Billions Destroyed — Do Imploding Exchanges Mean the End of Crypto?
With over $20 billion in value destroyed over the span of 24hr, the implosion of crypto exchange FTX has left investors & observers reeling. This follows on the back of LUNA’s $60 billion implosion earlier this year and Celsius’ multi-billion dollar collapse. Retail and institutional investors been left with a huge number of legitimate questions and concerns. What went wrong? Is crypto finally dead? Is blockchain just a failed experiment?
Emphatically, no, this does not “kill the crypto.” This does, however, cause a substantial amount of short-term pain, and, by some accounts, extend the bear market by a decent margin.
There are a number of high-level misconceptions about the events that recently unfolded, how they change the greater crypto ecosystem, and what they mean for crypto going forward. I’m going to break down three of them in a way you can explain over Thanksgiving dinner.
“This is The End of Crypto”
Crypto exchanges are under fire right now because it’s come to light that they’re almost entirely unrestricted from placing leveraged bets using customer funds, away from the eyes of the public and regulators. They are the “custodians” of your funds (i.e. they hold your cash for you), but, unlike traditional financial custodians, they’re not subject to banking provisions or reporting standards. They’re able to hold your tokens in various commercial arrangements that may not be reflected on-chain, and, you, as an unsecured creditor,¹ bear the risks of those commercial arrangements on their behalf.
Major exchanges losing billions in customer deposits is extremely bad for public adoption and investor returns, full stop. But this short-term pain may be the last straw that sets up crypto for the “Great Priming,” in which increasing pressures around transparency, standardization, and regulation set the stage for commercial & retail adoption at a much more substantial scale. Recall that a similar set of excesses in the late 2000’s caused the Great Financial Crisis and launched a global re-evaluation of financial scaffolds and regulatory frameworks that ultimately paved the way to an arguably safer and more widely adopted system.
Responsible regulation invites innovation via increased capital availability. The web3 community at large recognizes and invites this, and the actions of bad actors do not represent the ethos of crypto or its builders. This is certainly not the end of crypto.
“Crypto Has Failed, & It’s Clearly Not Transparent or Trustless”
The implosion of centralized trading entities (i.e. exchanges) has little to nothing to do with the core software proposals that comprise blockchain & web3. In stark contrast, these recent implosions overwhelmingly involve (a) centralized entities (b) with custodial control over customer funds (c) performing secretive and highly risky leveraged bets using those customer funds.
None of those three things have anything to do with blockchain, or the original promises of web3 at large, which can be distilled into:
- Decentralization
- Self-sovereign ownership
- Transparency and trustless execution
In contrast, these centralized crypto intermediaries are just the same as ordinary web2 banks and financial institutions, but with a bit more meme spice and a whole lot less regulation. The implosion of these entities is therefore the result of centralized human greed and hubris, not due to some fault of the underlying software or philosophical underpinnings of crypto & web3.
If anything, these recent events underscore the need for driving even further towards those original promises of blockchain, and ensuring retail clients have access to the same level of decentralization, self-sovereign ownership, and transparent & trustless execution as the computer geeks and insiders do.
When you hold your cash or tokens in a self-custodial wallet (e.g. Metamask), banks can’t gamble that away irresponsibly — only you can, for better or worse. It’s a problem of user experience (UX), not a problem of the technology or its supporting philosophical tenets. The software itself remains as trustless and transparent as ever, but we need to build and rely on systems that lean into those characteristics if we expect to see the benefits.
“No One Will Build in Crypto Anymore”
In Q2 2022 alone, venture capitalists deployed $8bn across crypto startups. Nearly a year of investment at that pace has set the stage for a massive burst of creative & potentially high-quality products to hit the market over the next 12–24 months as those builders come online. And make no mistake — the target audience is not just crypto die-hards; these ventures will be targeting moms & pops sitting at home using legitimate consumer-facing products that solve actual consumer issues and demands.
Crypto UX is rapidly improving. From what used to require users to painfully code and script individual transactions to now relatively smooth browser extensions and mobile apps, the onboarding experience continues to make leaps and bounds of progress. This will not abate, and crypto will continue to become more ubiquitous.
Exchanges (i.e. those imploding today) were incidental gatekeepers to crypto because there was just no other on-ramp for fiat into the ecosystem. But that’s no longer the case. In the past 6 months we’ve seen multiple one-click on-ramps directly into Metamask or other self-custodial/decentralized solutions that set the stage for real retail utility outside of financial machinations and speculation.² You can swipe a credit card, and, boom, you’re now wandering the decentralized landscape of web3.
Self-sovereignty (i.e. the ability to physically hold your own capital and choose what to do with it) in a digital environment is a novel innovation and uniquely enabled by blockchain. We haven’t even begun to tap its potential, and builders are certainly still sprinting to make blockchain stick.
Net: Crypto Remains Early, Risky, and Full of Potential
Exchanges are (were?) the public face of crypto. But make no mistake — there is a serious bifurcation between the centralized intermediaries that are essentially banks guarding the entrance to decentralization, versus the real software and economy that exists completely independent of them.
Exchanges crashing hurts everyone across crypto. The crypto winter will be extended. But crypto’s core software offering has not changed, and, arguably, has grown philosophically stronger by highlighting the continued risks of not adhering to the original principles of self-sovereignty, trustless execution, and transparency that blockchain proponents originally proposed.
Back in 2001, Bezos commented that at Amazon’s stock low he was incredulously looking at internal metrics and KPIs all pointing straight up, and just mentally dismissed the pundits. We’re seeing the same in web3. Major institutions are adopting new presence in the space weekly. New brand deals are signed. User onboarding experience is improving. I see this year as the “Great Priming” of the space. Web3 is about building fundamentally more efficient fully digital enterprises, and the world will continue to become more digital. The need for products to support that eventuality will not diminish.
¹If you deposit your savings into a bank, you’re by default an unsecured creditor to that bank. Banks are regulated and have to have insurance on customer deposits up to some amount (in the US the FDIC mandates insuring up to $250,000 per customer). But crypto exchanges are not regulated as banks, or, at least, not yet.
² On the back end, many of those clean one-click fiat conversion functions do use exchanges. That does provide a very quick moment of counterparty risk, but it’s infinitesimal compared to the risk of depositing your funds inside of an exchange (as effectively an unsecured and uninsured creditor).
Sam is the CEO of Playground Labs, a web3 protocol dev organization, and Partner & Head of Interactive at Hivemind Capital, a crypto-focused multi-strategy fund. Follow him on Twitter.
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