FTX collapse will get crypto’s great reset underway

It offered custody of digital assets for those people that wanted exposure to the crypto ecosystem without the hassle of holding those assets in their own private cold wallets. Its product offering and utility to customers was an easy-to-use application to gain exposure to, trade and manage digital assets. FTX was considered to be the preeminent system and had, to use an appropriate Enron term, “the smartest guys in the room”.

And in SBF they proclaimed to have a trusted industry leader who was calling for increased regulation, maintaining close relationships with lawmakers and preaching transparency.

What was not to like about a super-smart, white, male, MIT-educated, woke nerd backed by the elite establishment? He was our poster child, he was crypto’s acceptable face.

But, there are concerns that, all the while, he was perpetrating a brazen Madoff-esque Ponzi scheme. Authorities around the world are investigating.

Crypto’s favourite axiom is “not your keys, not your coins” and many native crypto early adopters believe centralised entities are anathema to the code-is-law philosophy of cryptocurrencies.

The FTX collapse demonstrated this point as investors found out they had no knowledge SBF would lose their assets because he maintained control of them. However, if broader blockchain-based technology adoption is truly going to occur, the industry’s way forward is not as simple as “trust-less” decentralised finance in a utopian crypto metaverse.

Tokenomics

“If you build it, they will come” is often the mantra for devotees of tech network-effect entrepreneurs and angel investors. Companies building burgeoning technologies care more about market share and customer adoption than near-term profitability.

Before working in the digital asset markets, I’d heard of pre-profit but never pre-revenue. But in this space it’s a common theme, with VC money so easy to come by.

The buildout of the crypto ecosystem (currencies, applications and infrastructure projects) has adhered to the growth style VC playbook, but with a nasty tech twist.

They utilise tokenomics as a novel way to monetise seed capital before projects are profitable, and earlier than the Web2 buildout.

As Bloomberg journalist Matt Levine has eloquently pointed out in his columns (a must-read), early stage tokenomics, before a network effect creates a broad-based user base, might be best described in “better fool” theory terms if not outright Ponzi ones.

Nonetheless, it is creating innovative open-source solutions to efficiently and securely keep databases, digitise ledgers to facilitate title transfers, fractionalise ownership of everything from real estate to intellectual property, and create Web3.

So, while the industry’s reputation has been tarnished and the vast majority of alt(shit)coins will suffer in this environment, it is not all bad.

Bitcoin and ethereum, the first and second-largest digital assets by market capitalisation, have distinct investment use cases and increasingly moat-like structures to ensure their viability going forward.

Other tokens and projects will likely turn out to have been mostly a speculative frenzy (zombie tokens) and only a handful of truly useful crypto projects will survive.

In real use cases of a multipolar world of rival central bank digital currency (CBDC), bitcoin will most likely have a use case as a clearing currency between “rival” systems.

Ethereum-enabled utility NFTs that help track owned assets without giving up personal details might well have a useful application in society, provided a far-reaching standard is adopted by sufficient stakeholders/users.

We trusted FTX to provide a practical on/off ramp from digital assets to fiat currency, and a familiar and easy-to-use liquid marketplace to exchange those assets.

The FTX collapse potentially pauses adoption because it has shaken trust in digital assets from those who were considering investments, and emboldened critics who never thought of it as anything but a Ponzi scheme.

When we emerge from this crypto winter, we will need new user-friendly solutions for bridging fiat and digital assets and transparent decentralised or centralised liquid marketplaces that are easy to navigate.

Crypto natives, us included, are already considering and proposing better transparent structures for assets, and we hope regulators make progress on oversight and legislation.

These improvements will be important steps that allows the industry to leave this mess behind us and allow adoption to continue.

A strong transparent infrastructure establishes trust and will add confidence even if the system is designed to be trust-less. If you build projects and infrastructure without trust, no one will come and the “network effect” ambitions will never materialise.

While it has been painful, I am convinced the digital ecosystem is durable enough to survive the SBF earthquake, and the reset now taking place will provide the necessary conditions for institutional adoption going forward.

Vimal Gor is group chief investment officer for Trovio.