One should not let oneself be dazzled: rapid profits in the billions cannot be generated risk-free. If investors want to be sure that offers keep what they promise, there needs to be a certain level of regulation in the crypto world that treats the same things equally. This does not mean that financial innovations have no future.
A casual T-shirt and frizzy hair didn’t make Sam Bankman-Fried’s rapid billion-dollar profits more serious and less risky.
The name says it all. Sam Bankman-Fried was the hero of an industry that wanted to “fry” conventional bankers with their crypto services, i.e. make them superfluous. It is just one of the many ironies in the history of the impending bankruptcy of the crypto exchange FTX, that its founder Bankman-Fried instead created an opaque financial empire of dubious quality and creditworthiness, which does not keep the promise of the supporters of a decentralized crypto world: the abolition of the intermediary.
Many details are still unclear and the presumption of innocence applies. But the conclusion is obvious that short pants, a casual T-shirt and frizzy hair of a 30-year-old physicist don’t make quick billions in profits any more serious and less risky.
At the heart of the problem is obviously that crypto exchange FTX was not just an exchange, but a bank, or more specifically an unregulated and opaque financial intermediary. Not only could cryptocurrencies be traded on it, but it also offered its customers loans. It was probably active in maturity transformation by using customer deposits as collateral for loans. There were also digital (FTT) tokens whose value was linked to the performance of the FTX exchange and which were used as collateral: the bank financed itself with itself.
But digital tokens are like traditional money: their value depends on who and what is behind them. Behind FTX and the FTT tokens is an extremely opaque network of interconnected offshore companies controlled by Bankman Fried, which obscures the connections. A loss of confidence (triggered by an industry platform and fueled by a competitor) has now led to a classic bank run; FTX lacks the liquidity to pay out its clients. But because the celebrated billionaire probably made risky bets that didn’t work out, there should also be a solvency problem behind the liquidity problem. Investors face billions in losses.
In addition to the truism that they shouldn’t have been blinded, the case also shows that it is difficult for laypeople to see what lies behind supposedly innovative offers. This does not mean that blockchain, tokenization and decentralized finance have no future. There is much to be said for new, more efficient and therefore more cost-effective services. But their business models shouldn’t just be based on evading regulation.
Investors in the “shadow sector” of the crypto industry need to be aware that they are taking risks that are difficult to assess and may fall victim to scammers. If you want to avoid this, you should be able to choose offers that are regulated in a similar way to conventional finance and thus offer some guarantee that what is promised is behind it.
The regulators should treat the same thing in the crypto area as in conventional banking: an exchange like an exchange, a payment system like a payment system, transactions with deposits, loans and maturity transformation like a bank. In fact, this is also the approach that Switzerland has taken in relation to its thriving crypto industry. Regulated financial services need a reputable legal basis, solid risk management and they must be backed by sufficient equity capital and sufficient liquidity.
It would be wrong to demonize the crypto industry across the board. It is to be hoped, however, that the impending billion-dollar bankruptcy of FTX will act like a cleansing thunderstorm in the industry, leading to more transparency and demand for regulation. You don’t need to “fry” the bankers or the crypto nerds. But they should have to keep risks under control, be liable for their actions with sufficient equity and pursue solid business models. Crypto or not.