Crypto must get to grips with its high-risk culture

The allegations of major accounting corruption and fraud make this a story of recklessness above all else, in which greed and inexperience trumped rationality. 

Calls for the imposition of clear rules across the market have dominated subsequent debate, yet the scale of the crisis demands an analysis of the crypto industry that goes beyond the regulatory sphere. To truly understand the FTX fallout, the framework underpinning this cold ‘crypto winter’ and how the industry can rebuild, we must examine the very culture that lies at the heart of this spectacular meltdown. 

Risk, inexperience and naiveté 

The collapse of FTX is a symptom of the crisis at hand, not a cause of it. The market capitalisation of digital assets has tumbled by an estimated $1.1tn from its peak of more than $2tn in 2021. Since the Terra-Luna collapse, there have been more than 26,000 crypto job losses and countless inexperienced investors have been wiped out. This is not just a matter of rules and regulation.

We must analyse crypto through the lens of our existing financial ecosystem. While the reliable financial regulation that exists today has evolved over the course of hundreds of years, crypto has been around for just over a decade. In this very short space of time, it has expanded rapidly, with complete and knowing disregard for these rules. 

Although there have been price drops, the industry has not previously experienced a downturn of this magnitude. Companies launched. Jobs were created. Money kept flowing in: a fundamental requirement of all Ponzi schemes. Demand for talent only skyrocketed, along with salaries. 

The vast majority of those who buy or work in crypto have also never lived through such a serious contraction as professional adults. After all, 94% of crypto investors are Gen Z or millennials. A staggering one in five are between the ages of 18 and 24. These are people who have most likely never seen the value of their assets drop so suddenly, nor felt the impact of contagion risks across their investments so heavily. 

And perhaps most importantly, they had false exuberance and did not even understand the underlying risk management strategies when real problems arose. They had no idea what they were up against.

Stepping up 

However, youth-driven inexperience is not solely responsible for the collapse of the crypto markets. This failure comes just as much from the top down. 

Many knowledgeable investors, some involved in knowing manipulation, wore rose-tinted glasses when it came to all things crypto. Seasoned veterans should have recognised the red flags associated with such a volatile market, the evidence of fraud and the tell-tale warnings of a bubble and warned their juniors of the extraordinary risk of an asset class that has minimal safeguards. 

These are venture capitalists, hedge fund managers and crypto start-up creators whose vision of prosperity lacked any precaution. They owed it to the next generation to teach them the lessons they learned earlier in their careers, but many ended up also getting carried away by crypto-mania. 

It is this gulf – between a lack of caution and crypto’s high risk factor – that explains why so many investors did not question the stability of ‘algorithmic’ stablecoins, or the legitimacy of outrageous returns on deposits of as much as 20% that defied basic economic principles. 

Regulation will undoubtedly play a role in bridging this gulf. A healthy regulatory environment will never stop all financial losses, nor should it. But it can help avoid those related to fraud and manipulation and foster much-needed trust; something now in dangerously short supply. 

Catalyst for change? 

The industry must learn from its mistakes. Investors must no longer pour huge amounts of money into assets that deliver ostensibly dazzling returns, but are in reality valueless and only one gust of wind away from falling down. Regulation can help infrastructure and operating practices catch up with enthusiasm, informing investors of the risks they are taking on through greater safeguards and transparency, but it is not a panacea. Culture change must happen in tandem. 

Much like the dotcom bust of the late Nineties, this difficult period for crypto is likely to filter out firms and propositions that do not strike the right balance between value, safety and innovation. Blockchain and related technologies can be a tremendous force for good in bringing real efficiency benefits to financial market infrastructure and are already modernising legacy systems across a range of use cases. 

Crypto is a forward-thinking industry, but it must learn from the past and filter out bad actors. These tough times will guide the industry into its next phase, and to get there, crypto must adapt to a safer, more responsible path.

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