The dust is beginning to settle on the collapse of FTX Trading Ltd., and as it does, the scale of the crisis becomes increasingly evident. Blockchain vendors servicing enterprise clients have been stuffing analyst and investor inboxes with assurances around their companies' distance from the cryptocurrency exchange. Some of these emails suggest the impact will be negligible. Others even forecast a positive impact due to escalated calls for regulatory reform. The least realistic suggest the collapse is not a commentary on blockchain at all. It is this thread that we will pull upon, looking at not just what FTX reveals about the state of blockchain ecosystems, but also the likely impact FTX will have on the enterprise blockchain market.
It is tempting to position the FTX collapse as a positive for enterprise blockchain applications. A stimulant for further regulation, the collapse could also trigger a transition away from the unsustainable business models and low-value assets associated with blockchain. Established companies planning to integrate blockchain into their product offerings, or technology providers already competing with Web3-native vendors, may see their position strengthened as a once burgeoning startup market cools yet further. The reality is more complicated, however. Lower investor confidence in cryptocurrency may limit the value organizations see in establishing business-to-consumer "on chain" offerings. The vision of selling into public blockchain networks has driven much of the convergence of the enterprise and cryptocurrency blockchain ecosystems. Lower cryptocurrency values will also reduce the capital available to many innovative projects, slowing improvements to tooling as well as critical initiatives around interoperability, scalability and security.
FTX collapse a lens to scrutinize a volatile market
FTX Trading Limited was founded in 2017, incorporated in Antigua and Barbuda, and headquartered in the Bahamas. The founders were Sam Bankman-Fried, who became CEO of the company, and Gary Wang, chief technology officer. The privately held entity operated a major cryptocurrency derivatives exchange and trading platform, FTX.com, claiming over 1.2 million registered users in early 2021. In January, FTX raised $400 million in a series C funding round, valuing the cryptocurrency exchange at $32 billion. In March, the FTX token, FTT, had a capitalization of $14 billion. FTX was commonly cited as the second-largest cryptocurrency exchange after behemoth Binance Holdings Ltd., which dwarfs competing exchanges.
Concerns about the sustainability of FTX alongside its sister company, trading firm Alameda Research, were first raised by media outlet CoinDesk on Nov. 2. Fears generated by this article led to a run on FTX, which had lent over $10 billion of funds, including customer deposits, to Alameda; this made meeting the scale of withdrawal demands impossible. Bankman-Fried, with FTX facing a major "liquidity crunch," agreed to a nonbinding letter of intent to sell the business to Binance. This deal fell through, with Binance CEO Changpeng Zhao citing corporate due diligence concerns, alongside alleged U.S. agency investigations. The cryptocurrency exchange subsequently filed for Chapter 11 bankruptcy protection in the U.S., and reports suggest that it could owe money to more than a million creditors.
A familiar refrain emerging from the collapse surrounds the credibility of the cryptocurrency industry and the level of confidence investors have in the space. The market has already faced significant strain from major crypto projects derailing, such as the popular UST stablecoin, and easily spooked investors are prone to shifting portfolios at pace. The influence held by a small number of figures on social media, such as the CEO of Binance, also makes the market hard to predict. Another issue plunged in the spotlight is the lack of a robust regulatory framework for cryptocurrency trading.
FTX will have a sizeable direct impact
FTX had been viewed as a stabilizing force in the cryptocurrency space, having notably backed troubled cryptocurrency lender BlockFi Inc. in July with a $400 million credit facility backed by its own balance sheet. Part of this stabilizing veneer derived from the company's claim to be the "most regulated" exchange on the market. FTX — and FTX US Services Inc. — engaged in a high volume of acquisitions, including a number to obtain trading licenses for regulatory purposes. FTX.US acquired LedgerX, renamed to FTX US Derivatives LLC, in September 2021. Other acquisitions included FTX's acquisition in 2020 of Blockfolio Inc., a mobile cryptocurrency tracking and management application; and QUOINE Corp., a cryptocurrency exchange platform.
As FTX declared bankruptcy, 130 affiliated entities did the same. Imperiled companies with significant exposure to FTX include Genesis Trading, Galaxy Digital and Voyager Digital. Genesis Trading has lost access to $175 million held on the FTX platform, and frozen funds have a major contagion effect for customers or business partners. These frozen funds, alongside the bankruptcies themselves, are generating waves of collapse in a market too emergent to be resilient to shocks — and one that had not yet recovered from the collapse of the luna cryptocurrency network earlier this year.
FTX's collapse removes a prominent investment pool for blockchain startups. Alameda Research, FTX and FTX Ventures invested aggressively. FTX Ventures only launched in January, but had engaged in 47 funding rounds, including leading a $300 million series B round for Mysten Labs Inc. and co-leading a $135 million series A round for blockchain interoperability startup LayerZero Labs Ltd. As with Alameda Research, a major proportion of investments by volume was with early-stage vendors, and the entity supported startups across Web3 and blockchain sectors.
