A Crypto Meltdown

INVESTORS DON’T OWN A CRYSTAL BALL BUT they fall back on clues. Nothing could have been as bad a premonition—or close to a crystal ball—for crypto in­vestors as the crash early this month of the high-profile Bahamas-based cryptocurrency exchange FTX and its partner firm Alameda Research, which is headquartered in Hong Kong. While more details of the FTX-Alameda saga are yet to emerge, crypto companies, even in India, are contemplat­ing diversification in order to generate alternate revenue streams amid a drop in transactions.

The well-connected and highly networked duo—Sam Bankman-Fried (SBF), founder of FTX, and Caroline Ellison, for­mer CEO of Alameda Research, which was also founded by SBF—are under sharp attack for being grossly irresponsible with other people’s money and for indulging in alleged fraud using customer funds. More damning is the proof surfacing of the potential con­nivance of institutions and people in positions of power. Both companies have filed for bankruptcy through Chapter 11 of the US Bankruptcy Code which would allow them to reorganise their businesses instead of liquidating them. Alongside business news, social media and even mainstream media outlets are abuzz with titillating stories about the grandees at the core of the team at FTX and Alameda fostering polycule relationships, besides being ad­dicted to hard drugs.

People who have lost their money, including those who withdrew their investments from FTX at the last minute, aren’t enthused about these love triangles or quads or such reported polyamorous partnerships among those they—as well as institu­tions—blindly trusted. Neither are crypto firms that feel the heat in the wake of what has been referred to as a ‘crypto contagion’, a term, they aver, is being lapped up to discredit the whole system as being opaque and infested with crooks. They are piqued, how­ever, that Bankman-Fried’s parents and FTX senior staff bought property worth around $300 million in the Bahamas with what they assume is their money.

A closer look at the FTX fall perhaps gives enough indication to suggest that the fault is not exactly in the alternative form of payment created using blockchain technology but in the way the activities of the now fallen crypto exchange and the like were brushed under the carpet. As early as May this year, Terrence Duffy, CEO of American global markets company CME Group Inc, which runs the world’s largest financial derivatives exchange, had offered hair-raising testimonies to the House of Representatives Commit­tee on Agriculture that FTX had not set aside sufficient financial resources to back its “proposed direct clearing model for crypto derivatives”. Which meant the now-bankrupt crypto exchange had not made proper arrangements to ensure a timely transfer of funds to the seller and tokens to the buyer. He also went on to say at the May 12 hearing that what FTX was doing, unlike the whole concept of cryptocurrencies, was not “innovation”, but an “inva­sion of best practices and prudent risk management.” Interestingly, after Bankman-Fried’s fall from grace, Duffy told reporters that he wouldn’t stop crypto-futures trading just because of “one bad actor”.

If such early warnings, like these ones by Duffy and others, were hair-raising, to say the least, eyebrow-raising is the apt ex­pression to qualify the institutional response to them. The pres­sure, certainly, is on authorities tasked with overseeing the US derivative markets.

But then the collateral damage cannot be underestimated. Even so, crypto players across the world, including in India, express confidence in weathering the storm on the back of the learnings from the FTX saga.

For his part, Atul Khekade, co-founder of XinFin (XDC) Network, tells Open in an interview that crypto is an evolving industry, and one that will have some speed bumps on its path to broader utilisation. “It is an industry that has brought innova­tion and fundamental changes to the world of finance. Some of the world’s largest financial institutions and global industries have committed to crypto’s underlying blockchain technology to improve long-held and archaic processes,” he says.

As regards the FTX crash, he points out that as the dust settles, there’s a lot that can be taken away from the FTX situation. “It drives home that transparency, accountability, and security remain the most important elements in community engagement, despite any other variables,” he notes, emphasising that crypto is a space that accommodates a large ecosystem of communities, from traders to artists to developers. He hastens to make the distinction between a downturn and the technology behind it. “The FTX commu­nity has suffered a great loss, but the blockchain industry has developed out of restric­tive, vulnerable systems and throughout its existence, has proven to be antifragile. Out of the pain of the FTX saga, the industry will likely learn and emerge stronger, better equipped with principles and standards,” he affirms.

To be sure, India is one of the countries where the tremors of the FTX meltdown have been felt the hardest. That is not surprising since it ranks fourth in blockchain analysis platform Chainaly­sis’ global crypto adoption index this year of nations with the highest cryptocurrency adoption rate. The index was prepared comparing investments in crypto with the wealth of the average person and the value of money generally within a country.

Nischal Shetty, founder-CEO of Mumbai-based crypto ex­change WazirX, argues that bull and bear cycles are part of any financial market, and crypto is no different. “What is important is to gauge user and investor interest. That seems to be on a steady upward trend for crypto historically. This interest peaks during the bull market but even in the bear market, there is a steady up­tick,” he posits. He goes on to say that in every bear cycle, there are narratives around the demise of crypto that get pushed. “All these narratives disappear during the bull cycle. We’re seeing the same pattern repeating every few years,” Shetty says.

