Is FTX Blockchain’s Superbowl Moment?
The FTX collapse is not crypto’s “Lehman moment.” That involved a regulated, public company whose bankruptcy spilled over in a global financial crisis via a dense network of interrelated credit relationships.
A more accurate description is that we’re experiencing crypto’s “Superbowl XXXIV moment.” Equally as problematic, but the lessons we draw are very different.
At that game, back in 2000, 20% of the ad space was purchased by dot-com companies, many of which would not exist by the end of the year. Pets.com (yes the one with the adorable sock puppet) flung around millions of dollars following highly lucrative venture capital rounds before losing all value just a few months later. Today, this looks a lot like FTX.
But if we go a little deeper, the parallels between this week’s events and the last hurrah of the dot-com boom reveal some deeper truths about what the FTX collapse says about blockchain’s progress.
Consumers need an easy way to connect to new instruments
A lot of the companies in the dot-com boom were facilitating consumers’ use of the internet. Remember how few websites existed when you had to code them yourself?
In a similar way, centralized exchanges, like Coinbase and formerly FTX, facilitate consumer use of a novel technological ecosystem. These exchanges operate at the gateway between decentralized finance (DeFi) and traditional finance. They are what you use if you want to try your hand at cryptocurrency, but are not sure how to navigate the DeFi ecosystem.
Or if we scale up our user one level – what if you are an institution that is interested in accessing the instruments being transacted in DeFi, but you’re legally prohibited from using the infrastructure? Centralized exchanges solve this problem. They allow investors to use fiat currency to transact with digital currencies.
The existence of centralized exchanges is exactly why digital assets have been increasingly common as an asset class.
An important caveat is that even as digital assets have scaled, regulation has lagged. There is no single standard way to regulate exchanges, and many of them are still, technically, venture capital funded startups which don’t fall under traditional corporate rules.
Spectacular collapses can obscure the underlying value of new technology
In the same way that we’re still here using the internet in 2022 after that fateful spate of Superbowl ads in 2000, blockchain is not going anywhere.
The dot-com bubble reflected the overvaluation of companies, not that the internet itself was a scam. Widespread adoption of the internet changed nearly every corner of the economy from agriculture to finance. It also built the foundations of Web1 without which we wouldn’t be talking about digital assets and Web3 today.
In the same way, when FTX collapsed, a lot of wealth evaporated overnight. The direct cause was a poorly-run company that was lending assets that it claimed to be holding on the exchange. Yet there were claims that this was an indication that digital currencies are a “fringe niche.” These fail to recognize the difference between the instruments being transacted and the infrastructure that facilitates it.
The sheer value of transactions that continue to happen in DeFi and on other centralized exchanges signal is evidence that blockchain has underlying value beyond just the headlines. The regulated financial infrastructure today has already adopted the technology underlying bitcoin in ways that improve settlement times and post trade processing.
Established companies like Fidelity are allowing participants to invest up to 20% of their 401K into bitcoin; stock exchanges like the Swiss Digital Exchange are issuing natively digital bonds. FMIs like DTCC are piloting blockchain in an effort to build a more resilient financial infrastructure.
The real economy was not affected, for now
One way in which the FTX crash is unlike the dot-com era bankruptcies is that in 2022, the broader economy emerged unscathed.
If you are a person (or a venture capital fund) with value tied up in FTX, you may have lost a lot of money when it halted withdrawals and then went bankrupt.
If you were not, you probably didn’t notice. The real economy continued on, relatively unaffected. Grocery prices were unchanged, your 401K is fine, and interest rates continue to stay too high. Crypto also continues to be transacted on all protocols.
This highlights the continuing lack of integration of DeFi into the traditional financial architecture. This is partly a result of regulation – banks are disincentivized from holding crypto, and partly a lack of infrastructure – digital currencies don’t circulate well using traditional architectures.
For now, this helped limit the carnage. But this segregation between DeFi and TradFi is softening. Bitcoin is no longer considered to be a hedge for traditional currencies and researchers acknowledge that its movements are correlated with tech stocks and more traditional indicators.
It’s not the end of volatility, but it’s also not the end of crypto
Both 2000 and 2022 were situations of volatility. And this didn’t change overnight. What did change is the need for regulation as new technologies get closer and closer to widespread consumer use.
FTX illustrated an important, and largely overlooked feature of cryptocurrencies. When the FTT token tanked, other cryptocurrencies also lost value. One of the main culprits for this is the unusually high degree of interconnectedness in price and volatility movements of cryptocurrencies. For an exchange like FTX which enabled trading of 300 currency pairs, this can translate to a lot of spillover price movements.
As regulators decide what and whom needs to be regulated and when, one issue they could consider is how to address the ongoing volatility caused by crypto interconnectedness. This can be addressed by various measures including classification of different types of cryptocurrencies as the SEC appears ready to do. It can also be helped by collateral requirements on stablecoins, and clear regulation of exchanges.
It is admittedly difficult to know what to regulate. Tellingly, the Prime Minister of the Bahamas reported to the Parliament: “Based on the analysis and understanding of the FTX liquidity crisis to date, we have not identified any deficiencies in our regulatory framework that could have avoided this.”
Many of the other large centralized exchanges have already pursued compliance with different relevant regulations in some jurisdictions. This is an important inflection point. The questions about blockchain are no longer about the technology, now they are about the regulation.