The FTX calamity explains why crypto is irrelevant

THE first remarkable thing about the collapse of FTX, a major cryptocurrency exchange, was its speed: In a little more than a week, it went from one of the largest, best-regarded exchanges to a bankrupt shell. It took even less time than that to wipe out the entire fortune of FTX founder Sam Bankman-fried; on Nov. 7 he was worth $16 billion, four days later, effectively nothing.

The second is how little effect this has had on markets beyond crypto, or even on the larger cryptocurrencies. Bitcoin and ethereum, the two most popular tokens, lost significant value during FTX’S death throes, but they’ve already regained a lot of lost ground. As for more conventional markets, there has as of yet been barely a ripple.

By crypto standards, FTX was a giant, one of the largest exchanges in the world by volume, and valued at $32 billion when it raised money last January. But relative to the financial system, FTX is tiny (the U.S. stock market alone is worth roughly $51 trillion). And more traditional financial institutions have been careful about taking hog-wild bets on crypto the way they did on dodgy mortgage bonds in the early 2000s.

Yet the relative insignificance of the crypto markets to the larger financial picture is exactly why this story is worth paying attention to. For all its prophecies of world-shaking change, crypto remains primarily the province of hobbyists, speculators and gurus. Bankman-fried looked like the guy best positioned to change that: He was pushing philanthropic projects, courting regulators, charming journalists and dumping a bunch of money into Democratic primaries. His high-profile meltdown means crypto is now back where it started, only more so, trying to figure out how to get the wider world interested in a market where major players get liquidated with startling regularity.

I don’t mean to say that crypto firms are constantly collapsing as their holdings get hacked, or maybe stolen by the founder, or turn out to be wildly overleveraged or inherently unstable, but … wow, there are a lot of stories like that! These failures occur so regularly, one begins to wonder if they are part of crypto’s appeal to a certain class of gamblers.

They certainly keep things exciting.

Heck, if all the market participants wanted was an exotic, techno-futurist way to wager on irrelevancies, I’d say we should let them. We allow dank casinos to strip retirees of their Social Security checks. Youngish nerds should have their fun, too.

But the retirees understand, however dimly, that the house has the advantage. Whereas many of the people buying crypto seem to sincerely believe that they are going to remake the financial system and get rich in the process.

It’s not crazy to believe that crypto can change the world. I myself can’t exactly see what it’s good for, but the same question could have been asked about the joint stock company in the 1720s, when England was trying to recollect itself after the South Sea Bubble. It seems at least plausible that crypto, as with the corporation, will eventually evolve into a key part of the financial system.

But as with public companies, a crucial part of that evolution will be making the product trustworthy. It took a lot of work to make the stock market boring enough to attract the wealth of more than half of all American households, a lot of institution building to control fraud and limit the fallout from speculation. If crypto wants to become a world-changing financial technology, it will need to take the same journey.

The problem is crypto tends to attract people who don’t want to trust the system — any system. That is the core idea behind bitcoin, the ur-cryptocurrency: no intermediaries who might be crooked, no government regulators, just a decentralized database and the remorseless, incorruptible logic of an algorithm.

This all sounds very exciting when crypto nerds talk about it. Decentralized finance! Permissionless innovation! But at present, too much of this freedom is being used to reinvent financial architectures that were de-permissioned for good reason — including the self-dealing clearinghouse, the undercapitalized market-maker and the Ponzi scheme.

Crypto must find some way to rein this in, or let government do it. Otherwise, the best-case scenario is that it will remain irrelevant to the larger economy, as ordinary folks stick with the old-fashioned money they understand and the institutions they feel they can trust.