Rebuild or Retreat? The Crypto Industry Faces Tough Choices in the Aftermath of FTX

Source: Financial Times

Compiled by: Mary Liu, BitpushNews

FTX co-founder and once-prominent figure in the crypto industry, Sam Bankman-Fried, was convicted of fraud and money laundering in New York just hours after a jury reached its verdict.

Alfred Lin, a partner at Sequoia Capital, stated, "After the collapse of FTX, we immediately conducted a broad review of our due diligence process and assessed our 18-month relationship with Sam Bankman-Fried." "We concluded that we were deliberately misled and deceived."

Crypto skeptics might argue that Lin is not the first to be taken in. Since the birth of Bitcoin in 2009, the industry has been associated with illegal activities (such as the now-defunct Silk Road marketplace) or business failures (like Mt. Gox in 2014), which at its peak handled nearly three-quarters of the circulating Bitcoin.

During SBF's heyday, he was seen as the most likely path to respectability for the industry. In addition to Sequoia Capital, FTX had mainstream backers such as Tiger Global, Singapore's state-owned Temasek, and the Ontario Teachers' Pension Plan.

In Washington, SBF testified before congressional committees in support of increased regulation and became a major political donor.

In the Bahamas, where FTX is headquartered, Prime Minister Philip Davis supported viewing the company as a major acquisition, as the Caribbean nation sought its next economic growth point.

Meanwhile, FTX secured celebrity endorsements and signed sponsorship agreements with Major League Baseball, the Miami Heat basketball team, and the International Cricket Council. It even filmed a Super Bowl ad with actor and producer Larry David.

However, on November 2, a 12-person jury in New York reached a unanimous verdict in under five hours, convicting SBF on seven counts.

U.S. Attorney for the Southern District of New York, Damian Williams, stated, "SBF committed one of the largest financial frauds in American history." "This fraud, this corruption has been going on for a long time, and we can no longer tolerate it."

As the former leader of the crypto industry considers the possibility of a lengthy prison sentence, the industry he supported may take one of two paths: either collectively restructure and attempt to gain acceptance in the mainstream financial world again, or revert to its long-standing image as a "niche market" for speculators, day traders, and those who firmly believe that currency should be separated from the state.

For John Reed Stark, former head of the SEC's Internet Enforcement Office, the trial verdict is "the death knell for cryptocurrency, Web 3, and blockchain."

"This industry has reached its end," he said. "If everything disappeared tomorrow, it wouldn't affect anyone on Earth except for speculators."

But others believe the industry can recover from the failures of SBF's trial and become part of mainstream finance.

Charles Storry, growth director at crypto futures index platform Phuture, stated, "The public image of cryptocurrency is at a historic low, but the industry is not over yet."

A Disgraceful History

For over a decade, SBF's disregard for traditional financial rules has drawn the ire of regulators worldwide, with accusations that cryptocurrency has been used to fund terrorism and nuclear proliferation, culminating in a career that ended with a fall from grace into prison. Meanwhile, the carbon footprint generated by the computing power required to "mine" cryptocurrencies like Bitcoin is roughly equivalent to the land area of Ukraine.

FTX filed for bankruptcy in 2022, ending a crisis of trust that saw popular digital assets like Bitcoin and Ethereum lose more than half their value. Other once-prominent companies, such as Terraform Labs and Three Arrows Capital, also collapsed.

In response, legislators and regulators across multiple jurisdictions ramped up regulatory scrutiny of the industry to unprecedented levels in 2023. U.S. regulators launched a series of enforcement actions and lawsuits against some of the largest remaining cryptocurrency companies. This includes publicly traded Coinbase, which faces a lawsuit from the SEC for allegedly violating securities laws, and Binance, a major competitor to FTX and the largest cryptocurrency exchange in the world.

The Commodity Futures Trading Commission (CFTC) sued Binance in March, accusing it of illegally soliciting U.S. customers and knowingly facilitating potential illegal activities.

Three months later, the SEC filed a lawsuit against Binance, accusing it of commingling customer cash with a separate trading firm owned by its CEO, Changpeng Zhao. Both Binance and Coinbase deny the allegations and state they will respond to their respective lawsuits.

Following the atrocities on October 7, Israeli law enforcement shut down over 100 Binance accounts and identified around 150 cryptocurrency donation schemes linked to Hamas, sparking new allegations of the industry's ties to terrorism financing and calls for renewed crackdowns.

Charley Cooper, former chief of staff at the CFTC, stated, "After the failures of Mt. Gox and the Silk Road controversy, negative news about this industry has steadily increased. Throughout its history, it seems to have more scandals than any other industry—despite its much larger market share."

Cooper added, "Most doctors do not defraud the healthcare system, and most lawyers do not violate court ethics. You can say Wall Street guys are greedy, but they are not breaking the law."

Vanderbilt Law School professor Yesha Yadav described Bankman-Fried's conviction as "a landmark moment for the broader cryptocurrency industry." "The jury's decisive conclusion indeed highlights how far and deep a key figure in the industry has fallen… it's hard to imagine a greater blow to its reputation."

Industry professionals are concerned that their career prospects may suffer as a result. One professional who contacted the Financial Times expressed, "I'm a bit worried about how traditional industry recruitment fairs will view my association with cryptocurrency."

He suffered losses at both FTX and another cryptocurrency company, Voyager, which collapsed last year. He added, "This experience has made me more conservative."

Crypto Transparency

After FTX filed for bankruptcy in November last year, industry leaders called for a renewed focus on transparency.

