The FTX Fallout Yet to Come
FTX and SBF were hypervisible representations of the crypto industry. What now?
Plenty of people have covered the FTX fallout already, including here, here and here. Now, FTX and its subsidiaries have filed for Chapter 11 bankruptcy. A week of disbelief is slowly transitioning into lengthy and painful shock waves that will work through the system for months if not years. Hedge funds with funds locked on FTX, BlockFi etc are at a standstill, many will be flushed out and consolidated by the end of this. Startups with treasuries locked on FTX are unable to make payroll. The Solana ecosystem is in disarray. Regulators are circling. The crypto-curious and crypto-natives alike are seriously disillusioned.
It’s still unclear how much this trickles through DeFi, credit platforms, OTC desks — the lifeblood of liquidity for the rest of crypto.
It’s a sad time for the industry.
When we look at what went wrong here, there are a few clear learnings:
There was a complete lack of transparency, likely even within the company.
There was rampant self-dealing which created interdependent risks.
In the bear market, the crypto market is becoming consolidated to the point of “too big to fail”
To address the lack of transparency, it seems like Proof of Reserve is about to become an industry norm. Basically, institutions prove their outstanding assets and liabilities on-chain using some combination of auditors, public-facing data and merkle proofs. We’ve seen the largest exchanges announce plans of PoR since FTX’s collapse, and I suspect that this exercise will be documented to create an ongoing template. Hopefully, regulators are taking notice of the process.
FTX and Alameda’s relationship clearly represents self-dealing and conflicts of interest no longer allowed in TradFi. In TradFi, this separation of commercial and investment banking activity was initially regulated by Glass-Steagall Act starting in 1933. The GSA was repealed in 1999, but after the 2008 economic crisis new regulations emerged to address the same issue, such as the Dodd Frank Act and the Volcker Rule. Thereafter, banks shut down prop desks and started holding far higher capital reserves. While there is no clear regulating body in crypto to institute such rules, I’d expect to see more funding pressure and diligence around legal structure and interdependent entities. Crypto has long struggled with self-dealing of many forms — I hope this is the final frontier before investors and consumers alike start pushing back more.
While we still don’t understand the full ripples here, it’s clear that crypto entities are reaching consolidated levels such that the whole asset class can be massively impaired by one player’s actions. FTX’s situation raises questions of antitrust and M&A regulation as we look at access to different assets and geographies. We may see whole ecosystems (by blockchain or location) taken down by over-reliance on a single exchange and custodian.
This is a huge moment for the industry, which hopefully precipitates massive changes. This time, it feels like the necessary changes are more regulatory than technological.
Stay safe out there.