FTX is Not the End of Crypto

Editor’s Note: Welcome back to Jeff Brown’s prediction series. Over the next several days, Jeff will share his biggest predictions for the new year. Today, Jeff discusses digital assets, the future of blockchain technology, and the dramatic collapse of FTX. Read on…

Van Bryan (VB): Jeff, I’d like to talk about your predictions for digital assets and crypto markets next year. But I think we need to start with the dramatic collapse of FTX. When you look back, what do you make of that?

Jeff Brown (JB): I believe the entire ordeal will go down as one of the greatest financial frauds in history. But let’s take a step back and look at the wider market first. Because 2022 has been very difficult.

The trouble began in the spring. A project known as Terra Luna collapsed in May. The simplest way to explain what happened with Terra Luna was that it experienced a “bank run.”

The fall of Luna had ripple effects. By June, a multibillion-dollar fund called Three Arrows Capital became insolvent. The fund was highly leveraged and badly exposed to Luna, and other assets got caught up in the volatility.

The ripples from these blow-ups continued to spread into the second half of the year. Three Arrows had created its leveraged trades by borrowing capital from entities like BlockFi and Gemini, among others.

Fear began to spread that these companies would also fall. And it was at this time that a supposed savior appeared.

Sam Bankman-Fried (SBF) agreed to extend a $250 million line of credit to BlockFi. SBF also agreed to bail out Voyager, another company on the brink of collapse.

Some proclaimed SBF to be the “JPMorgan of cryptocurrencies.” And for a moment, it looked like stability had returned to the digital asset markets. But it wouldn’t last long.

As we all now know, FTX and its quantitative research arm, Alameda, was a house of cards. The level of mismanagement and corruption is hard to fathom. And it’s still unclear if another shoe will drop.

We’re not ending the year on a good note. That’s for sure. And what I hate about all this is that normal investors—even those that weren’t caught up in the FTX collapse—are being punished because the overall market has declined because of all this nonsense caused by bad actors.

VB: Some are saying that the fall of FTX will be the end of crypto as an asset class. I take it you don’t agree with that?

JB: I don’t. But you’re right that some in the media have been quick to predict this will be the end of the entire asset class. I saw an op-ed in The Wall Street Journal recently saying “crypto’s final price could be zero.”

That’s ridiculous. It’d be like saying that the Man Financial scandal or the Great Financial Crisis would lead to the end of equities. The fraudulent behavior of SBF and others is not an indictment of an entire industry.

The financial media and the naysayers are sensationalizing what happened and extrapolating the events to the broad digital asset industry. I get it, it’s one heck of an insane story.

But they’re missing one key point. 

Aside from the fraud, the digital asset market has been tightly correlated to equities this year. They’ve suffered hand in hand. Digital assets were lumped right in with any kind of growth equities. 

It has been a “risk off” market all year as institutional capital fled to safety. High quality digital assets suffered right alongside high-quality growth stocks.

And in many ways, SBF’s actions are entirely counter to the ethos of the blockchain industry.

Blockchain technology is designed to create a more open, transparent, and decentralized version of the internet. We know this as “Web 3.0” or just “Web3.”

FTX and Bankman-Fried never believed in that. I remember in an interview, SBF said he would switch to trading orange juice futures if it meant he could make more money. This is not a mission-driven person. And we’re learning more about just how cynical he really is.

SBF was something of a wunderkind for the mainstream press. He was on the cover of magazines and was being compared to Warren Buffett. And a lot of the admiration was because he believed in all the “right” causes.

FTX sponsored initiatives for “future pandemic preventions.” SBF was a proponent of “effective altruism,” i.e. making money just to give it away.

And he was the second largest doner to democrats in the recent election cycle. Interestingly, it turns out he also donated to republicans, but didn’t disclose that because he thought it would hurt his image with the press.

And why did he do all this?

He said it himself. It’s a “dumb game we woke westerners play where we say all the right shiboleths [sic] so everyone likes us.” And the media fell for it. Just like they did with Elizabeth Holmes of Theranos.

This type of person does not represent the blockchain industry. And he doesn’t speak for it either.

