owed total of about $3.1 billion (CoinDesk)
• Crypto broker Genesis Trading halts withdrawals at lending unit (FT)
• Financially linked to FTX, BlockFi eyes Chapter 11 (PYMNTS)
• Wall Street tests crypto dollars with Fed, defying FTX gloom (American Banker)
• UK high street lenders toughen crypto stance on fraud concerns (FT)