FTX collapse blows a hole in crypto’s decentralised promise
Big crypto failures thus far have been catalysed by sudden revelations of poor governance
WE’VE seen this movie before. The recent implosion of crypto exchange FTX features a similar cast and plot as the collapse of other industry peers: charismatic founders, blue-chip backers who may have failed to ask tough questions, and market hype that masked weak internal controls.
The string of collapses serves a timely reminder: the crypto industry – if it ever wants to have mainstream relevance – needs to hold itself to higher regulatory standards.
Regulators have been cautious thus far. In a Monday (Nov 14) statement, the Monetary Authority of Singapore said licensed digital payment token service providers are regulated for money laundering, terrorism financing and tech risks, but not for “safety and soundness”.
These platforms are not subject to the same regulatory safeguards as traditional financial institutions, such as capital or liquidity requirements, nor are they required to protect customer monies or digital tokens from insolvency risk.
In theory, the crypto industry should not require rigid regulation. Cryptocurrencies are supposed to be transparent because transactions take place on a publicly visible blockchain. A decentralised system was to have functioned without intermediaries and centralised governance.
In fact, the big crypto failures thus far have been catalysed by sudden revelations of poor governance: a lack of hedging policies, overleveraging, and conflicts of interest, for instance. None of these were uncovered by looking at the blockchain; all of it came out of leaked documents.
The blockchain also does not solve the problem of capital adequacy and solvency, which is important when crypto exchanges are holding onto retail investor funds.
The cruel irony of FTX’s collapse is that some investors had parked their holdings there because they perceived it as a relatively safe option. Its founder Sam Bankman-Fried had seemed an exception in the cowboy town of crypto, advocating greater regulation for the sector.
As the poster child for a sustainable crypto future, the 30-year-old attracted some of the biggest names as investors, including Sequoia Capital, SoftBank, Tiger Global and Singapore’s Temasek. When crypto peers were in trouble, FTX swooped in as a buyer of distressed assets.
Bankman-Fried’s confidence now appears to have been built on fragile foundations. The trading house he founded, Alameda Research, was allegedly tapping customer deposits on FTX for trades, according to reports. In addition, nearly US$6 billion of Alameda’s assets comprised FTT tokens issued by FTX and used as loan collateral.
Strangely for a company with so many big-name investors, FTX’s board of directors comprised only its founder, an employee and a lawyer – with no investor representation or independent parties.
Revelations about Alameda’s potential insolvency, coupled with a tweet from Binance chief Changpeng Zhao about offloading FTT tokens, were enough to knock FTX off its pedestal in a matter of hours. As spooked investors rushed to withdraw their funds from FTX, the exchange faced a run on assets.
The rapid escalation of FTX’s collapse mirrors those of crypto hedge fund Three Arrows Capital, as well as crypto lenders Celsius Network and Voyager Digital.
Their fates show that a blue-chip slate of investors is still no guarantee of a company’s viability. If supposedly sophisticated institutional investors are unable to reliably make calls on the comparative strength of a crypto market player, retail investors can hardly be expected to be much wiser.
While many crypto insiders continue to chant the mantra of regulation stifling innovation, the collapse of FTX and the many cases before it together sound a clarion call for the opposite.
