Dec 3, 2022 - Economy

FTX downfall threatens crypto existence

Sam Bankman Fried, CEO of FTX Cryptocurrency Derivatives Exchange, speaks at a Bloomberg event in July 2022.

Sam Bankman-Fried, founder and chief executive officer of FTX Cryptocurrency Derivatives Exchange, during an interview on an episode of Bloomberg Wealth with David Rubenstein in New York, US, on Wednesday, Aug 17, 2022. (Jeenah Moon/Bloomberg via Getty Images)

Crypto has an Enron-sized scandal that threatens to completely undermine the trust proposition for its existence, regardless of Sam Bankman Fried's mea culpa tour.

Why it matters: The house of cards built by Bankman-Fried has drawn several parallels, including Enron, Theranos, Bear Stearns, Lehman Brothers and Madoff Investment Securities.

  • In that vein, there’s nothing really new under the sun — even with the head-spinning volatility that’s come to characterize the nascent market for digital currencies.
  • We’ve sort of seen this movie before, and we suspect we know how it will end.

The big picture: FTX's "first day declaration" in bankruptcy court affirms the picture that’s emerged over the last month.

Like Theranos/Madoff/Lehman, the principal spark for FTX’s downfall was its founder's staggering ineptitude and dishonesty, and the failure of anyone around him to notice (or at least care).

  • “The fallout from [FTX’s] co-mingled client assets, poor disclosure and missing internal controls should remind us that while the cast of characters and products may change, the script of financial market disorder remains painfully familiar,” Robin Vince, president and CEO of banking giant BNY Mellon, wrote in a Financial Times op-ed on Friday.

Yes, but: What is specific to crypto is an untested, interconnected, and interdependent ecosystem that's ripe for contagion and dramatic spillover effects. And since this fuse was lit, the fire is spreading faster, and wider.

  • This matters a lot when it comes to crypto’s long-term prospects — and why it could take a very long time for investors (especially small ones) to trust the industry again.

What they're saying: FTX's downfall "will radically transform the crypto ecosystem, further shaking trust and raising doubts around its ongoing prospects," analysts at Moody's wrote last week.

  • The firm's failure "has left a market share void that will prove difficult to fill without a renewed client interest in crypto assets, a scenario to which we currently assign a very low probability."
  • Crypto firms are in damage control. Voluntary audits are suddenly in vogue again, with crypto exchanges scrambling, trying to stem a raft of outflows. But even these have limitations in what they can prove.

Flashback: Crypto was birthed in the glum aftermath of the 2009 crisis; its principal selling point was its decentralized nature.

  • The idea was that individuals couldn't trust traditional finance, and granting smaller players more power to make their own decisions without the influence of bigger players.

The bottom line: The crypto industry was already facing a trust deficit. And this has set it back far.

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