FTX implosion is a costly lesson for retail investors

With the global crypto industry in a state of total disarray, the collapse of crypto giant, FTX, points to the grim future of an industry premised on decentralisation, albeit with no underlying asset to safeguard its value

The implosion on November 10 of one of the largest crypto exchanges in the world, FTX, valued at $32 billion, has roiled the already troubled global crypto industry. For a transnational industry that was once going to rid the world of governmental and central bank evil, the meltdown was swift. It has taken just seven months — a time during which the United States (US) Federal Reserve raised borrowing rates by 3.75 percentage points to reach 4% — for the big talk around crypto to unravel. While this is bad news for private cryptocurrencies and their investors, the ground has been prepared by the blood on the street for a central bank digital currency (CBDC) that comes with the checks and balances of a regulated marketplace.

The immediate cause for the run on FTX was not just a liquidity crunch as suggested by the till-now-whiz-kid promoter Sam Bankman-fried but a deeper problem of reportedly using client funds kept with the exchange to shore up the balance sheets of a promoter-owned trading firm, Alameda Research. The trading firm used its assets to save other crypto firms from going under. Bankman-fried’s problems escalated when the lifeline thrown by erstwhile friend, and nowrival, Changpeng Zhao (called CZ), the founder of the world’s largest crypto exchange, China-based Binance, was snatched away. Binance tweeted that they would not close the deal as FTX reportedly mishandled customer funds. Ironically, Binance is in trouble with regulators in many countries. FTX filed for bankruptcy on November 11, and Bankman-fried stepped down as CEO.

While the big boys of crypto battle it out, the retail investors who bought into the “crypto as the asset of the future” sales pitch lie trampled. The collapse in the industry has seen the value of the bellwether cryptocurrency, Bitcoin, sink from a high of $64,400 a year ago to $16,880 on November 15, losing almost threefourths its value. There is worse in store for the industry that grew out of almost thin air in the past decade as global liquidity dries up and the appetite for risk dips.

Retail investors were lured by greed, seeing the supernormal returns that an expanding asset bubble usually gives. Remember that cryptocurrency is just a digital token used as a digital payment system. Its unique selling proposition was that it is not dependent on a bank, and transactions take place directly between people. Over the past few years, crypto enthusiasts looked at overthrowing the control of banks, regulators and governments by the full democratisation of currencies and their exchange. But they forgot that currencies derive value from an underlying asset or promise. When currencies were pegged to gold, the underlying asset was gold. After that, the underlying asset has been the promise of the government to honour the currency. It is the might of the US economy and military that stands behind the dollar. It is the might of the fifth largest economy in the world, India, that stands behind the rupee. There is no such strength underlying in a cryptocurrency. It can be seen akin to people exchanging coloured marbles or cricket cards in a closed group. There is a price because there is demand that seems to exceed supply. The day the demand collapses, the currency vanishes. We are at that point where closed-loop transactions will continue, but privately held tokens will not replace fiat. And in an ongoing ironic story for an industry that touted disaggregation and decentralisation as a unique selling proposition, it has been the aggregation and centralisation in some exchanges that put investor money at risk. The industry is now clamouring for regulation, from the same bunch they wanted to overthrow.

Another reason for the collapse of the market is the stain on some exchanges of money laundering. The transparency argument used in favour of crypto seems to be a bogey as exchanges the world over are being caught laundering drug, terror and human trafficking money, other than allowing sanctioned countries to route their money. Several Indian exchanges have been raided, and their assets frozen over the past year on these allegations.

While the market for private tokens will be restricted to closed loops of demand and supply, this giant asset bubble and the millions of investors who made and lost money have built the road on which CBDCS will roll. Cryptocurrencies are useful in markets such as the US that do not have a digital payment system akin to the Indian Unified Payments System (UPI). After launching the wholesale digital rupee, the Reserve Bank of India is in the process of launching the retail digital rupee. But for the Indian market with its state-of-the-art UPI and BHIM system in place, fiat crypto will be more useful in the clunky and expensive global money transfer space. A World Bank report pegs the cost of overseas transactions at a huge 6%. A potential common ground in various fiat CBDCS for transfer between countries will bring costs down and increase efficiency. Central banks are in the process of launching fiat cryptocurrencies but there is some distance between a global central bank handshake on an agreed-upon medium of global exchange currency.

What happens to the retail investors who bought into the “crypto as a money multiplier” dream peddled by exchange owners, celebrities and hordes of digital media influencers? It will be an expensive lesson learned that what looks too good to be true, is actually too good to be true.

Monika Halan is adjunct professor at NISM and author of the best-selling book, Let’s Talk Money

The views expressed are personal