Crypto in Crisis: Can Order Emerge from the Chaos?

By Whit Knapp

The “crypto” world has been rocked by disaster after disaster in 2022. The trouble started in May with the collapse of the algorithm based “Stablecoin” Terra. That was followed by the collapse/bankruptcy of cryptocurrency exchanges and hedge funds, Three Arrows Capital (3AC), Celsius Network, and Voyager Digital, with a cumulative loss of approximately $20billion. Finally, the implosion and bankruptcy of the Sam Bankman-Fried (SBF) cryptocurrency exchange, FTX, and his trading vehicle, Alameda Research, has thrown the “crypto” world into chaos. The once highly respected SMB, who was backed by blue-chip investors such as Temasek, BlackRock, Sequoia Capital, the Ontario Teachers’ Pension Plan, Tiger Global and SoftBank has proved to be the emperor who was wearing no clothes. SMB created one of the most spectacular bankruptcies of all times based on “plain old fraud.” So called “smart money,” hedge funds, and family offices who could afford to lose money, were highly embarrassed. But it is JQ Public, mislead by the “smart money” investors, who threw money into FTX and now face total loss of their life savings. We will not go into the hacks, rug pulls, thefts and other significant monetary losses which doted the “crypto” landscape. Regrettably, we have not seen the end of the chaos.

Amidst the chaos, however, there are three positive notes to come out of this man-made disaster:

1.  A new vocabulary and dialog is emerging providing clarity and insight into the reality of this world.
2. The total absence of any base value of cryptocurrency has been exposed for all to see.
3. A dialog has started on how to create real value use cases for the digital asset world.

First, perhaps the most overdue benefit to come from the turmoil is the start of a turn to an accurate vocabulary used to describe the base line activity in this space. Virtually all press and other public writings on this ecosystem have to date, started out with “crypto.” This directed virtually all participants’ dialog to “cryptocurrency.” The foundation for this world is built on digitalization enabling Distributed Ledger Technology (DLT). To secure the movement of value digitally on the DLT, cryptography is essential. The correct use of “crypto” therefore should focus on “cryptography” not “cryptocurrency.”

It is encouraging to see Digital Assets starting to become the lead descriptor of the dialog around this world today. While bound to be controversial, Elizabeth Warren’s new Digital Asset Anti-Money Laundering Act leads with an accurate and useful definition of Digital Assets. In addition to its contribution to a more correct vocabulary for Digital Assts, the Act also provides a start of putting in place the critically needed guard rails for Digital Assets. Though discussion of the regulation of cryptocurrency overwhelms this space today, the real issue is how to set an appropriate legal and regulatory framework for Digital Assets in all their current and emerging forms.

In an additional sign of progress, DLT is beginning to replace blockchain as the “go to” word. This is a positive recognition that the blockchain is just one use of DLT. One of the most important fields for development in digital assets is how to move value securely between two parties without introducing the inefficient and costly intervention of a third party. This, of course, was the point of Satoshi Nakamoto’s 2008 white paper. Regrettably, his brilliant work was hijacked by the purported “smart money” and his blockchain- based bitcoin turned into a speculator’s casino coin outside legal and regulatory constraints – a Wall Street trader’s speculative paradise. The end results were inevitable from day one.

Second, the current turmoil has exposed the cryptocurrency world for its lack of any fundamental real world economic/asset value. The ability to create tokens/coins/currencies out of thin air, and then pump up their value via classic trading tactics was taken advantage of by the “smart money,” This sleight of hand was completely unseen by JQ Public who were blinded by the hype coming from the “smart money.” This hype was further pumped up by the glitterati of today social media dominated world. The confusion was heightened by the abstruse mechanics of cryptocurrencies. This opaqueness mixed with hype proved a toxic brew where little understanding of the basics of the ecosystem were ever discussed. It is more likely than not that of the 12,000 or so cryptocurrencies currently in existence, fewer than 100 will exist when the chaos finally ends. The digital asset providers will have to develop a means of valuing the remaining cryptocurrencies which anchor and facilitate the surviving blockchains which can form the rails for the movement of digital value. 

There are a significant number of extremely bright people working in this field. The work of the Bank for International Settlements (BIS) and the world’s leading Central Banks on the development of the Central Bank Distributed Currency (CBCD), the continued development of real, verifiable fiat based stablecoin’s, the work of the Regulated Liability Network (RLN), amongst other efforts, will ultimately produce new means and structures for moving digital assets in a secure, efficient, and cost-effective manner.

Third, the work cited above is essential to providing real world use cases for digital assets. There is no question that the current financial system needs updating/overhaul. Still running on procedures to enable the movement of funds by telex, which were developed after World War II, transaction banking needs modern rails to move value. The digital asset world can and will fulfill that promise which was launched ca. 1980 with of the start of internet providing the base for the digitalization of financial services.

It must be recognized that regrettably, the real-world application of DLT has been set back by the turmoil around the collapse of the cryptocurrency world. Financial institutions, corporates, and the investment world are understandably hesitant to look to the digital asset and DLT to provide enterprise-ready solutions. However, if a more reality-based dialog continues, we may be able to bring order out of chaos and create the new rails for transaction banking in the digital era. 

 
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