Crypto Crash Update

Both the US Senate and House of Representatives have scheduled hearings for next month to investigate the spectacular failure of crypto conglomerate FTX Group. They’re interested in not only malfeasance on the part of the former management team, but also identifying systematic risk in the crypto ecosystem. This could be the beginning of a long-overdue effort to regulate cryptocurrencies. In the meantime, investor confidence has been profoundly shaken. Crypto-related securities continue to fall. Grayscale’s Bitcoin and Ethereum exchange-traded funds (ETFs) are now down 77% and 81%, respectively, on the year. Publicly-traded crypto stocks Coinbase (COIN) and Riot Blockchain (RIOT) are down more than 80%.

FTX’s new interim CEO says he can’t find the lion’s share of customer funds. He did confirm, however, that the company was misusing those funds and may have even deployed software to cover it up. But wait, there’s more. This is the guy who cleaned up Enron’s mess in the early 2000s and he is saying, “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information.” He also cited “concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals” as a contributing factor to FTX’s implosion. That FTX was a massive fraud is suddenly dawning on everyone. As a Bloomberg News columnist puts it, FTX looks to have been “a badly-run casino.”

Another Bloomberg opinion piece warns that FTX isn’t alone in its risky business practices. The saga highlights “everything that’s wrong with crypto markets.” For example, balance sheet assets are often “notional digital tokens” with “no associated cashflows or practical uses.” Building a company’s market capitalization on such a shaky foundation is dangerous, as is trying to use tokens as loan collateral. Next, the authors charge that most crypto intermediaries like FTX don’t publish audited financial statements and remain mostly unregulated. Thus, consumer protections are lacking.

Crypto believers like to point out that FTX’s meltdown is similar to what happened to some traditional (regulated) financial institutions back in the Housing Crisis. That’s true. Citigroup, for example, packed its balance sheet full of sup-prime mortgages, which, because they were originated on a lie, turned out to be worth a fraction of their notional value. I suppose these die-hards are implying that crypto didn’t cause this problem, human greed and stupidity did. But that misses the point. These tokens are neither assets nor investments. They are simply the lie. The Wall Street Journal says FTX’s former CEO admitted it last April in a podcast interview. He said, it is “completely reasonable” to believe that many crypto assets are “worth zero.”