Two Worlds Colliding: The Fall of FTX and the Future of Crypto

The crypto community watched a media maelstrom closely as FTX Trading collapsed over a two-week period in November 2022 and filed for Chapter 11 bankruptcy protection. On December 13, the US Securities and Exchange Commission (SEC) charged Sam Bankman-Fried—the founder of FTX—with fraud for a scheme that defrauded investors for years¹. Allegedly, the FTX founder diverted FTX customer assets to a hedge fund for which he held majority control—Alameda Research (something he hid from FTX equity investors). Alameda Research was provided special treatment on the FTX platform (including allowing the company to hold a negative balance in its FTX customer account—untethering it from any collateral requirements), giving it a virtually unlimited line of credit that was funded by FTX customers.

The FTX frenzy had several downstream impacts. One crypto lender lost $800 million² in equity holdings through its exposure to FTX and filed for Chapter 11 bankruptcy in November. Another crypto lender paused withdrawals³ after FTX’s collapse, and other casualties were noted across the cryptocurrency industry. This domino effect highlighted the interconnectivity between crypto-lending platforms. There is no doubt that regulators, politicians, financial institutions, and consumers will attempt to bring lessons learned from FTX into the future. We are already seeing regulators such as the SEC warn investors⁴ to put little faith in crypto companies’ proof-of-reserves.

Despite the controversy, innovation in crypto products and services and global adoption are flourishing. Innovation in digital payments is allowing customers to easily open debit cards to pay for purchases using cryptocurrency and are allowing investors to easily trade crypto assets. US investor adoption is up year over year. The president of Fidelity Digital Assets remarked, “The increased adoption reflected in the data speaks to a strong first half of the year for the digital assets industry. While the markets have faced headwinds in recent months, we believe that digital assets fundamentals remain strong and that the institutionalization of the market over the past several years has positioned it to weather recent events.” In reality, the FTX collapse had little to do with crypto, and much to do with bad actors, and a lack of basic corporate governance and sound risk management.

In the eighth edition of the Two Worlds Colliding series, we explore regulatory activity, crypto adoption both domestically and globally, security concerns, and the potential future of digital finance.

Regulatory Activity Influenced by FTX

We are seeing US regulators and politicians attempt to apply lessons learned from the FTX collapse and prevent potential future consumer harm.

• In December, the Financial Stability Oversight Council hosted a session where several key regulators voiced concerns over cryptocurrency companies⁵—including the SEC’s Gary Gensler, who remarked that cryptocurrency companies are noncompliant with existing laws,  and the Consumer Financial Protection Bureau’s Rohit Chopra, who said existing laws for money transmitter licensing is inadequate to begin with. We are seeing regulators continue to push for stricter licensing requirements. 
• The U.S. House Democrats were split on whether Gensler has taken the right approach to considering digital assets⁶. In a post-FTX collapse world, the House is speculating on what the SEC could have done to stave off the massive fraud event without irony, as commentators had long criticized the SEC for overstepping its jurisdiction. This skepticism exemplifies the ongoing difficulty in reaching consensus for managing digital assets.
• In December, California’s Department of Financial Protection and Innovation released a sharp increase in alerts related to crypto scams⁷. The alerts aimed to warn consumers of potentially fraudulent websites and brokers. Victim losses reached $1.2 million.
• As of December, Binance.com is now a member of the executive committee of the Chamber of Digital Commerce⁸ (a US lobby group for the blockchain industry) and will support and influence potential regulatory requirements placed on crypto.

Attacks on Crypto Platforms Remain a Concern

Decentralized Finance (DeFi) hacks continue to grow in quantity and magnitude, with the 10 largest in 2022 resulting in over $2.5 billion stolen.

• In November, $477 million worth of crypto was stolen from FTX⁹. Sam Bankman-Fried said in an interview the hack was likely caused by malware installed on an ex-employee’s computer. On December 27, a Department of Justice criminal probe¹⁰ into the stolen assets was announced.
• In October, the BNB Chain was paused due to “irregular activity”¹¹ on the network, which later was revealed as an exploit that drained around $100 million from its cross-chain bridge, the BSC Token Hub. Initially, it was thought the attacker was able to take around $600 million due to a vulnerability that allowed the creation of roughly two million BNB, the chain’s native token. However, $400 million of the digital assets were frozen on the blockchain.
• In December, the blockchain infrastructure platform, Ankr, was manipulated by a hacker¹², causing an over circulation of HAY currency. This was accomplished by exploiting vulnerabilities in Ankr’s smart contract code to mint 20 trillion Ankr Reward Bearing Staked BNB contracts, which were used as collateral to borrow 16 million HAY.