The tumbling in value of major cryptocurrencies after the crisis suggests that the run on FTX may extend a "crypto winter," which some analysts were suggesting was beginning to thaw. The token associated with major public blockchain network Solana ("sol"), an ecosystem that FTX and Bankman-Fried individually had made significant investments in, has performed particularly poorly. In addition to these direct impacts, however, the collapse of FTX may lead to longer-term transitions in how distributed ledger technology evolves.
A call for yet further decentralization
FTX's collapse is a further reflection on the shortcomings of the CeFi (centralized finance) framework for trading cryptocurrencies. As with DeFi (decentralized finance), CeFi services provide a platform for cryptocurrency financial services, but require customers to trust the technology providers as intermediaries. CeFi platforms provide a custodial wallet to users, which leads to some ambiguity as to who owns the cryptocurrency held on those platforms. Celsius Network, a CeFi cryptocurrency lending platform that filed for Chapter 11 bankruptcy in September, claims it owned all the cryptocurrency held on its platform. This position, thus far accepted by bankruptcy judges, means the recovery of customer funds is low on the priority list as assets are recovered.
While CeFi platforms are associated with better customer support and ease of use than DeFi alternatives, another collapse in a major provider will likely generate further skepticism in the model, which continues to underpin the major exchanges, such as Binance and Coinbase Global Inc. In an attempt to remedy the situation, many of the major exchanges have declared a commitment to publishing statements that illustrate the depths of their reserves on an ongoing basis. This is unlikely to entirely allay the concerns of investors or market commentators, with many calling for a transition away from CeFi platforms.
An attempt to further reduce reliance on intermediaries could place greater emphasis on ensuring trustlessness and decentralization, an interesting trend in a blockchain space that has claimed both aspects as differentiating characteristics since its emergence. It may pose a threat to vendors hoping to insert themselves as an intermediary between users and the blockchain — blockchain-as-a-service providers, for example — although this may be of less concern for prospective enterprise customers that will likely undertake greater due diligence than consumers in identifying partners.
A challenge to evolving commercial models
Blockchain ecosystems represent a hotbed of emerging business models. A notable tendency is for vendors to generate income from the appreciation of tokenized assets associated with their offerings, and this commercial model has kept many blockchain products and services free. The sustainability of such frameworks now appears to be under threat. Whether this causes blockchain tooling projects to transition to alternative financing models — employing freemium pricing strategies, for example, or becoming more reliant on subscriptions or enterprise clients — remains to be seen. Blockchain vendors that already have paying customers, or are actively targeting enterprise clients, are likely to be in a comparatively stronger position than vendors reliant on interest in their cryptocurrencies. For vendors with tokens that have a clear utility value — used to power applications or vote on the direction of a project, for example — this challenge may be less pronounced than for projects reliant on funding from users looking to speculate on asset valuations.
The collapse of FTX may further throttle the once flourishing space of nonfungible tokens and cryptocurrency projects centered on asset appreciation. Quick investors into such projects in early 2021 made significant returns, despite many of these tokenized assets having little utility beyond speculation. Even prior to the recent events surrounding FTX, many of these assets had collapsed in value, and some projects were having to reframe their value proposition to suggest greater utility. From membership-only communities to the representation of tokenized avatars in games or films, emerging NFT projects appeared to be reacting to an existential crisis — a crisis that is set to only escalate with a further reduction in investor confidence. Enterprise interest, and capital, may well transition to projects with a more concrete value proposition; be that asset tracking, decentralized identity or secure data exchange.
Hardening regulatory environment
Bankman-Fried was a prominent figure in regulatory discussions and was a major donor in the U.S. midterms. Revelations about his companies will now make him even more visible, albeit in a debate he may be significantly less welcome to contribute to. Statements made by senior figures within the U.S. House Financial Services Committee, the Bank of England and EU Financial Stability Board, among others, in the wake of the crisis suggest an upcoming regulatory response. A number of politicians in the U.S. have taken aim at regulatory ambiguity and risks surrounding digital assets.
The collapse happened at a critical juncture for cryptocurrency legislation. The EU is expecting to implement its Markets in Crypto Assets regulation by 2024. The Digital Commodities Consumer Protection Act bill in the U.S. is still in progress. It is hard to imagine that upcoming regulation will not place significantly more regulatory restrictions on the breadth of providers able to offer cryptocurrency services and increase levels of oversight. Stronger regulations may be seen as a boon by enterprise-focused blockchain vendors. By improving the quality of assets and services "on chain," the reputation of the technology may improve, and companies may be able to reduce the risk in engaging with public blockchain ecosystems. Concerns will surround the role that regulation could play in reducing financial inclusion — through "know your customer" rules, for example — or access to innovation. A hardening regulatory environment stimulated by FTX's collapse might improve the legitimacy of the space, but it could also close off novel use cases, reduce pools of prospective on-chain customers or condense the vendor space significantly.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.
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