Depending upon whom you ask, last week’s FTX blowup feels bigger than when Mt. Gox, the original Bitcoin exchange, fell to ruin in 2014. Bigger than The DAO hack of 2016, which forced Ethereum to fork into two chains as a way to recover user funds. Bigger, too, than the implosion of Terra, the crypto stablecoin operator that went bust this past spring and brought down firms like Voyager, Celsius, and 3AC in its wake.
FTX’s financial impact was smaller than some of the events. So why does it feel existential?
Maybe it’s because crypto is already in the midst of a brutal bear market, making yet another blow feel heavier than it would have at the market’s peak.
This article originally appeared in Valid Points, CoinDesk’s weekly newsletter breaking down Ethereum’s evolution and its impact on crypto markets. Subscribe to get it in your inbox every Wednesday.
Perhaps it’s because the key person behind the failure, FTX founder Sam Bankman-Fried, was until a week ago considered crypto’s white knight, trusted by sophisticated investors and institutions as one of the most responsible actors in the space.
But, in this writer’s opinion, the real reason why FTX was such a colossal failure is not because the crypto industry was duped, but because it proved that the industry was vulnerable to being duped.
This distinction, while seemingly minor, strikes at the core of what crypto is supposed to be – a foundation to build systems that are trustless. The FTX blowup and contagion are proving, yet again, that the crypto industry, if not its core technology, is currently as trust-based and corruptible as the traditional financial system that it sought to circumvent.
The ‘Crypto Industry’ isn’t ‘Crypto’
We need to do a better job of differentiating between Crypto and the Crypto Industry.
Capital-’C’ Crypto will not be killed by FTX. The core technology undergirding platforms like Ethereum and Bitcoin are still working as advertised. FTX and its sister company Alameda Research used blockchains and cryptocurrency, but they were old-fashioned companies killed by old-fashioned fraud.
As for the Crypto Industry, FTX will prove cataclysmic. We can talk all we want about the sanctity of “decentralized” and “trustless” technology, but so much of the attention and money that has poured into the space over the past several years has gone toward companies like FTX, BlockFi, Celsius and Voyager – unregulated, token-based extensions of traditional finance.
Sure, we always knew that these weren’t really Crypto companies, but investors, influencers and users let that distinction slide. We let these companies use their venture-backed liquidity reserves to pump up tokens and entice retail investors with promises of sky-high yields.
As these companies die, so too should the insane valuations, free-money schemes and money-printing accounting practices that have come to typify the Crypto Industry.
DeFi has shown promise…
Decentralized finance (DeFi) – tools built on blockchains that allow people to trade and transact without centralized intermediaries – are pitched as a direct antidote to frauds like the one that seems to have been perpetrated by FTX.
As fear continues to spread around the solvency of centralized platforms like Crypto.com, decentralized platforms like Aave and Uniswap claim to be structurally incapable of misappropriating user funds.
These platforms, which require users to trust code rather than central parties, have generally proven resilient amidst the FTX turmoil.
As my former CoinDesk colleague Andrew Thurman noted on Twitter, DeFi platforms have seen big boosts in activity over the past week as their centralized counterparts have been experiencing record withdraws:
…But DeFi isn’t a fix-all
DeFi is just a tool. While it carries certain intrinsic advantages relative to other tools (e.g. transparency), it can be used for good or for ill.
DeFi did not fall apart as a result of FTX, but this week reminded us that incumbent DeFi ecosystems are not immune to rot from the wider, oligarchical crypto ecosystem.
As CoinDesk reported earlier this week, Solana’s DeFi ecosystem, already struggling amid the market downturn of the past few months, was crushed by the failure of FTX.
This failure stemmed largely from the SBF-empire’s massive stake in the Solana ecosystem – not only in terms of its token holdings, but in terms of the role that FTX developers played in building out the projects at the core of the network’s DeFi ecosystem. For example, CoinDesk reported last week on Serum – a leading Solana DeFi platform that was built and maintained by FTX engineers.
Though FTX couldn’t easily steal Serum funds, governance rights on the platform were basically controlled by SBF’s own developers, and the “Serum DAO” that was supposed to govern the protocol was virtually toothless when it came to making changes.
Moreover, FTX and Alameda’s outsized stake in certain low-market-cap tokens granted it the theoretical ability to manipulate markets.
The FTX-Solana contagion is not the only recent example of DeFi’s corruptibility. Terra, which was ostensibly decentralized, has been accused of using venture money to rope in retail investors to fuel its $60 billion blowup.
Even more credibly decentralized platforms, like Uniswap, have faced scrutiny this week. The venture firm Andressen Horowitz and centralized exchange Binance have amassed a large amount of governance power within the leading decentralized exchange’s governance system.
Though you may not agree with his full take, Ben Thompson encapsulated one skeptical viewpoint on DeFi in this week’s edition of his stellar Stratechery newsletter:
“The FTX case is not, technically speaking, about cryptocurrency utility; it is a pretty straightforward case of fraud. Moreover, it was [...] a problem of centralization, as opposed to true DeFi. Such disclaimers do, though, have a whiff of ‘communism just hasn’t been done properly': I already made the case that centralization is an inevitability at scale, and in terms of utility, that’s the entire problem. An entire financial ecosystem with a void in terms of underlying assets may not be fraud in a legal sense, but it sure seems fraudulent in terms of intrinsic value.”
Hero worship needs to stop
Before his spectacular fall from grace last week, SBF was a kind of crypto golden boy. Dubbed the JP Morgan of Crypto, SBF recently began facing criticism in some corners of Crypto Twitter for his pro-regulation stances (which seem more cynical in retrospect), but in general, when he spoke, people listened.
Despite long-standing questions around Alameda’s relationship with FTX, savvy investors trusted SBF, poured billions into his custody and promoted his platform to retail investors.
The lionization of SBF in the mainstream press, crypto press and Crypto Twitter is undoubtedly a big reason why the FTX collapse was so painful. But now that SBF is public enemy number one, Twitter has been filled with a wave of self-righteous critics.
Among the most vocal SBF critics over the past week have been recent industry villains like Terra creator Do Kwon and Three Arrows Capital (3AC) founders Su Zhu and Kyle Davies. After months of relative quiet, the trio have used the negative attention on SBF to mount their own comebacks – hoping, apparently, that attacking the FTX founder along with everyone else will help them rebuild their own sullied reputations.
It’s doubtful that any of these folks will succeed. However, the re-emergence of these characters – along with waves of sycophantic tweets in support of Binance’s Changpeng Zhao and Tron’s Justin Sun – should reminded us of the toxic role that hero worship has played, and continues to play in the “trustless” world of cryptocurrency.