Rebuilding Trust In Crypto After FTX

The FTX bankruptcy on November 11 shocked the crypto market wiping out FTX’s $34 billion valuation overnight with investors like Sequoia and Softbank writing their investments in FTX down to zero. Market contagion is spreading with BlockFi the latest casualty filing for bankruptcy earlier this week and Coinbase’s debt trading at near distressed levels.

FTX was reported to have been $8 billion short of fulfilling customer requests for their money just 2 days before the bankruptcy and estimates vary about how much customer money is locked up in the bankruptcy. There is an estimated $10 billion shortfall of funds with FTX owing $3 billion to creditors. Customers, who are unsecured creditors, are at the back of the line and are unlikely to see their money.

John Ray, the specialist that led Enron’s wind down was appointed to run the FTX bankruptcy said he had never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information”. This, in the unregulated crypto market where there is no investor protections or insurance schemes.

Everybody is blaming someone else – policymakers are pointing fingers at the crypto industry, and crypto industry leaders are pointing fingers at regulators, and the regulators are pointing fingers at FTX saying “we’ve been telling you for years this is going to happen, its why we have never brought crypto onshore.”

The unfolding story is becoming more tragic and weirder by the day and is now shining a light on members of the establishment, many who idolized SBF for his political and philanthropic donations underpinned by his excessive virtue signaling.

The disgraced Wonderkid, took to the airwaves this week with Andrew Ross Sorkin at the New York Times DealBook Summit to claim that he did not try to commit fraud blaming huge management failures and sloppy accounting – that he was more a Blunderkid than a Wonderkid.

Jim Cramer, who will not utter the name of SBF (putting SBF in the same category as Lord Voldemort), subsequently ranted about the Times interview and called him an outright fraud. Cramer wasn’t buying the Blunderkid story and accused SBF of being a fraud – more Ponzikid – the likes of Bernie Madoff, Kenneth Lay, Elizabeth Holmes, or Wirecard’s CEO Marcus Braun who goes on trial next week on charges of fraud.

Bankman-Fried has blamed Caroline Ellison, the CEO of Alameda – FTX’s sister company, for the failure of FTX. Ellison is now infamously attributed to her Tumblr comments on her “foray into poly” decrying a need to move away from hierarchy to personal ranking for such amorous encounters. Live by the ranking die by the ranking – her CEO ranking in the market could not be lower.

The FTX bankruptcy has appeared to have broken crypto’s social promise and is now at its lowest level of trust in its 13-year history. Its promise of delivering a better, safer, and more inclusive financial system, of the people, by the people, for the people, looks shattered.

The Senate AG hearing on Thursday brought things back to a semblance of normality. This is the same committee SBF appeared at in January of this year, heralding the crossroads of better industry and regulatory collaboration. No one should be surprised that the calls for legislating crypto now have a bigger audience across both houses with CFTC Chair Benham leading the call.

The Dodd-Frank Act was passed in 2010 in response to the Global Financial Crisis of 2008, and established regulatory measures to keep consumers and the economy safe from risky behavior by insurance companies and banks. We may see a similar act for crypto, the question is what, when, and how far reaching it will be.

The 2008 crisis was the most serious since the Great Crash of 1929 which opened the doors to the Great Depression. In the Great Crash of 1929, it was excessive leverage to buy stock which led to the Glass-Steagall Act which forced banks to separate deposit and loan taking business from the riskier investment banking business. Glass-Steagall was largely repealed in 1999 which arguably paved the way for the 2008 crisis.

In the 2008 crisis, excessive leverage tied to mortgage-backed securities and complex derivatives resulted in the highly regulated banking system facing a cardiac arrest. Regulations nor regulators would have stopped the meltdown which was arguably largely due to human error and poor leadership and governance across the global financial network.

In any case, we didn’t stop using the US dollar or banks following the 1929 or 2008 crises, and it is doubtful we will stop using the blockchain or buying bitcoin after this crypto crisis.

Banks, and the financial system were not well trusted in society following the 2008 crisis. In 2011, Occupy Wall Street occupied Wall Street to protest a financial system that did not effectively serve 99 percent of the American population – the fintech revolution and crypto promise were two of the potent antidotes whose star was in the ascendent.

Crypto exchanges have lost the confidence and trust of the market. The rumor in the market is the “flight to quality” after the FTX bankruptcy with clients abandoning crypto exchanges and seeking to be in the safe hands of banks for their crypto. The hunter is now the hunted, and the great promise of crypto is having a near death experience.

The days, weeks, and years following the 2008 crisis, most of the people in most of the banks were responsible, did their jobs, and did the right thing, and had to suffer the ignominy of an industry that no longer had the public’s confidence and importantly trust. Banks were bad, and it was bad to work at a bank. A small number of rotten apples spoiled the barrel.

Whether through malfeasance, misfeasance or nonfeasance, the FTX bankruptcy looks like that is precipitating a systematic failure of the crypto market, more than it looks like a bit of back luck or timing in a tough market with over-leveraged counterparties.

The failure looks as if has little to do with crypto, bitcoin, or the blockchain, nor does it have little to do with policymakers, regulators or regulation. It is a human failure. And it is human failure that extends to the worship of idolatry and putting trust in false icons. This human failure further extends to poor leadership and governance and how FTX was run and managed.

In 2017, almost a decade following the 2008 Global Financial Crisis, the insolvencies, the scandals, and the regulatory fines, many believed that banks still had a long way to go in restoring trust.

The crypto industry would be well advised to quickly learn the lessons of market failures and start out on the long road to recovery. Pay close attention to how long it takes to re-build trust and win back the customers, counterparties, and ecosystem partners that are needed to successfully scale as a going concern.

All of us working in the crypto, digital assets, and the digital financial services ecosystem are also well advised to be supportive of the mostly honest and highly professional people and firms working in the crypto and digital assets ecosystem. Most people and firms are working towards a better financial system for everyone, and like every crisis, one or two have brought the system to its knees through a single point of failure.

Staff, counterparties and partners not realizing their complicity in the network through to a firm’s single point of failure is a real learning we must take on board following the failure of FTX. It is the root cause of most crises, and one we really must fix for a more resilient financial system. We must stop thinking and believing that everything is fine until it is not, and waiting to fail.