The collapse of a key company in an industry that’s creating a new kind of money has put an odd twist on an age-old question:
Why do bad people happen to good things?
Why We Wrote This
The big question: If most of the trading in cryptocurrencies is high-risk speculation and they will require traditional regulation anyway, does the world really need such alternative money?
The latest character in this financial saga appears to be Sam Bankman-Fried, founder of FTX, which served as an exchange for a digital form of money called cryptocurrency. On Nov. 11, FTX collapsed in spectacular fashion, declaring bankruptcy after 10 tumultuous days of revelations that the company was using customers’ money to buy assets of a sister company. Since FTX is the world’s No. 2 exchange for cryptocurrencies, its failure has stunned the crypto world the way that the failure of the NASDAQ exchange could cause stock investors to panic.
Already, on Monday, lender BlockFi filed for bankruptcy and analysts say other dominoes could fall in the crypto world, which is already reeling from a string of bankruptcies this year. FTX’s collapse has also shaken confidence in the technology and left its supporters red-faced, including celebrity athletes such as football’s Tom Brady and basketball’s Steph Curry.
And yet, in the midst of what’s become known as the crypto winter, many enthusiasts remain steadfast in their confidence that the technology will transform the way people pay each other.
The collapse of a key company in an industry that’s creating a new kind of money has put an odd twist on an age-old question: Why do bad people happen to good things?
The latest character in this financial saga appears to be Sam Bankman-Fried, founder of FTX, which served as an exchange for a digital form of money called cryptocurrency. On Nov. 11, FTX collapsed in spectacular fashion, declaring bankruptcy after 10 tumultuous days of revelations that the company was using customers’ money to buy assets of a sister company. Since FTX is the world’s No. 2 exchange for cryptocurrencies, its failure has stunned the crypto world the way that the failure of, say, the NASDAQ exchange could cause stock investors to panic.
Already this week, BlockFi filed for bankruptcy and a Japanese exchange called Bitfront shut down. Analysts say other dominoes could fall in the crypto world, which is already reeling from a string of bankruptcies this year, including Celsius and Three Arrows Capital. FTX’s collapse has also shaken confidence in the technology and left its supporters red-faced, including celebrity athletes such as football’s Tom Brady and basketball’s Steph Curry. And yet, in the midst of what’s become known as the crypto winter, many enthusiasts remain steadfast in their confidence that the technology will transform the way people pay each other.
Why We Wrote This
The big question: If most of the trading in cryptocurrencies is high-risk speculation and they will require traditional regulation anyway, does the world really need such alternative money?
“I’m embarrassed to be working in an industry that has had this tendency to rally around people like Sam Bankman-Fried or the people who own Celsius or Three Arrows Capital,” says Omid Malekan, a Columbia Business School professor and author of a new book, “Re-Architecting Trust: The Curse of History and the Crypto Cure for Money, Markets, and Platforms.” “Unfortunately, there’s actually a long history with new and transformative industries – whether we’re talking about railroads, whether we’re talking about the internet itself, other telecommunication – that there’ll always be violent boom-bust cycles in the beginning. And there’s also a tendency to attract certain kinds of grifters and scam artists.”
That confidence stems from the technology that underlies cryptocurrencies, called blockchain. It’s a ledger of transactions spread over a network of computers that makes it easy to check transactions and hard for anyone to hack them. Blockchain is so secure that it’s streamlining real estate sales, giving banks new ways to lend money, and allowing artists to digitally authenticate their art.
“Blockchain is certainly a technology that is here to stay and will continue to evolve,” says Joseph Silvia, a Chicago-based attorney with Dickinson Wright representing financial institutions with a focus on financial technology and crypto.
With cryptocurrencies, the outlook is murkier, in part because of several contradictions that muddy the crypto world.
The most obvious contradiction is that most people who buy crypto tout it for one reason but invest in it for another. Crypto is a digital money that’s built to move. It doesn’t require a banking system to transfer funds. The sender and the receiver don’t need to know each other or trust each other. The currency’s blockchain takes care of that. But the lion’s share of crypto trading has little to do with trust. It’s about greed.
Investors in the biggest cryptocurrencies such as bitcoin are eager to become instant millionaires. Their optimism isn’t totally unfounded. In the past five years, bitcoin, the most popular cryptocurrency, has fallen from more than $14,000 to about $3,500, then topped $61,000 just over a year ago to plunge to about $16,000 today. Investment adviser Cathie Wood predicts bitcoin will reach $1 million by 2030.
Such volatility attracts speculators but hardly represents the stability that everyday users look for in a currency. That currency is more likely to be a special kind of crypto called stablecoins, designed to maintain their value with the U.S. dollar or some other financial asset. Throughout the crypto winter, these stablecoins, when properly backed by a physical asset, have maintained their value.
The contradiction is that as trustworthy as the underlying technology is, it hasn’t protected the crypto world from bad actors. Mr. Bankman-Fried’s fall from grace proved as stunning as the failure of his company. Until this month, he was hailed as a hero for bailing out two crypto companies after two cryptocurrencies collapsed in May. But when another crypto trading company headed by Mr. Bankman-Fried began to lose money, FTX reportedly began using its customers’ funds to bail out that trading company. When that became known in early November, the firm quickly imploded.
“Everything we talk about in finance regarding good corporate governance … things that prevent people from stealing from the company or customers – were really absent in that company,” says Richard Thakor, a finance professor at the University of Minnesota. What’s needed, he and many other analysts say, is regulation from the same government entities that cryptocurrency purists thought they could avoid.
Thus, stablecoins won’t replace today’s currencies anytime soon. They may serve as an alternative currency, these analysts say. The big question: If most of the trading in these cryptocurrencies is high-risk speculation and they will require traditional regulation anyway, does the world really need such alternative money?
“A financial innovation is going to last in the long run if it serves the core function,” says Professor Thakor. “With cryptocurrency, I really struggle with regard to what its core economic function is and what exactly drives the value of the cryptocurrency.”
Some central banks are pushing forward with the idea of issuing their own government-backed stablecoin, notably in China and the European Union. That could help modernize today’s creaky financial system, but it raises a hornet’s nest of privacy and other issues. For instance: Will people use a currency that allows their government to so easily track their every expenditure?
Businesses, with fewer privacy concerns and more financial savvy than consumers, may lead the charge in driving wider acceptance of stablecoins, says Mr. Silvia, the corporate attorney.
And in certain niches, consumers are also turning to crypto. Denis Smykalov, who sells luxury real estate in Miami, has seen interest grow in crypto, especially from his international clients. With Russia’s invasion of Ukraine, both nations have made it harder for their citizens to get money out of the country. So they have turned to crypto as an alternative to snap up foreign real estate.
“It’s growing steadily,” says Mr. Smkalov, with about 15% of his deals at Wolsen Real Estate transacted in crypto. “Crypto was, five years ago, something nobody knew,” he says. “A year ago, everybody started accepting it. … They’re not concerned about FTX at all.”