And the only reason this fraud went on for as long as it did was because FTX was centralized and it was able to cloak what it was really doing from the public. If all of FTX/Alameda’s transactions had been conducted on a blockchain, the industry would have seen it immediately.

If anything, the collapse of FTX shows us that the industry should renew its focus on the decentralized ethos upon which the industry was created.

VB: Aside from FTX, what else happened in the blockchain space that caught your eye this year? Good or bad.

JB: Let’s start with the bad, then we can talk about some of the good developments. Because market weakness aside, there were plenty of positive things that happened.

But one of the real disappointments in my eyes was the highly antagonistic stance of the SEC and the current administration. And what’s baffling is that the SEC went after some of the most buttoned up projects.

Late last year, Coinbase approached the SEC to discus a potential “lend” product that would let customers earn a yield on their deposits. The company was coming to the SEC to just discuss the project. And what did the SEC do? In essence, they told Coinbase to drop the project or prepare for a lawsuit.

And then there’s the ongoing battle between the SEC and Ripple Labs, the company behind the XRP token. Like Coinbase, Ripple is one of the most buttoned up companies in the industry.

And Ripple’s blockchain technology is one of the most widely employed in the industry for the purpose of cross border transactions with central banks, international banks, financial institutions, and other multi-national corporations. 

And what is the SEC doing at the same time that its levying battles against Coinbase and Ripple? The office of Chair Gensler is having secret meetings with SBF/FTX. It’s almost unbelievable. But when we understand how much money SBF donated to the “right people”, it’s pretty easy to get that he was buying favors.

What the industry needs—what it has been asking for—is clear, fair, and consistent regulatory guidelines. We’re not there yet. But my sincere hope is that this will start to materialize next year.

The FTX debacle is really a wakeup call. I’m hopeful that it will finally give the industry the regulatory clarity it has been asking for.

VB: You mentioned there were also positive developments. What else stood out to you?

JB: One of the bigger events was “The Merge.” This was the process by which the Ethereum network moved from a “proof of work (PoW)” to a “proof of stake (PoS)” model.

The technical details are less important, but at a high level, what it means is that the Ethereum network will no longer need expensive, energy-consuming “mining rigs” to validate transactions. The result is that energy consumption for the network will drop by more than 99%.

That’s important for a few reasons. First, it incentivizes holders of ETH to “stake” their assets. This effectively takes ETH out of circulating supply and—assuming an increase in demand—will lead to higher prices for the asset.

But another reason this is interesting is because it means Ethereum has “gone green.” And that means it will be a target for institutional investors that have to deploy capital into ESG (environmental, social, governance) investments.

The other thing that really stood out about this year was that, despite the horrible regulatory environment, despite the terrible economy, despite the inflation and market volatility, the industry powered on.

Private investment into blockchain companies and projects was extremely strong this year. Venture capital for blockchain companies came in at $28.3 billion this year. That’s down just slightly from around $32 billion last year.

In many ways, the industry was unfazed. Incredible progress was made in scaling blockchain technology, digital identity, decentralized compute, decentralized storage, smart contracts, and on and on. 

Strong projects still thrived in this environment and those that needed to raise additional capital had no problem doing so.

VB: What about the non-fungible token (NFT) market? That’s a big area of focus for you. What happened there?

JB: The broad NFT market also fell alongside the digital asset market. This isn’t surprising at all. The value of famous NFT’s have declined, assets linked to this technology have also declined, and overall, we’ve seen a slowdown – in terms of transaction value – in this segment of the market.

VB: Some have suggested NFTs were just a “fad” and that they won’t come back.

JB: Some are saying that, yes. But when I look at the NFT space, it really reminds me of Bitcoin in the early 2010s.

At the time, the industry—which was just getting off the ground— and investors were still trying to get their arms around what this asset was. There were a lot of competing ideas and skepticism of Bitcoin back then.

And of course, the price of bitcoin was wildly volatile. It peaked at a high of around $1,000 in late 2013 and then fell all the way to $200 by 2015. And as we might expect, there were plenty of critics saying, in essence, “Bitcoin is done.” Of course, it wasn’t. And it was around that time that I first recommended it.

