For many people, myself included, who were drawn to cryptocurrencies by the prospect of fixing or replacing an exclusionary, extractive, outdated global financial system, the failure in crypto markets this past year has delivered an extremely cold bath.
Now, to be clear, most of the massive financial hit to investors was not due to a failure of technology.
For the Bitcoin blockchain, for example, none of the drama of the past year matters. Every 10 minutes, day in, day out, it adds a block of transactions to its ever-growing ledger. It’s a reminder that the global, decentralized networks of computers running Bitcoin, Ethereum and other permissionless blockchain’s protocols continue to forge systems for intermediary-free value exchange with which no one person or entity can interfere, regardless of the ups and downs of markets. The presence and persistence of these vast autonomous machines continue to leave me awestruck.
But “crypto” is more than protocols, smart contracts and cryptography. It’s also the community of humans who have gathered around this amalgam of technologies. Without this community, the technology can’t enter real-world adoption and foster change for good. And unfortunately, the failures in 2022 were due to their actions. While a few people in particular are rightly lumped with the bulk of the blame, there is mass collective responsibility here. The theft, deception and staggering breach of trust happened on our watch.
If we are to take lessons from the wealth destruction of 2022, the conclusion cannot be that this is all the fault of Sam Bankman-Fried and his ilk. SBF deserves the prison time he seems sure to receive with his extradition to the U.S., but the real question is how do we create a system – not merely a technological system but one of laws and standards – that makes it much harder for people like him to do what they did.
There is much work to do to build that system in 2023 and beyond. But it starts with the lessons of 2022. There are many. Here are the five that I think are the most important:
1. Crypto does not exist in an economic vacuum.
With all the headlines generated by the collapse of FTX in November, it’s easy to forget that far bigger losses hit cryptocurrency markets in the first months of the year – not because of a crypto-endemic scandal but because the Federal Reserve was hiking interest rates. That put an end to the surfeit of dollars pouring into speculative assets around the world, including cryptocurrencies. The macro environment matters.
2. Leverage, taken too far, always leads to contagion.
The domino effect, seen when the failure of one crypto institution quickly spreads to another, is hardly without precedent. It was there in the 1997 Asian financial crisis, the 1998 Long-Term Capital Management collapse, the 2008 subprime mortgage crisis and many other such moments in financial history. They all had the same characteristics: an overly bullish belief in the upward momentum of financial assets fueled an excessive buildup of loans to speculators. When those beliefs proved unfounded, the rush to the exits exposed an interdependent network of creditors and debtors as they dragged each other down in unison. Crypto speculation was never going to be immune from this, regardless of the decentralized nature of the underlying protocols.
3. DeFi is resilient, but needs constant economic and technical auditing.
Most of the high-profile collapses in 2022 – FTX, Celsius Network, Voyager Digital, Three Arrows Capital, Genesis – involved custody-holding CeFi (centralized finance) companies that put customer funds at risk. That has galvanized supporters of DeFi (decentralized finance), who rightly note that the most robust decentralized market-making and exchange systems survived, precisely because they lack a trusted intermediary capable of such abuse. (Genesis is owned by Digital Currency Group, which is also CoinDesk's parent company.)
Yet as of October, Chainalysis estimated that DeFi investors had lost a record $3 billion year to date because of smart contract breaches, “rug pulls” by founders, and because the underlying tokenomics of some protocols were deeply flawed. (The destructive collapse in the Terra ecosystem was exemplary of the latter instance.) DeFi is a wild, volatile, confusing, unpredictable place. To achieve widespread participation, it needs a more comprehensive audit model in which trustworthy independent analysts or bounty-hunting developers assess projects’ code security, founder practices and tokenomics.
4. Back to basics: Crypto cannot be sustained on “number go up.”
In 2020 and 2021, when social media-driven meme coins were turning kids into instant millionaires, when DeFi projects were paying yields unavailable anywhere else in the world and when institutional and retail investment sent crypto’s market capitalization up 15-fold to almost reach $3 trillion, we should all have been asking tougher questions. The most important one should have been: what’s underpinning all this?
If we peel back the layers of interlocking protocols and the justifications for the returns they were promising, we’re left with little more than speculation for speculation’s sake. Most of that was built on momentum trading, on “numbers-go-up” expectations. It’s time to get back to basics and seek out real-world utility. Token returns need to point back to actual value cases, whether its cross-border payments, decentralized energy, new marketing models offered by non-fungible tokens (NFTs) or one of many other promising use cases.
5. Crypto needs an informed, independent, hard-hitting press.
Sure, this one’s self-interested, but 2022 proved it to be undeniably true that this industry needs a robust “Fourth Estate” to hold accountable the people and entities working within it. Permissionless blockchains should be viewed as public goods – much as the air we breathe, the water we drink or the highways we drive on are public goods. They must be protected as such, which means there must be transparency (balanced with a respect for individual privacy). And while we are all enormously proud of the catalytic role CoinDesk played in exposing the FTX house of cards, it raises the question of why this wasn’t caught earlier. Answer: There aren’t enough crypto-savvy, professionally managed, independence-protected journalists covering this market. (That’s why we got those naive softball articles from the New York Times and others that glossed over SBF’s fraudulent behavior and got my colleague David Morris fired up.)
Still, here’s a hill I will die on: The requisite transparency isn't something that can be achieved solely through the work of “citizen journalists” on Twitter or elsewhere. Those who claim the FTX debacle was brought to the fore by crowd-sourcing the sleuthing work of ordinary people on social media ignore the fact that the meltdown was triggered by an investigative article by Ian Allison, a trained journalist working within the structure of a professionally run newsroom, with editors and management who have carved out a position of independence from their proprietor to earn the trust of their readers. (CoinDesk is a subsidiary of DCG but operates independently and abides by a core code of ethics.) Before Ian’s piece, where was all that Twitter wisdom-of-the-crowd discovery?
If this industry is to thrive it can’t again be blindsided by revelations of wrongdoing as extreme as those uncovered in 2022. That requires vigilance to transparency and recognition that journalists who dig into issues at relevant institutions are doing a service to the longer-term interests of this industry rather than undermining it.