IN A BUDDING industry like cryptocurrency, entrepreneurs and participants should keep an eye on regulatory efforts that provide a clear framework for industry organisations to work lawfully while providing appropriate investor protections, says Khekade. “That will lead to the sustainable growth of users and healthy development of industry infrastructure. Legitimate or­ganisations will likely embrace such frameworks and seek to maintain compliance and appropriate levels of transparency,” he adds. Shetty, meanwhile, warns that regulators should not take the FTX crash as an opportunity to implement stringent laws that won’t benefit anyone. “Paying high taxes on gains could also keep genuine enthusiasts out of the ecosystem. Instead, they should work towards preventing such incidents in the future. Investor protection laws are the need of the hour,” he cautions. Shetty doesn’t pull any punches when he talks of the FTX collapse. “In­cidents like these deter the motivation of the community and make them question the fun­damentals of crypto,” he rues.

With a centralised crypto exchange like FTX crumbling, there are those who favour peer-to-peer crypto trade through the blockchain platform that eliminates middlemen, as originally envisaged by the founder of Bitcoin, the first cryptocurrency.

Khekade is not averse to such a migration from cen­tralised exchanges (CEX) to decentralised exchanges (DEX). “Decentralised ex­changes have seen major growth in the last few years. With decentralisation as one of the fundamental concepts of blockchain technology, it would be reasonable to see the continued growth of DEX. A de­centralised system that facilitates exchange can increase security, liquidity, and efficiency, while decreasing reliance on centralised parties, making it an attractive alternative to CEX,” he tells Open.

The problem at hand however refuses to go away, at least for the time being, thanks to problems at FTX. Shetty admits that without a doubt, this crash has led many investors to question the Web 3 movement, which will make use of blockchain-based tech­nologies, and wonder whether it continues to be a safe space with all the adversities around us. “However, like every black swan incident, this will also help us learn some fundamental lessons about what should be avoided going forward,” he adds.

He, however, expects centralised exchanges to be the most popular option for investors for holding crypto. “If investors plan to use crypto as a store of value, the principle should be the same as it is for a traditional store of value assets—diversification. Doing extensive research on tokens before investing in them and not putting large sums of money in one single asset are some of the fundamental principles. You can follow the same value alloca­tion principle as you would do for traditional assets,” Shetty says. He explains that due to the recent downturn, there has been an uptick in chatter among customers on the use of hardware wal­lets and other self-custody options. “For seasoned investors who know how to handle their private keys, this is definitely a good option. But self-custody is still to reach a stage where the maxi­mum number of users can use it. We need more products with simpler UX [user experience] for self-custody to go mainstream. Until then, centralised exchanges will continue to be the major custodians of digital assets,” he prophesies.

Louder, though, are forecasts of crypto dying a fast death.

Sapna Singh, crypto influencer with a huge social media fol­lowing in India, dismisses them as a figment of the imagination of people with certain interests. “We know the crypto market is not as big as the stock or the commodities markets. This means a big collapse of a large exchange will shake the entire industry to its roots. But it will definitely recover from this collapse because the Bitcoin fundamentals haven’t changed,” she asserts.

Bengaluru-based crypto enthusiast and former MNC banker Sreejith Sreedharan highlights the power of blockchain technol­ogy and its pre-eminence. He also states that what we know about FTX’s collapse till date is only the tip of the iceberg, yet singling out crypto for attack is a short-sighted move. “Pronouncing its death is far worse a diagnosis, especially when more than 90 per cent of all financial crimes happen on supremely regulated financial turfs,” he adds.

Sreedharan, who continues to invest in crypto and is gung-ho about the widely adopted Pi cryptocurrency, shares the view that the future of crypto is its use case or usability. He also bets big on decentralised exchanges and avenues where money is separated from state power that can confiscate money on a whim.

A senior executive at a global crypto company, who spoke on condition of anonymity, also agreed with Sreedharan that “what is happening in crypto is a result of a lack of use cases.” He regrets that the only thing several people these days do is speculate and make financial gains. He goes on: “So, you see sophisticated financial products. Some of them overextend themselves with leverage, and are caught flatfooted when the values drop.” The crypto space really needs use cases, he reaffirms. “Then we’ll be hearing about how it is improving people’s lives,” he declares.

But then this is the season of cautionary warnings about cryp­to, with the markets crashing once again six months after the col­lapse of the Luna currency operated by Terra Labs in May .

Mumbai-based Ritesh Bhatia of V4web Cybersecurity tells Open that lately his firm receives more complaints than in the past about financial crimes involving cryptocurrencies. “Now, I get as many as 3-4 complaints a week compared with once a month ear­lier. Most of the complaints are about pig-butchering scams with victims having lost all their money. In pig-butchering, a scammer builds trust with their victims before eventually persuading them to deposit more and more of their crypto assets into bogus digital wallets or websites controlled by the scammer.” From a security perspective, he says, investors should not put all eggs in one bas­ket and must have multiple crypto wallets. Pig-butchering, in the world of cryptos, is also called a confidence crime.

Confidence in crypto seems to have dipped amidst all the chaos and reported sleaze scandals involving FTX and Alameda hotshots, but with insiders terming such incidents, rightly, as business-as-usual in markets, it looks unlikely that their obit writers will have the last laugh anytime soon.

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