M&A and Strategic Partnerships—Google Enters the Cryptocurrency World

Google took its first step into the cryptocurrency industry through a strategic partnership with Coinbase, while other big-name financial services companies expanded their existing presence in crypto.

Google selects Coinbase to take cloud payments—with cryptocurrencies and will use its custody tool—On October 11, 2022, Google and Coinbase announced a partnership¹³ where Google will start allowing a subset of customers to pay for cloud services with digital currencies in early 2023. In addition, Google said it would explore using Coinbase Prime (a service for storing and trading cryptocurrencies) and Coinbase will move some of its applications to Google’s cloud from Amazon Web Services.

Mastercard to bring crypto-trading capabilities to banks—On October 17, 2022, Mastercard expanded its partnership with Paxos Trust Company, a leading regulated blockchain infrastructure platform, to introduce Crypto SourceTM, a new program to enable financial institutions to bring secure crypto-trading capabilities and services to their customers. The partnership aims for Paxos to provide crypto-asset trading and custody services on behalf of the banks¹⁴, while Mastercard will leverage its technology to integrate those capabilities into banks’ interfaces, resulting in a seamless experience for the consumer.

Mastercard and BitOasis sign strategic partnership across MENA to launch crypto-linked cards—On October 25, 2022, BitOasis, the leading cryptocurrency platform for the Middle East & North Africa (MENA), and Mastercard partnered to launch a series of crypto-card programs in the region that will facilitate day-to-day usage of cryptocurrencies at points of sale and across ecommerce platforms¹⁵. BitOasis customers will be able to convert their cryptocurrency holdings to fiat currency, allowing the consumer to easily shop and pay at more than 90 million merchant locations globally. The first BitOasis cards are expected to launch in early 2023.

PayPal Working With Crypto Wallet MetaMask to Offer Easy Way to Buy Crypto—On December 14, 2022, PayPal announced that it will integrate its buy, sell, and hold crypto services with MetaMask Wallet¹⁶ as the companies look to broaden users' options to transfer digital assets from their platforms.

Emerging Products & Services—Cryptocurrency as an Everyday Payment Option

A continued innovation and inception of digital asset products and services aims to familiarize consumers with daily use cases of cryptocurrency.

Blockchain.com partners with Visa to offer crypto debit card—On October 26, 2022, crypto exchange Blockchain.com partnered with Visa¹⁷ to launch a crypto card, available only to US residents, which allows users to pay using their crypto or cash balance wherever Visa debit cards are accepted. Blockchain.com revealed that there would be no sign-up or annual fees, no transaction fees and, users would earn 1% of all purchases back in crypto.

Fintech company ZELF launches anonymous Visa debit card with crypto recharge—On December 8, 2022, American fintech company ZELF introduced an anonymous¹⁸ Visa debit card that can be used at any of Visa’s locations worldwide. ZELF’s latest initiative will allow users to open a USD checking account with only their name, email, and phone number, sparing them from having to provide documentation such as a Social Security number and proof of address. Holders of the Visa debit card will have the option of funding their accounts through traditional electronic payments, money and wire transfers, or crypto payments.

Binance.US finally rolls out mobile payments service to US customers—On December 14, 2022, Binance.US rolled out a feature called "Pay"¹⁹ that was launched by its global parent (Binance) to users outside the US in 2021. The service, which includes peer-to-peer payments and merchant transactions, allows mobile users of the Binance app to instantly transact with nearly 150 supported cryptocurrencies (without fees).

Hong Kong's New Bitcoin and Ethereum Futures ETFs Raise $79 Million in Trading Debut—On December 15, 2022, CSOP Asset Management listed Asia’s first Bitcoin and Ethereum future ETFs²⁰. The products offer the region a regulated environment for access to these contracts, as Hong Kong continues its plan to become a top Asian crypto hub by offering legalized retail trading and digital-asset ETFs.

