Strengthen protections against crypto risks
ON Monday, Bangko Sentral ng Pilipinas (BSP) Governor Felipe Medalla issued a warning to consumers about the dangers of investing in cryptocurrency, following the spectacular collapse of the world’s second-largest trading exchange FTX. While urging the public to be cautious is certainly appropriate, we believe even stronger measures are needed to prevent serious harm from investing in the volatile and controversial cryptocurrency sector.
FTX, which until last week was the world’s second largest cryptocurrency exchange, fell apart after it was revealed in a news report that a crypto hedge fund owned by FTX founder and one-time industry darling Sam Bankman-Fried held billions of dollars’ worth of FTT, the cryptocurrency exchange’s own digital coin, raising questions over FTX’s solvency. The news prompted Changpeng Zhao, CEO of Binance, which is the world’s largest exchange by volume, to order his company’s entire holding in FTT tokens to be liquidated; the effect of this digital bank run caused FTX’s entire worth — said to be about $15 billion — to instantly evaporate, leaving thousands of other customers with stranded and essentially worthless portfolios.
FTX has since filed for bankruptcy and dismissed BankmanFried and several other executives, who reportedly fled the US for the Bahamas and could be facing massive criminal fraud charges, as well as hundreds of millions of dollars in civil suits.
FTX’s collapse was not the first time the crypto world has been rocked by a large-scale failure and millions in financial losses due to mismanagement, fraud, or hacking, and the warning issued by the BSP’s Medalla on Monday was not the first time he has cautioned Filipinos. “I have already said many times in the past that crypto assets are very risky and those who invest are advised to invest only what they can afford to lose,” Medalla said. In the past, he has memorably said that cryptocurrencies were driven by the “greater fool theory,” meaning that such an investment only had value because of the likelihood that a “greater fool” than the first investor would come along to buy it at a higher price.
On the same day that Medalla made his statement, the Bank of International Settlements (BIS) in Switzerland, an institution considered the “central bank for central banks,” released a study that seemed to empirically confirm the “greater fool theory.” Analyzing seven years of crypto market data from 2015 to 2022, BIS economists discovered that at least three out of every four crypto investors lost money. Further, increases in prices of various cryptocurrencies, particularly Bitcoin, directly correlated to increases in the numbers of retail investors, and that every subsequent decrease in prices could be traced to sell-offs by large individual and institutional investors known as “whales.”
Any investment carries some level of risk of loss, but the risk associated with cryptocurrency investing, even without the occasional but still too-frequent scandals, are far greater than even the most extreme “normal” investments, such as foreign exchange speculation or trade in volatile commodities. Mere warnings about getting involved in cryptocurrency investing may not be enough.
The BSP and the banking industry might not find an absolute ban on cryptocurrency to be feasible or acceptable — although some countries have done just that — and we would not suggest that for the simple reason that it raises the risk of illicit trading activity. There may yet be some uses for cryptocurrency technology; the BSP and the financial sector are currently exploring these, and it is reasonable to allow that to continue.
However, it also seems reasonable to impose some greater controls over cryptocurrency speculation among retail investors, because it is the lack of regulation that seems to allow disasters like the recent FTX collapse to occur. For example, whether or not fraud was involved, FTX was simultaneously an issuer of cryptocurrency, a trading market, and a holder of customer deposits — conflicting functions that no bank or other institution would be allowed to carry out under one roof in any other circumstances. It was legal for FTX to do it, however, only because the necessary rules making it illegal do not yet exist. The BSP should carefully review the cryptocurrency business in this country, and take steps to close loopholes in regulation that could lead to ruin for investors.