The fall of FTX has got us thinking a lot about the cryptocurrency industry. One of the most important issues we feel this event has highlighted is the need for regulation. In this article, we will go over some of our thoughts on the subject.
- The FTX collapse has highlighted the need for regulation.
- The boom-and-bust cycle of cryptocurrency companies mirrors the evolution of the commercial banking sector.
- It was humans, not the technology behind crypto, that failed.
- But, the lack of clarity surrounding how to comply with the existing legislation in the U.S. has disincentivized crypto firms from operating onshore.
- It’s important for regulators to provide that clarity, so that the industry can innovate in a safe and compliant manner.
Hubris, not technology, at fault for the FTX collapse
What happened at FTX should never have happened. Full stop. However, we think it’s important to stress that it was not the technology and promise behind cryptocurrencies that failed us. It was humans.
The reality is that high-risk business models, liquidity crunches, over-leverage, and cabalism—all prevalent in the FTX implosion—are traits of people, not blockchains. And this fact is seen in the rise and fall of countless start-ups, institutions, investment funds, and even entire industries due to human behaviour.
The 2008 Financial Crisis was caused by predatory lending to lower-income households and unsustainable levels of leverage taken on by large financial institutions coupled with a burst in the housing bubble.
The dot-com bubble was a result of investor euphoria pumping money into “get big fast” or “get large or get lost” business models that incurred net-operating losses.
The point here is that people are going to be people. But the technologies that underpin all of the largest cryptocurrencies continued to operate as designed despite the market conditions. So, while we absolutely believe in the future of crypto, we also see the importance of thoughtful regulation that protects consumers.
We’ve already seen how regulated crypto ETFs, like our own Purpose Crypto Funds, are excellent ways for investors to get exposure to digital assets without worrying about whether they will be rug-pulled or not. And it’s the level of oversight, transparency, and due diligence underpinning these products that need to be expanded to the industry as a whole.
Regulatory uncertainty can lead to undesirable consequences
Centralized exchanges present an interesting real-world case study. There has been a lot of uncertainty, especially in the U.S., around the classification of cryptocurrencies and digital assets and whether they are securities, commodities, or something else entirely.
Currently, there is a lack of clarity around what is required to comply with existing legislation. The risk of being deemed non-compliant with legislation has created a disincentive for crypto firms to set up their operations onshore. Instead, many have chosen to operate in jurisdictions where there is very little oversight.
Although not all firms operating off-shore are bad actors, some, including FTX in the Bahamas, engaged in high-risk practices, which would be illegal in many countries. It’s important for regulators to provide clarity, so that the industry can innovate in a safe and compliant manner. The launch of Purpose’s Bitcoin and Ether ETFs are excellent examples of regulators taking a forward-thinking approach in providing clarity and creating a framework to allow for a safe, regulated, and accessible way for consumers to gain exposure to crypto.
Still early days
We have to remember crypto is still in its infancy. And many of the centralized companies that have been built up around it are playing lead roles in a story that very closely mirrors that of the commercial banking system.
In 1933, there were over 4000 bank bankruptcies in the U.S. To combat this, the Federal Deposit Insurance Corporation was created in 1934 to insure people’s deposits in banks. That same year only four banks went out of business. This is a poignant example of the kind of results properly structured legislation and backstops can achieve. (1)
For the crypto industry to grow in a sustainable and less volatile way, regulators will need to take similar action.
The bottom line
What happened to FTX is not unique to crypto. However, the lack of regulatory clarity and oversight within the industry has made it very easy for companies to engage in unsustainable, high-risk business models that continually jeopardize the stability of the ecosystem. For crypto to have a robust future, lawmakers need to prioritize crafting regulations that protect consumers and promote sound business practices.
At Purpose, we continue to believe in the long-term prospects of cryptocurrency and digital assets. However, scenarios like FTX and the Terra Luna collapse have illustrated just how important it is for investors to have options to get safe and secure exposure to cryptocurrency.
We continue to believe that spot crypto ETFs, like the Purpose Bitcoin ETF, are optimal ways for retail and institutional investors to get access to the space. Before investing in a quickly developing asset class that can be both very risky and highly rewarding, do your research. To get regular updates and insights into cryptocurrency markets, consider signing up for our newsletter.
—Haan Palcu-Chang, Crypto Specialist
(1) “Crypto Needs an FDIC-Like Protocol to Prevent Liquidity Crises,” CoinDesk: https://www.coindesk.com/layer2/2022/11/15/crypto-needs-an-fdic-like-protocol-to-prevent-liquidity-crises/
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