The International Crypto-Outlook

Progress on Central Bank Digital Currencies (CBDCs) and digital currencies continues. However, speculatory eyes are placed on private crypto companies.  

• In December, the European Union’s financial markets regulator published guidelines for potential market participants of the decentralized ledger technology (DLT) Pilot Regime²¹ starting in March. The DLT Pilot Regime (overseen by the European Securities and Markets Authority) will give traditional financial institutions and new crypto firms an opportunity to test decentralized technology—a framework that removes the need for intermediary parties.
• The Reserve Bank of India’s governor, Shaktikanta Das, broadcasted²² his concern that private cryptocurrencies should be banned and that such cryptocurrencies “have no underlying value” and “have huge inherent risks for our macroeconomic and financial stability.” However, Das still condones the spread of CBDCs and the proposed digital rupee.
• In December, Brazil’s Chamber of Deputies approved a bill²³ to regulate providers of virtual assets after seven years of legislative consideration. The law includes criminal penalties for fraud schemes involving virtual assets, the creation of a virtual service provider license for digital asset companies and appoints the Securities and Exchange Commission of Brazil to supervise digital assets that are considered securities.
• The Central Bank of Ireland granted Coinbase approval to operate as a Virtual Asset Service Provider. The decision means Coinbase will be able to provide its service offerings internationally from Ireland, and Coinbase Ireland will now be subject to Ireland’s Criminal Justice Money Laundering and Terrorist Financing Act 2010.  Coinbase’s vice president of international and business development remarked, “Ireland has been a natural home for Coinbase in Europe, not least because of its talent pool and openness to industry, but also because of its EU membership and access.”
• The Basel Committee—a Swiss-based organization that sets international banking standards—released proposed guidance²⁴ for banks managing exposure to digital assets. The guidance retracts previously drafted rules for stablecoins and incorporates feedback from stakeholders and events such as the algorithmic stablecoin crash last spring.

US Adoption Has Not Stopped—Can’t Be Stopped?

Despite heated newscasting over the past quarter, decentralized exchange volumes²⁵ are up by almost 70% and surveys show a continued interest by the American population in crypto.

• 85% of investors “agree there is a need for open-source digital currencies as a diversifier in a portfolio or treasury account” according to a 2022 survey by The Economist²⁶. The same survey also identified lack of regulation as the most cited barrier to digital asset adoption among institutional investors and corporate treasuries.
• Volatile market conditions have not deterred institutional investing in digital assets. According to Fidelity’s Institutional Investor Digital Assets Study²⁷, 58% of surveyed institutional investors are invested in digital assets, a six-point increase year-over-year.
• Appeal of digital assets has continued to grow among institutional investors²⁸. In 2022, 88% of the US institutional investors surveyed found digital assets an appealing investment vehicle, up from 83% in 2021.

Deep Dive: A Numerical Look into Momentous Cryptocurrency Events of 2022

As the chart below shows, there were many momentous and notable events that took place in the crypto world in 2022, including the Ethereum merge and downfall of major companies such as FTX. The market responded²⁹ to these events—market cap of crypto dropped from roughly $2 trillion at the beginning of the year to less than $1 trillion by the end of the year.

However, the crypto community at large is also responding to an astounding amount of innovation and increase in crypto adoption. The number of smart contracts³⁰ deployed on the ETH networked surged from 1.4 million in Q1 2022 to 4.6 million in Q4 2022. An increase in the number of smart contracts deployed is a tell-tale sign that leveraging cryptocurrency, spreading global adoption, and continuing development of products and services remain a priority for private companies, investors, and consumers.

What Industry Luminaries Say

“In a year where bitcoin prices fell by 63%, a clear bear market precipitated by irrational exuberance and an overly hawkish Fed, it is encouraging to see investors on the whole still choosing to invest.”—James Butterfill, researcher at CoinShares.

“Concerns about the risks they pose to financial stability are therefore likely to come back to the fore sooner rather than later, as are public expectations that policymakers have in place a robust international framework to identify, monitor and address those risks.”—Klaas Knot, chair of the Financial Conduct Authority Board, says in a letter to the G20.