FTX downfall threatens crypto existence

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Sam Bankman Fried, CEO of FTX Cryptocurrency Derivatives Exchange, speaks at a Bloomberg event in July 2022.

Sam Bankman-Fried, founder and chief exec­u­tive offi­cer of FTX Cryp­tocur­ren­cy Deriv­a­tives Exchange, dur­ing an inter­view on an episode of Bloomberg Wealth with David Ruben­stein in New York, US, on Wednes­day, Aug 17, 2022. (Jeenah Moon/Bloomberg via Get­ty Images)

Cryp­to has an Enron-sized scan­dal that threat­ens to com­plete­ly under­mine the trust propo­si­tion for its exis­tence, regard­less of Sam Bankman Fried’s mea cul­pa tour.

Why it mat­ters: The house of cards built by Bankman-Fried has drawn sev­er­al par­al­lels, includ­ing Enron, Ther­a­nos, Bear Stearns, Lehman Broth­ers and Mad­off Invest­ment Securities. 

  • In that vein, there’s noth­ing real­ly new under the sun — even with the head-spin­ning volatil­i­ty that’s come to char­ac­ter­ize the nascent mar­ket for dig­i­tal currencies.
  • We’ve sort of seen this movie before, and we sus­pect we know how it will end.

The big pic­ture: FTX’s “first day dec­la­ra­tion” in bank­rupt­cy court affirms the pic­ture that’s emerged over the last month. 

Like Theranos/Madoff/Lehman, the prin­ci­pal spark for FTX’s down­fall was its founder’s stag­ger­ing inep­ti­tude and dis­hon­esty, and the fail­ure of any­one around him to notice (or at least care).

  • “The fall­out from [FTX’s] co-min­gled client assets, poor dis­clo­sure and miss­ing inter­nal con­trols should remind us that while the cast of char­ac­ters and prod­ucts may change, the script of finan­cial mar­ket dis­or­der remains painful­ly famil­iar,” Robin Vince, pres­i­dent and CEO of bank­ing giant BNY Mel­lon, wrote in a Finan­cial Times op-ed on Friday. 

Yes, but: What is spe­cif­ic to cryp­to is an untest­ed, inter­con­nect­ed, and inter­de­pen­dent ecosys­tem that’s ripe for con­ta­gion and dra­mat­ic spillover effects. And since this fuse was lit, the fire is spread­ing faster, and wider.

  • This mat­ters a lot when it comes to crypto’s long-term prospects — and why it could take a very long time for investors (espe­cial­ly small ones) to trust the indus­try again. 

What they’re say­ing: FTX’s down­fall “will rad­i­cal­ly trans­form the cryp­to ecosys­tem, fur­ther shak­ing trust and rais­ing doubts around its ongo­ing prospects,” ana­lysts at Moody’s wrote last week.

  • The fir­m’s fail­ure “has left a mar­ket share void that will prove dif­fi­cult to fill with­out a renewed client inter­est in cryp­to assets, a sce­nario to which we cur­rent­ly assign a very low probability.” 

  • Cryp­to firms are in dam­age con­trol. Vol­un­tary audits are sud­den­ly in vogue again, with cryp­to exchanges scram­bling, try­ing to stem a raft of out­flows. But even these have lim­i­ta­tions in what they can prove.

Flash­back: Cryp­to was birthed in the glum after­math of the 2009 cri­sis; its prin­ci­pal sell­ing point was its decen­tral­ized nature.

  • The idea was that indi­vid­u­als could­n’t trust tra­di­tion­al finance, and grant­i­ng small­er play­ers more pow­er to make their own deci­sions with­out the influ­ence of big­ger players. 

The bot­tom line: The cryp­to indus­try was already fac­ing a trust deficit. And this has set it back far.

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