How the Crypto Collapse Impacts the Broader Economy

FTX and related crypto collapses come amidst a broader downturn in tech financial performance. Its impact thus accelerates and exacerbates the uncertainty in the global economy as institutional and individual investors face a reckoning from what many once thought risky but manageable bets on new technologies which has blown up both as the scale and the impact of money borrowed to make those investments becomes clearer. 

The economy can weather this storm, but the notion that permitting the growth of unregulated crypto markets is somehow a worthy diversification strategy has hopefully been laid to rest. JL

Erin Griffith reports in the New York Times:

Cryptocurrencies were part of overlapping investment manias including meme stocks, trading cards, NFTs and sneakers, all speculative investments. Not everyone understood the level of risk. Crypto is largely unregulated. Hacks can’t be reversed, misplaced funds can’t be retrieved, and a failing crypto exchange is not likely to get a government bailout. Investors have few protections. Crypto “death spirals” this year incinerated billions of dollars’ of investors’ money. FTX’s collapse arrives amid a broad pullback as tech stocks have crashed. Venture capital funding is drying up. 800 tech companies have laid off 120,000 workers. FTX’s bankruptcy filings list more than one million creditors.

How could a $32 billion company vaporize overnight? That’s what anyone watching the sudden collapse of FTX, a hot cryptocurrency start-up that plunged into bankruptcy last week, might be puzzling over.

It will take time — and multiple federal investigations — to fully understand what happened behind the scenes at FTX, a Bahamas-based crypto exchange. But the impact is already becoming clear. Lawmakers are calling for more oversight. Crypto die-hards are trying to distance themselves. Critics of this sector of finance are crowing. And for those of you who had, until now, managed to ignore the rise and rise and rise of crypto as a phenomenon? First of all, good for you. And second, you may want to watch this one play out. I’ll explain why shortly.

But first, here is the simplest explanation of what happened that I can manage: FTX let people and companies buy and sell digital currencies, holding billions of dollars’ worth of customer deposits. FTX’s founder, Sam Bankman-Fried, also created an investment fund that trades cryptocurrencies called Alameda Research. The businesses were supposed to be separate, but this year, Alameda needed cash and apparently dipped into FTX’s customer deposits. Then, this month, FTX customers became worried about their deposits and rushed to withdraw them, setting off a bank run and pushing FTX into bankruptcy.

The apparent commingling of funds between Alameda and FTX is highly suspicious and could lead to criminal fraud charges and lawsuits. The Securities and Exchange Commission and Justice Department are investigating. I want to explain today why the disintegration of FTX matters — it’s more than simply one man’s financial catastrophe.

Three reasons

1. Crypto went mainstream in the pandemic. Regulation has yet to catch up.

Cryptocurrencies were part of overlapping investment manias — including meme stocks, trading cards, NFTs and sneakers — that got people chasing speculative investments over the past few years. But not everyone buying in understood the level of risk involved.

If a bank fails, the government might step in and bail it out. A hallmark of crypto is that it is largely unregulated — buyer beware. Hacks can’t be reversed, misplaced funds can’t be retrieved by calling customer service, and a failing crypto exchange is not likely to get a government bailout. Investors have few protections.

Risky bets at several crypto projects once deemed valuable have already led to “death spirals” this year, incinerating billions of dollars’ worth of investors’ money. But FTX and Bankman-Fried stand out. He appeared on magazine covers, schmoozed regulators, grew his profile in philanthropy and politics and even sponsored a sports arena in Miami. He made hundreds of investments in smaller crypto projects and aggressively bailed out failing ones.

Evangelists for cryptocurrencies and their underlying technology promote them as investment vehicles that eliminate the need for faith in people and institutions. But Bankman-Fried made a point of fostering trust: from investors, journalists, politicians and charities. Now he’s a pariah, and he brought all of the crypto industry under scrutiny.

2. FTX’s collapse is connected to the broader tech industry retreat.

Bankman-Fried is already drawing comparisons to Bernie Madoff. And just as Madoff’s Ponzi scheme fell apart during the 2008 financial crisis, FTX’s collapse arrives amid a broader pullback for the tech industry. Tech stocks have crashed. Venture capital funding is drying up. Nearly 800 tech companies have laid off more than 120,000 workers this year, with cuts hitting Meta, Amazon and Twitter.

The tough times in tech can be traced to interest rates for borrowing money. For more than a decade, rates were low, pushing investors to chase risk and pour money into high-growth tech companies. Now, rates are rising, just as the pandemic-fueled growth of the last two years fades. The rate increases have hurt tech company valuations and access to capital — including those focused on crypto.

3. There’s more to come.

FTX’s bankruptcy filings list more than one million creditors. In addition to people who used the platform to store their cryptocurrency investments and investors who backed the company directly, numerous funds and crypto start-ups had assets locked up there.

Investment managers that dabbled in crypto “should really be considering whether they should have relatively new, relatively unproven, relatively unregulated assets in their retirement plans,” said Marcia Wagner, founder of the Wagner Law Group, a firm focused on employee benefits. “There are certain types of assets that frankly don’t belong.”