Post-FTX Meltdown, Regulation-Abiding Companies Can Restore Trust

Only just a few weeks ago, it seemed like the crypto universe had found a new sense of calm and stability – leave it to Coindesk’s journalists to pop that illusory bubble in dramatic fashion.

We’re now around two weeks out from the report that took down FTX, strongly suggesting that its financial foundation was built on a shell game it played with sister-firm Alameda Research using its FTT Token. That news touched off a series of events that led to FTX’s bankruptcy at the end of last week.

This week, other companies are starting to fall, and it may take a long time for them to stop falling. As we have documented in recent years, Sam Bankman-Fried and FTX were among the most prolific investors in crypto companies on the planet. Beyond Bankman-Fried’s status as a “rescuer” of fallen crypto companies like Voyager Digital, he also was an active venture capital and private equity investor.

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Consolidation coming

Now, all of those investments are coming unwound. Just this week, after news that the FTX rescue of Voyager has been rendered void, Genesis has stopped withdrawals. After halting withdrawals last week, crypto lender BlockFi appears to be preparing for bankruptcy. These firms are just the tip of the iceberg.

Rather than a period of relative stability, the tide is now going even further out in the crypto universe, and a much smaller cohort of firms are going to emerge unscathed.

What’s worse, with a full bankruptcy impacting such a large, complex firm, the fallout will stretch over a very long period of time, said Daniel Shamah, co-head of the bankruptcy litigation group at international law firm O’Melveny.

“Bankruptcy court is a fishbowl,” said Shamah. “Every decision FTX made in recent weeks will be highly scrutinized by a litany of players – committees, potentially an examiner or a trustee, other investors – with a range of tools at their disposal. Expect this to be a long, expensive process that will take years to play out.”

The process is likely to uncover more weakness in the crypto space and perhaps more dominos ready to fall.

Watch: FTX Contagion: Who Are the Winners and Losers in the Ecosystem?

Mud on a trusted face

Even worse is the loss of trust in FTX and Bankman-Fried, who were seen by some as reliable and stable entities, if not out-and-out saviors of the crypto space. FTX and its founder were among the most recognizable and outspoken faces in the industry.

What advisors and clients need now from the digital assets space is a trusted partner, someone they can work with. Crypto exchanges will need to diversify their revenue streams to create more stability during crypto downturns, according to Suneet Muru, an analyst on the thematic intelligence team at GlobalData. This demand for more diversification puts pressure on young, technology-driven companies, many of which are still trying to define, develop and scale their businesses.

“FTX’s bankruptcy will be a classic example of ‘short-term pain, long-term gain’. It will deflate the crypto market cap over the next few months, but will force exchanges to realign their business models toward effective risk management. Now more than ever, exchanges must demonstrate how they differ from banks and keep far less of their own cryptocurrencies on their books.”

Warning signs were there

Not everyone trusted FTX. Digital Asset Research, a provider of institutional data, insights and research for the crypto space, never passed FTX as a “vetted” exchange and never placed it on its own list of trusted actors.

Some of the reasons FTX failed to pass DAR’s muster included opacity, weak KYC/AML controls and its unusual relationship with Alameda research.

LevelField Financial CEO and founder Gene Grant was also wary of FTX long before the CoinDesk report.

“The yellow caution lights were flashing for FTX for some time,” said Grant. “The world loved the story of a brash young man taking on the world, building an empire, and creating a firm from nothing. The problem is that financial services companies are not the same as other companies, and the qualities that make a great leader are those that are less flashy: trustfulness, safety and risk mitigation.”

Read more: These Crypto Market Makers Were Wary of FTX Before Collapse

While much of the world was enthralled by Bankman-Fried's ability to move billions to fund and bailout others in the digital assets space, Grant was concerned with FTX’s origin story, which had its roots in a quasi-illegal arbitrage crypto trade in South Korea, and that Alameda Research was purportedly named under false pretenses to secure bank accounts for the company.

Sam Bankman-Fried surely isn’t the only person in the crypto universe who has built a mostly positive reputation by playing it loose with regulators. While many in the financial services industry scoff at the stringent regulations placed upon them by state, federal and industry agencies, failure to follow those rules should be taken as a huge red flag in and of itself.

A company that plays it fast and loose with regulators may be willing to do the same with investor money.