Changpeng Zhao stated, "All cryptocurrency exchanges should provide proof of reserves and commit to being 'fully transparent' in their operations." Days later, rival exchange OKX announced it would launch the first proof of reserves "to set a new standard for transparency, risk management, and user protection."

However, according to industry data provider CCData, only about one-third of cryptocurrency exchanges currently provide proof of reserves or alternatives, such as regularly audited financial statements.

Exchanges that offer some form of financial transparency to customers account for about 81% of the market, but this is down from 86% in March, roughly equivalent to the level at the time of FTX's bankruptcy in November 2022.

CCData research analyst Jacob Joseph stated that this indicates "user discernment regarding proof of reserves may have become less acute compared to the initial months following FTX's collapse."

James Newman, co-head of perfORM Due Diligence Services Limited, noted that the largest and most influential exchanges "have taken steps to improve the transparency of their held assets."

"However, many are slow to adopt proof of reserves," he added, suggesting this "may be a sign that retail funds held by exchanges continue to dominate, and these exchanges do not speak with one voice."

Retail traders—individuals trading for themselves—have played a significant role in the industry's growth. But many believe it now needs to broaden its appeal. "The survival of cryptocurrency relies on external support and trust from other industries," Storry said. "Retail has joined, but we now need institutional support to elevate the industry to a new level."

There are signs that this is happening. This summer, payment giant PayPal became the first major financial institution to launch a cryptocurrency token pegged to the U.S. dollar. Since 2020, the company has offered trading in the world's most popular cryptocurrencies, but the launch of the so-called stablecoin (a type of crypto asset whose price tracks that of a more recognized asset, typically a fiat currency) has provided a boost to the beleaguered crypto industry.

Greater hopes for institutional support rest on BlackRock, the world's largest asset management company, which has applied to the SEC to launch a spot Bitcoin ETF, allowing investors to speculate on Bitcoin through regulated financial instruments operated by well-known brands.

Last month, as speculation grew that BlackRock's application might be approved, Bitcoin's price surged to $35,000, erasing all losses since the onset of the crypto market crisis in May 2022.

Ilan Solot, co-head of digital asset brokerage Marex, stated, "There are signs of entry into this industry if you know where to look: we're talking about BlackRock launching a Bitcoin ETF, PayPal launching a dollar-pegged stablecoin."

But it is not a certainty. The SEC, led by Chair Gary Gensler, has so far refused to approve any such applications and may never open the door for BlackRock or any other candidates to bring Bitcoin to the mass market.

Legislators have also become more cautious. Last month, Senator Cynthia Lummis and Representative French Hill urged the Justice Department to consider criminal charges against Binance and the largest stablecoin issuer, Tether.

Following Hamas's attack on Israel, over 100 lawmakers from both major U.S. parties signed a letter urging the Biden administration to outline measures being taken to reduce the use of cryptocurrency for terrorism financing.

A cryptocurrency industry lobbyist in Washington stated, "It will become more difficult to pass legislation in the U.S., and Congress's attitude will be more lukewarm." Whether Coinbase and Binance will be willing—or even able—to lobby regulators and politicians like FTX remains to be seen by 2024.

Returning to First Principles

Former SEC commissioner Reed Stark remarked, "All these cryptocurrency people are now desperately in need of a Bitcoin ETF, but the reason they started Bitcoin projects is that they were uneasy about the 2008 banking crisis. They were uneasy about the government being able to monitor their financial transactions."

He added, "So what do they do? They cling to the thigh of the world's largest financial services company, because there is nothing left, which is the ultimate hypocrisy and humility."

However, while many in the industry pin their hopes on a mainstream future, another faction is more eager for cryptocurrency to return to its roots.

Erik Voorhees, founder of cryptocurrency platform ShapeShift and a libertarian, issued a rallying cry last month to those still loyal to the original crypto mission.

He said, "Why should we accept a world where we can only trade freely if strangers approve it conditionally? This is certainly not freedom. This is submission, this is serfdom, and in most cases, the chains are lightly pressed down, but that should not let us forget the existence of the chains."

Voorhees and others do not dive into the increasingly hostile group of regulators and legislators but instead push for the industry to return to first principles: permissionless finance, which is a clear rejection of the establishment, government oversight, and unelected regulators.

Writer, investor, and former Coinbase CTO Balaji Srinivasan launched the Network State conference in Amsterdam last month, aimed at "building parallel institutions."

Speakers including Vitalik Buterin and Anatoly Yakovenko (thought leaders behind Ethereum and Solana crypto blockchains, respectively) and the Winklevoss twins (founders of the Gemini cryptocurrency exchange) attended the conference.

Srinivasan stated, "This is a conference for all those building parallel institutions. This is not just about parallel currencies. This is parallel media, parallel education, parallel science, parallel construction, and even parallel cities."

In the aftermath of the SBF scandal, the decision to retreat from a failed battle with legislators and regulators may be tempting, but it could undermine an already lukewarm market.

According to data shared by CCData, at the beginning of 2023, it took over 1,400 BTC (then about $23 million) to push the token price up by more than 1%.

But by the end of April, only 462 BTC—worth about $13 million at the time—was needed to achieve the same market movement. This marked the lowest point for Bitcoin and the global largest stablecoin Tether's market depth since the industry fell into chaos in May 2022.

Today's data shows improvement, with retail momentum warming up and new funds flowing in; it now takes 752 BTC (worth about $26 million) to pull Bitcoin's price.

But that is far from enough. Solot from Marex stated, "In my view, the negative sentiment from SBF's conviction has long been priced into the market. But suppose this proves to be a watershed moment for slowing or even failing crypto adoption, then the risk is that only internal funds are trading in the market, and it is basically predictable that it will continue to shrink… there will be no new funds, no growth."