Crypto will survive FTX collapse but more scandals will follow | Kenneth Rogoff

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The epic collapse of prodigy Sam Bankman-Frieds’ $32 billion (27 billion) crypto empire, FTX, is set to become one of the greatest financial debacles of all time. With a storyline full of celebrities, politicians, sex and drugs, the future looks bright for producers of feature films and documentaries. But, to paraphrase Mark Twain, rumors of the death of crypto itself have been greatly exaggerated.

Certainly, the loss of confidence in exchanges such as FTX, essentially crypto financial intermediaries, almost surely means a sustained sharp decline in the prices of the underlying assets. The vast majority of bitcoin transactions are done off-chain on exchanges, not on the bitcoin blockchain itself. These financial intermediaries are much more convenient, require much less sophistication to operate, and don’t waste as much energy.

The emergence of exchanges has been a major factor fueling the growth of cryptocurrency prices and if regulators crack down on them, the price of the underlying tokens will plummet. As a result, bitcoin and ethereum prices fell.

But a single price adjustment is not the end of the world. The relevant question is whether crypto lobbyists will be able to contain the damage. Their money so far spoke volumes; Bankman-Fried reportedly gave $40 million to support Democrats in the United States, and his FTX colleague Ryan Salame reportedly gave $23 million to Republicans. Such largesse has surely helped persuade regulators around the world to take a wait-and-see approach to crypto regulation, rather than being seen as stifling innovation. Well, they waited, and with FTX crashing, hopefully they saw.

But what will they conclude? The most likely path is to improve regulation of centralized exchanges of companies that help individuals store and trade cryptocurrencies off-chain. The fact that a multi-billion dollar financial intermediary was not subject to normal record keeping requirements is astounding no matter what one thinks of the future of crypto.

Firms would face compliance costs, but effective regulation could restore confidence, benefiting firms keen to operate honestly, which surely are the majority, at least if one weights these exchanges by size. Greater confidence in the remaining exchanges could even drive crypto prices higher, though much of that depends on the extent to which regulatory requirements, particularly on individual identities, ultimately undermine demand. After all, the major transactions currently being made with crypto may be remittances from rich countries to developing economies and emerging markets, and capital flight the other way. In both cases, the willingness of the parties to avoid exchange controls and taxes implies a premium for anonymity.

On the other hand, Vitalik Buterin, the co-founder of the Ethereum blockchain and one of the most influential thinkers in the crypto industry, argued that the real lesson of the FTX collapse is that crypto must return to its decentralized roots. Centralized exchanges such as FTX make holding and trading cryptocurrencies much more convenient, but at the cost of opening the door to managerial corruption, as in any conventional financial business. Decentralization can mean greater vulnerability to attack, but so far the biggest cryptocurrencies, such as bitcoin and ethereum, have proven resilient.

The problem with having only decentralized exchanges is their inefficiency compared to, for example, Visa and Mastercard, or normal banking transactions in advanced economies. Centralized exchanges such as FTX have democratized the crypto field, allowing ordinary people without technical skills to invest and transact. It is certainly possible that ways to duplicate the speed and cost advantages of centralized exchanges will eventually be found. But that seems unlikely for the foreseeable future, making it hard to see why anyone not engaged in tax and regulatory evasion (let alone crime) would use crypto, a point I’ve long emphasized.

Perhaps regulators should push for a decentralized balance by requiring exchanges to know the identity of anyone they transact with, including on the blockchain. Although it may seem innocent, it would be rather difficult to trade on the anonymous blockchain on behalf of an exchange client.

It is true that there are alternatives involving on-chain analysis, in which transactions entering and leaving a bitcoin wallet (account) can be examined algorithmically, allowing the underlying identity to be revealed in some case. But if this approach were still sufficient and any semblance of anonymity could still be erased, it’s hard to see how crypto could compete with more efficient financial intermediation options.

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Finally, rather than simply banning crypto intermediaries, many countries may eventually try to ban all crypto transactions, as China and a handful of developing economies have already done. Illegal transactions in bitcoin, ethereum and most other cryptos would not stop everyone, but it would certainly limit the system. Just because China was among the first doesn’t mean the strategy is bad, especially if major deals are suspected to be tied to tax evasion and crime, like banknotes. high-value paper like the $100 bill.

Eventually, many other countries will likely follow China’s lead. But the most important player, the United States, with its weak and fragmented crypto regulation, is unlikely to embark on a bold strategy anytime soon. FTX is perhaps the biggest crypto scandal to date; Unfortunately, it is unlikely to be the last.

Kenneth Rogoff is a professor of economics and public policy at Harvard University. He was chief economist of the IMF from 2001 to 2003.

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