Following the dramatic collapse of FTX, we’ve been left with lots of questions. Customers are asking where their money is, investors are worrying how far the contagion will spread, and experts and legislators are asking if regulation is the answer.
In a little over a week in November, multibillionaire whizz kid Sam Bankman-Fried, once considered the JP Morgan of the crypto industry and one of its most trusted figureheads, saw his status drop from once-in-a-generation genius to pariah, and FTX customers have lost millions. It seems unlikely the industry will be allowed to continue to self-regulate or, for that matter, ever be the same again.
But has the crypto bubble burst once and for all? And where will crypto go from here? Read on to get industry experts’ thoughts on where it’s headed. But first, a quick recap of the rollercoaster we’ve witnessed over the last few weeks.
FTX collapse: what happened?
It was supposed to be the “safe and easy way to get into crypto”. But when the balance sheet of Alameda Research, FTX’s sister trading company, was leaked and published by Coindesk on 2 November, it was the beginning of a couple of weeks that would change the crypto industry irrevocably.
The leaked statements revealed a black hole in the trading company’s finances, with over $2 billion of its assets held in FTT, the FTX-issued tokens, raising serious questions about both companies’ liquidity.
With Binance, the world’s largest crypto exchange announcing it would sell off its own FTT holdings, and the revelation that FTX had been taking assets from customer accounts to fund Alameda’s trades, FTX’s demise was rapid.
In just a few days, the exchange collapsed, losing its customers in excess of $1 billion dollars. While the majority of customers were institutional investors, many retail investors have lost out too, unable to withdraw their funds before the exchange filed for bankruptcy.
With New York-based Genesis Trading also halting withdrawals at its lending unit and announcing it’s seeking emergency funding, we’re already seeing that more high-profile and well-regarded crypto giants are at risk.
The fear is that we’ll see widespread contagion, akin to what happened after the dotcom bubble burst in 2001-2, as investors withdraw their money and funding dries up.
As the shockwaves reach anyone with exposure to FTX and Alameda, and beyond, as general confidence in crypto plummets, could the FTX collapse bring down the whole industry? Unlikely. But what seems certain now is that the period of unbridled funding, rapid expansion, self-regulation, and minimal oversight has come to an end.
How do industry experts think the crypto space will evolve?
What’s next for crypto?
Unlike traditional exchanges, crypto exchanges such as FTX and Binance have so far been self-regulated, beyond the reach of regulators such as the Securities and Exchange Commission (SEC) in the US, the Financial Conduct Authority (FCA) in the UK, or the European Securities and Markets Authority (ESMA) in the EU.
Many investors, both retail and professional, choose the crypto space precisely because it isn’t regulated like traditional, centralized exchanges. There are risks, of course, but huge potential gains, in addition to reduced red tape and more accessible trading opportunities.
“The crypto industry has conceived a new way of decentralizing finance, but through the recent liquidity crunches and high-profile collapses, it’s now learning some of the lessons that led to regulations being imposed in traditional markets,” says Simon Ullrich, TTMzero Managing Partner.
“Looking back now at what has happened with FTX – how it mismanaged customer assets and failed to perform adequate recordkeeping, how it targeted a mainstream audience of retail investors through sponsorship deals and celebrity-endorsed advertising campaigns, as well as making donations to political parties and lobbying policymakers – this lack of oversight and regulation seems glaring and worrying.”
Is it time, then, for regulators to step in?
SBF, himself, was outspoken in calling for “thoughtful regulatory leadership”; however, this was a minimal type of regulation opening the door for crypto giants like FTX to legitimately reach a mainstream audience. If regulators and legislators move to impose regulations following the collapse of FTX, it seems likely they’ll choose a stricter, more traditional route.
At the Indonesia Fintech Summit 2022, Changpeng Zhao, Binance CEO, said: “Regulators rightfully will scrutinize this industry much, much harder, which is probably a good thing, to be honest.”
These exchanges are where most crypto transactions are done, and should regulators crack down on them, experts expect the price of the underlying tokens to fall. So, a price adjustment would likely follow, and companies would face the costs of compliance, but increased regulation could also restore trust and increase demand, leading to an inflow of investors and higher crypto prices.
Move towards DEXs
Some experts, such as Ethereum co-founder Vitalik Buterin, believe decentralization is the way forward.
Centralized exchanges (CEXs) such as FTX and Binance may have made it possible for retail investors without technical knowledge to enter the market, but they also expose investors to the risk of inadequate governance and corruption.
With decentralized exchanges (DEXs), people make peer-to-peer transactions, retaining control of their own funds. Hayden Adams, the founder of UniSwap, the largest DEX in the world, recently described the FTX collapse as “a good learning moment for the industry”.
Increased demand for crypto-based ETPs
Effectively regulating the crypto industry won’t happen overnight. In the meantime, other than DEXs, what options are there for investors who want to gain exposure to cryptocurrencies without such high risks of counterparty or exchange default?
Simon Ullrich, founder and managing director at TTMzero, one of the United Fintech Group’s family of innovative fintech solution providers, says exchange-traded products (ETPs) may hold the answer.
“More sophisticated and experienced investors often choose to invest in cryptocurrencies indirectly via ETPs, because of the risk mitigation qualities they offer. Rather than expose themselves to the risks associated with cold storage solutions or centralized exchanges, ETP investors can store their exposures to digital assets in regulated systems. But investors have to select the ETP issuers carefully.”
“Cryptocurrencies aren’t dead after the FTX collapse,” says Simon. “We divide the universe of cryptocurrencies into (a) tokens that allow holders to participate in a specific DeFi project, and (b) plain cryptocurrencies that don’t have any intrinsic value. The prices of instruments in both categories have fallen dramatically during the turmoil in recent weeks.”
“However, there are plenty of coins that belong to the category of utility tokens and that represent DeFi projects with the potential to reshape or drastically improve the way transactions in capital markets are executed – including Ether 2.0, Cardano, and Solana.”
“These utility tokens can still be a lucrative investment, because they’re part of technological platforms that have the potential to change the future.”
By investing in these tokens via ETPs or structured products, investors are able to manage investment-level risks, while enjoying the protections of trading on regulated exchanges. It is, however, important to pay attention to the credit risk associated with the ETP issuer.
“Investors in less developed financial markets have no choice but to invest directly in these coins if they want to participate in the performance,” says Simon. “Market participants in developed markets, however, can usually choose between a direct investment into the tokens and an investment into ETPs or structured products linked to the token.”
“In most developed countries ETPs and structured products are well-regulated financial instruments. This is as true for products linked to traditional assets as it is for products linked to digital assets such as cryptocurrencies and tokens.”
“If the issuer takes regulation seriously, then these products can bring real value.”
As we learn more about what went on at FTX and see how others in the industry are affected in the coming weeks, we may start to see these trends emerge. However things unfold, we firmly believe that technology will be at the heart of crypto’s evolution.
Stay ahead of the digital curve
At United Fintech we believe in the power of technology to disrupt and transform sectors. Progress sometimes brings growing pains, but in technology lies the answer too.
Our mission is to bring the best FinTech and RegTech tools, products, and solutions together all in one place to help players in the financial sector stay ahead of the digital transformation curve.
We are covering this topic here in a webinar with our partner company, TTMzero, where industry experts will discuss how investors can participate in the performance of blockchain technologies without being exposed to FTX-like risks.
The TTMzero platform makes it possible for ETP issuers to automate their processes for security issuances, lifecycle management, and regulatory documentation, reporting, and filing. Learn more about TTMzero’s Financial Instruments Automation Platform and other tools here, or find more insights and resources here.