Over the past week, FTX, a worldwide cryptocurrency exchange backed by the biggest names in Venture Capital (Sequoia, Greylock, Lightspeed, Tiger Global, Softbank) blew up in spectacular fashion.
FTX founder Sam Bankman-Fried rose to fame in crypto through his crypto hedge fund Alameda Research. His success at Alameda Research funded FTX in the early days. Three years after starting FTX, it had amassed an arsenal of venture-capital funding, pro athlete endorsements, stadium-naming deals, and a $32 billion valuation.
He was considered a driving force for the regulation of cryptocurrency exchanges. Bankman-Fried regularly met with Washington lobbyists and even Gary Gensler, the chairman of the Securities and Exchange Commission, to discuss policy. In June, FTX bailed out BlockFi and Voyager (crypto lending platforms). Bankman-Fried’s empire appeared to be an unstoppable force.
Unfortunately, the exchange went insolvent due to risky cryptocurrency trades/investments with user funds placed by FTX and its subsidiaries, balance sheet instability, and a run on the exchange to withdraw funds. As of Friday morning, FTX had filed for bankruptcy for 134 entities. However, by Friday night the FTX exchange was allegedly hacked, over $1 billion in customer funds was reportedly transferred to private accounts or crypto wallets, and there were rumors of FTX executives fleeing the Bahamas. To quote an expression attributed to a variety of humorists, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so"; FTX is now unequivocally the "what you know for sure that just ain’t so."
So where does this put cryptocurrencies?
Venture capitalists and investors in cryptocurrencies are culpable. These parties either lacked the strength to do legitimate due diligence or there was miscommunication between them and Bankman-Fried. Financial destruction of this magnitude shouldn’t be possible with this many high-profile and intelligent investors involved.
More broadly, venture capital investing in cryptocurrency has ballooned; $33 billion invested in 2021 up from less than $1 billion in 2017. Unfortunately, these investors work in tight circles to create excitement, buzz, and marketing around businesses to lure in new participants while pumping the valuations of their particular crypto token.
They have governance controls over their tokens that are generally unknown to retail investors. CEOs of these cryptocurrencies can produce more tokens if they please or change the rules of the protocol at any time. These are unregistered securities trading on exchanges that venture capitalists can cash in on. It’s a bastardized IPO with no regulation and all of these venture-backed tokens have zero value. To make matters worse, many of the same VCs have funded the exchanges where these worthless tokens are traded. In other words, the VCs helped build the casino, have designed the games, secured their chips and are active participants.
Regulators have allowed this pervasive behavior to thrive. Gensler has done a horrific job at trying to protect retail investors in the digital asset space to the point that it appears intentional. FTX is another unfortunate example of Gensler’s desire to control the entire industry rather than work with the Commodity Futures Trading Commission (CFTC) and other regulators to develop thoughtful policy for exchanges. This inability to collaborate has allowed the creation of thousands of cryptocurrencies that are unregistered, liquid securities – again, generally funded by venture capitalists and private investors.
Luna, Three Arrows Capital, Celsius, Voyager, FTX and BlockFI have experienced insolvency issues in 2022. The persistent government inaction fills the space with potential for criminals and scammers. Yet Gensler and the regulators do nothing and watch crisis after crisis unfold while doubling down on the "the regulation is clear" rhetoric. What is abundantly clear is the regulators are either unclear on how this space works, are trusting the wrong people or are corrupted. FTX was one of the most regulated exchanges and was very active in D.C. with regulators while shaping policy.
So, one has to wonder how this could happen when the founder was so close to the SEC, CFTC, and other regulatory agencies? Why are some companies getting preferential treatment with the regulators while Caitlin Long’s Bitcoin focused Custodia Bank can’t get a broker-dealer licenses or bank charter? Broadly, there needs to be tighter controls on centralized, venture –capital-backed tokens that are allowed to freely trade with no consequences. The FTX collapse has all the ingredients of Enron, Theranos, and Lehman Brothers moment combined. Many people will never see their money again. They’ve legitimately lost their money.
However, Bitcoin will live on. Those that lost money on the next big venture-backed token will need to be honest with themselves about the distinguishing factors between Bitcoin and the thousands of other cryptocurrencies. Bitcoin is not cryptocurrency. Bitcoin has no CEO. There is no centralized authority controlling the protocol. There will only be 21 million Bitcoin. Bitcoin has no counter-party risk if you self custody or keep your crypto in your personal hardware wallet.
Unfortunately, events like this tend to happen every four years. The result? An overwhelming number of former "crypto investors" turn into Bitcoin Maximalists – those that only hold Bitcoin. This new class of Bitcoiners will usher in a new wave of education, companies, and infrastructure to support the Bitcoin ecosystem. Over the past decade, we’ve seen thousands of crypto projects and exchanges disappear; I expect many more to fail in the coming months. Despite the carnage, Bitcoin will continue to operate, Bitcoin miners will continue to mine, and Bitcoin will grow stronger.
Brad Myers is an operational leader at Workrise, a skilled labor startup based in Austin, Texas. Follow him on Twitter @skibumsatoshi