Photo Credit: Blockworks
While the news of the collapse of FTX is empowering crypto skeptics, we would point out that all of the recent collapses in the crypto ecosystem have been from centralized players and not from decentralized protocols.
-JP Morgan
If you spent even 30 seconds looking at the news this past week you saw the name FTX. FTX dominated the news cycle even with US midterm elections last Tuesday. This fact alone should signal the absolute size and scale of the FTX blowup. What is FTX? FTX was a leading cryptocurrency exchange specializing in spot markets, derivatives, and leveraged products. Founded in 2018 by Sam Bankman-Fried, FTX was an overnight success leveraging a strategy of hyper-growth into the world’s third largest crypto exchange.
You may have seen FTX’s stadium naming-rights deal with the NBA’s Miami Heat (FTX Arena), the FTX logo on MLB umpires’ uniforms, or heard of the infamous FTX Series B-1 capital raise of $420.69 million with 69 investors. FTX was seemingly everywhere the last bull market. Even when the crypto markets collapsed in March of this year, FTX repeatedly stepped in as the buyer of last resort. Many in the crypto industry viewed FTX as crypto’s central bank. In the aftermath of the Terra-Luna and 3AC market crashes FTX acquired troubled CeFi (“Centralized Finance”) companies, Voyager and Blockfi. FTX even acquired a stake in Robinhood.
In the end, all this projected confidence was smoke and mirrors. On November 6th, Binance CEO, Changpeng Zhou (“CZ”), announced Binance’s intention to liquidate all ~23 million FTT tokens in their possession, representing $530 million. FTT tokens were the native token of the FTX ecosystem. The liquidation announcement triggered an immediate bank run on the FTX exchange forcing a massive liquidity shortfall. In the end, FTX was unable to handle the contagion and was forced to file for bankruptcy.
Investigators are still piecing together the details that lead to FTX’s blowup while others are looking into potential contagion. There will likely be significant institutional crypto blowups in the coming months. Centralized crypto exchanges Crypto.com and Gate.io are rumored to be under duress. When the dust settles, we will likely be shocked at what is uncovered. Trusted 3rd parties like FTX (i.e., centralized exchanges more generally) were assumed to operate honestly and with integrity. What we are learning is FTX perpetrated one of the largest frauds in modern history (only Madoff & Enron were bigger). As a result, many of the industry’s leading investors, operators, and supporters have watched in horror as their funds disappeared in one of the largest capital destruction events ever recorded.
The pseudonymous Satoshi Nakamoto created Bitcoin in the depths of the 2008 Great Financial Crisis (“GFC”). The GFC was the direct result of “trusted” Wall Street entities abandoning conservative risk management strategies in favor of get-rich-quick schemes. NINJA loans (“No Income, No Job, No Assets”) became the industry norm and the largest real estate bubble ever formed was created. The general public remembers the devastation wrought by the GFC. In many ways the collapse of FTX is similar to the GFC as “trusted” 3rd parties were overcome by greed. The result was a complete abandonment of financial controls, the commingling of user funds, and eventual fraud. This disaster will likely haunt the crypto industry for years.
Since Bitcoin’s inception, a core crypto vision has been to build a decentralized and trustless system free from human fallibility. In the most recent bull-market many of the largest players abandoned crypto’s core principles. As a result, many suffered catastrophic losses on FTX. FTX’s failure as trusted intermediary is why I remain bullish on the future of crypto. In my opinion, the thesis for decentralization and transparency remains fully intact. The near-term will likely remain choppy with regulation fears and participants exiting the industry. Longer-term, the industry will return to first principles: decentralization; transparency; and trustlessness.
So why am I still bullish? FTX’s blowup represents a central point of failure, human fallability. The crypto industry’s overarching goal has been to disintermediate “trusted intermediaries” into fully decentralized, transparent, and trustless protocols. In the euphoria of the bull market players big and small abandoned these principles. And as a result, nearly one million users lost more than $1 billion worth of assets on FTX. The losses will not be forgotten (nor forgiven).
Bitcoin is the separation of money and state. Crypto tokens are the separation of corporation and state. In 2020 we saw the rise of Decentralized Finance (“DeFi”) and in 2021 the explosion of non-fungible tokens (“NFTs”). Both of these innovations drove greater transparency to finance and entertainment markets and are forcing both industries to innovate or die. DeFi performed flawlessly in the FTX implosion. NFTs were also largely unaffected by the carnage. Crypto users in both of these industries largely avoided the chaos through the use of self-custody wallet solutions. I expect future users to increasingly self-custody their crypto in the wake of FTX. Further, I expect consumer-friendly apps to funnel new users into self-custody. Social wallets are one of many solutions in development.
Currently, there are problems transacting exclusively on-chain (protocol hacks, bridge exploits, scam links, and vaporware tokens). Maturing crypto infrastructure is slowly but surely improving the user experience by overcoming many of these issues. The steady march of innovation will ultimately realize Satoshi’s vision. As JP Morgan mentioned above, the implosion of centralized entities will not stop the progress of the decentralized economy. For this reason alone, I am still bullish on crypto and the greater crypto industry at large. It may take time to earn the public’s trust, but the underlying goals are too important to be abandoned.
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