NFTs are in a similar situation. It’s only been in the last two years that the industry has begun to think seriously about how to apply this technology.

At their core, NFTs are smart contracts. They are digital certificates of ownership. They show that a unique asset—whether it’s a piece of digital art, an item in a video game, a ticket to an event, or a real-world asset—belong to this specific person. 

NFTs are smart, secure, and transferrable versions of things that we use and need today; and capable of even more thanks to blockchain technology.

And I will make a prediction for NFTs…

I predict the next major use case for NFTs – the thing that will really reignite interest in the technology – will come from gaming.

Earlier this month, The Wall Street Journal published a story with the title: “Kids Don’t Want Cash Anymore.” The article outlined how young people no longer value real-world currency as much as generations before.

Instead, they want virtual currencies – in this case, virtual currency for the game Roblox or V-Bucks from the game Fortnite – to buy virtual items to use in their video games.

This may seem strange for older generations, but it’s part of a larger trend. Gaming is just as much a social activity today as it is a game. It’s how so many of us hang out with friends and have fun.

And for the younger crowds, physical possessions that sit on a shelf at home have far less value. Increasingly, people – especially young people – value virtual items as much or more as physical items.

To them, a virtual piece of clothing is as desirable as the real thing. What they look like online or in a game, of what they can do with their characters/avatars is often far more important than what they look like in real life (IRL).

VB: And if you were to make any high-level predictions for the digital asset market next year, what would you say?

JB:  We’re going to continue to see a tight correlation between growth equity and digital assets next year. We should expect that they’ll continue to be seen in the “risk on” category.

That means that the first two quarters of next year will be volatile. And we’ll have to wait to see what the Fed does next year before seeing a turning point in digital assets.

I continue to expect that in the March/April timeframe we’ll see the Fed pause on interest rate hikes. That will almost certainly be accompanied by some form of quantitative easing and/or stimulus. And in the second half of next year, I’m predicting that the Fed will begin the process of dropping rates again. All three of these steps will ultimately be positive for both growth equities and digital assets.

We should also expect further antagonism from the SEC next year, but I believe that it will be an improvement over this year. The FTX debacle will bring things to a head and force more open and transparent discussion between industry and regulators.

And I also have a major prediction about CBDC’s and the impact that will have on the regulatory environment, but I think you wanted to dig in on that topic in our next session.

VB: I did. Perhaps we can reserve that for tomorrow?

JB: Sure thing. For now, these things lead me to believe that the overall digital asset market will be higher by the end of next year. 

When we have a market like the one we are faced with today and growth assets are irrationally valued, the most important things to be tracking are investment levels and technological progress. If those two things are intact, there is always a strong recovery ahead.

And that’s the reality with blockchain technology. We’ve continued to see record levels of investment and record sized funds which continue to fuel technological advancement. This will all lead to the next leg up, and our next bull run in digital assets.

The only wildcard is if there is another high-profile collapse. I’m paying particular attention to Tether right now. That’s the largest stablecoin used in the industry. Tether’s backing for its stablecoin have always been a bit opaque. And that’s being generous.

But Tether’s dominant position has been eroding quickly to USDC – a stablecoin managed by Circle. Circle’s is the most transparent stablecoin available and backed entirely by U.S. dollars and equivalents like short-term U.S. Treasurys.

If the industry can gracefully migrate a larger portion of stablecoin assets from Tether into USDC, that would help to reduce any systemic risk associated with a run on Tether. That’s presuming it has allocated its reserves to volatile assets that have declined in value.

Hopefully Tether has strong risk management in place that would make this issue irrelevant, but the lack of transparency tells us that something may not be right, so I’d prefer for the industry to self-regulate and move away from Tether until it becomes more transparent.

We’ll see how the situation develops. Either way, readers should know we’ll be watching this market like a hawk.

VB: Thanks as always, Jeff.

JB: Anytime.

Editor’s Note: Tune in tomorrow for Jeff’s next prediction when we’ll discuss central bank digital currencies (CBDCs). Is 2023 the year we finally see a “digital dollar”? And what does that mean for financial privacy? Check back tomorrow for that and much more.