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The End of FTX and the Future of Crypto

This last week in Crypto has been one of the worst I have witnessed.

An industry that was founded on the idea of being the anti-thesis to the traditional finance world has been hit extremely hard by the unravelling of FTX. A crypto-version of a Bernie Madoff scam has unfolded right in front of our eyes.

We seem to have gone full circle and ended up where we had started.

The usual suspects are quick to judge and condemn ‘crypto’ and the industry as a whole. From many I would not have expected otherwise. To quote Naval, ‘if you believe that money should be controlled by the state, then nothing in crypto will ever make sense to you.’ But this crisis strikes differently as so many crypto-natives were impacted. Ironically, in an industry meant to be built around ‘trustless-ness’, FTX had been among the most trusted counter-parties.

The fall-out goes far beyond crypto. FTX US was a regulated entity. Its founder Sam Bankman-Fried spoke in front of congress. FTX had auditors. Maybe most incriminating: top VCs such as Sequoia and Paradigm invested nearly $2bn, the company’s valuation reached a staggering $32bn as recently as January 2022. Not even a basic pretence at Due Diligence seems to have happened. Quelle surprise, from regulators to VCs, everyone was making it up as they were going along.

To be clear, none of this should be a surprise. We live in a time of late-stage financial capitalism during which the monetary regime has been so loose, that even the suggestion of managing risk gets one laughed out of the room at most financial players. When Central Banks try to ‘encourage’ the ‘animal spirits’ and drive more investment, loose monetary policy drives out the risk-curve. ‘Conservative’ investments now yield less returns. Everyone chases riskier and riskier yields. 10 years after Quantitative Easing first started, someone should start asking the question of why the Ontario Teachers’ Pension Plan was an investor in FTX. But I am digressing here.

The FTX disaster is being used to argue that crypto is dead and will be used in arguments on how the industry should be regulated in the future. This of course will be a complete misunderstanding of what actually transpired and what the ‘essence’ of crypto is.

The reasons behind the failure of FTX are exactly the same reasons why Bitcoin was created in the first place and why we need to change the system and drive towards decentralisation. Any financial system that relies on assumptions of trust in a central counterparty faces major risks and has points where corruption can enter the system. FTX was a centralised counterparty that should not have been trusted. Its failure is painful but not systematic, not for the wider financial system or even the crypto industry Could the same be said about any of the massive, centralised, so-called ‘Too-big-to-fail’ banks? Yes, we cannot fully remove human agency but there are many more systems that can be made trustless and failure points that can be removed. And that’s before we even bring the Eurodollar system and the Cantillon effect into the mix. If you actually think that the existing financial system works, you are probably part of the problem.

The best to come out from the FTX disaster is what critics continuously miss. Crypto and Blockchains are not invalidated by the failure of centralised actors like FTX, Celsius or Genesis. DeFi protocols like Aave, Uniswap, Compound and many others are holding up just fine. Yes, there have been many scams and yes smart contracts have been hacked many times. The new system does not come without its own set of challenges. Yet, thanks to Blockchain technology, trustless systems and a “don’t trust, verify” mindset have become engineering and UX challenges, not challenges of the human condition where the next scammer is always around the corner. Smart contracts on public Blockchains can be verified and audited by anyone, not just a select few potentially corrupt players. A system that is 100x more transparent and better can emerge.

Most importantly, outflows from centralised exchanges to cold wallets have been massive over the past days. Actors are learning to trust DeFi, not CeFi.

As always, the anti-crypto tirades barely touch on what is actually happening. As the mainstream media (NYT, WaPo, etc) are proving their corruptness by publishing adoring pieces on FTX founder SBF (WaPo headline: ‘Before FTX collapse, founder poured millions into pandemic prevention’), ‘citizen-journalism’ on Twitter has done significantly more to uncover what actually happened than either regulators, auditors or ‘journalists’ have done. This is a sign of where things are heading.

What this has shown: nobody, not politicians, not regulators, not founders, not traders have much of a clue. Few players remain ethical, prudent and aware of risk-management in the face of immense opportunity, FOMO and greed. What you need to do to stay afloat is practice humility, be patient, avoid putting too much trust into any one entity, have systems in place to improve and review your security and have risk management measures across the board. Even then you can still be unlucky, but if you are prepared, the ‘bad luck’ should at least not wipe you out entirely. Blockchain technology will help to remove a lot of this ‘need for trust’ out of today’s financial systems. Over time, it will allow actors to focus much more on actual fundamentals.

We can even dig deeper. The real technology behind the ‘Blockchain’ buzz word is cryptography. In its best form, cryptography can protect citizens from tyrants and allow the return of privacy as a human right. With advances like zero-knowledge Cryptography, privacy could even be maintained whilst proving compliance with laws. Cryptographic advances are what underpins this ongoing revolution. Increasingly centralising power is a risk, cryptography can help reduce it. The collapse of a scam-exchange run by a fraudster is only a minor footnote in this wider context.

Today we widely have consensus that we are in the age of Technology. The reality though is that at best we are at the end of the beginning in the transition towards that age. We are just scratching the surface of what the future will hold. Technology is moving at a breakneck speed. Trustless financial interactions in a purely digital realm, private currencies, extremely strong cryptography, private Central Banks, algorithmically driven Central banks — we are getting a glimpse of where Finance will be in 50 years time. You can fight it or you can prepare for it. The world will not always be run by people born in the 1940s.

What is in store for crypto over a shorter time-horizon? I personally know from some smart money that is now starting to slowly scale back in. Make of that what you will. An invention cannot be uninvented, at worst it can be delayed. Inflation and a failing global monetary system show that the case for money outside of government control has never been stronger. The rise of authoritarianism and populism around the world is yet another data point to highlight the urgency and importance for decentralising power and building technology that enables citizens to opt out of the increasingly panoptic system. For me, fighting the centralisation of power in all its forms is the most important challenge of our time and I will fight tooth and nail to see crypto reach its full technological potential.

Despite being declared dead a gazillion times, this industry is here to stay. And the world is a far better place for it.

FTX
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