Crypto Will Survive FTX Collapse – But More Scandals to Come | Kenneth Rogoff

The epic collapse of prodigy Sam Bankman-Fried’s $32bn (£27bn) crypto empire FTX is set to go down as one of the biggest financial failures of all time. The future looks bright for the producers of feature films and documentaries with storylines full of celebrities, politicians, sex and drugs. But, to paraphrase Mark Twain, rumors of the death of cryptocurrency itself have been greatly exaggerated.

It’s true that a loss of confidence in “exchanges” like FTX—essentially cryptocurrency intermediaries—will almost certainly mean a continued sharp decline in underlying asset prices. The vast majority of bitcoin transactions are done “off-chain” on exchanges rather than on the bitcoin blockchain itself. These financial intermediaries are much more convenient, require less complexity to use and consume almost no energy.

The emergence of exchanges was a major factor driving the rise in the price of cryptocurrencies, and if regulators crack down on them, the underlying tokens will fall in price. Accordingly, the prices of bitcoin and ethereum fell sharply.

But price regulation alone is not the end of the world. A relevant question is whether crypto lobbyists can sustain the damage. Until now, their money spoke volumes; It is reported that Bankman-Fried gave 40 million dollars to support the Democrats in the United States, and his FTX colleague Ryan Salame gave 23 million dollars to the Republicans. Such wealth has undoubtedly helped convince regulators around the world to take a wait-and-see approach to cryptocurrency regulation rather than being seen as stifling innovation. Well, they waited and we have to hope they see with the FTX crash.

But what will they conclude? The most likely way is to improve the regulation of centralized exchanges – firms that help individuals store and trade cryptocurrencies “off-chain”. The fact that a multi-billion dollar financial intermediary is not subject to normal accounting requirements is mind boggling, no matter what one thinks of the future of cryptocurrency.

Firms will face compliance costs, but effective regulation can restore confidence by benefiting firms that aim to act honestly, at least if one evaluates these trade-offs by their size, which is surely the majority. Greater trust in the rest of the exchanges could even lead to higher cryptocurrency prices, although much will depend on how much regulatory requirements, particularly the requirement for private identities, undermine demand. After all, the main transactions currently carried out with cryptocurrency can be remittances from rich countries to developing economies and emerging markets, and capital flows in the other direction. In both cases, the desire of the parties to avoid exchange controls and taxes involves a premium on anonymity.

On the other hand, Vitalik Buterin, co-founder of the ethereum blockchain and one of the most influential thinkers in the cryptocurrency industry, argued that the real lesson of the FTX collapse is that cryptocurrency should return to its decentralized roots. Centralized exchanges like FTX make it easier to hold and trade cryptocurrencies, but at the cost of opening the door to management corruption, just like in any traditional financial firm. Decentralization may mean more vulnerability to attack, but the biggest cryptocurrencies to date, such as bitcoin and ethereum, have proven to be resilient.

The problem with having only decentralized exchanges is their inefficiency compared to, say, Visa and Mastercard, or normal banking in developed economies. Centralized exchanges like FTX have democratized the crypto domain, allowing ordinary people without technical skills to invest and transact. Ways to replicate the speed and cost advantages of centralized exchanges will undoubtedly be found eventually. But that doesn’t seem likely in the near future, which makes it hard to see why anyone who isn’t involved in tax and regulatory evasion (not to mention crime) would use cryptocurrency.

Perhaps regulators should push toward a decentralized balance by requiring exchanges to know their identity. everyone who they transact with, including blockchain. While this may seem innocent, it will make it much more difficult to trade anonymously on the blockchain on behalf of exchange clients.

It is true that there are alternatives that involve “chain analysis” whereby transactions within and outside of a bitcoin wallet (account) can be algorithmically verified, which in some cases can reveal the underlying identity. But if this approach were always sufficient and all semblance of anonymity could always be removed, it is hard to see how cryptocurrency could compete with more efficient financial intermediation options.

Finally, instead of simply banning cryptocurrency intermediaries, many countries may eventually try to ban all cryptocurrency transactions, as China and several emerging economies have already done. Making bitcoin, ethereum, and other cryptocurrencies illegal won’t stop everyone, but it will certainly limit the system. The fact that China is among the first does not make the strategy wrong, especially if you suspect that the main transactions are related to tax evasion and crime, such as large-denomination paper money, such as the $100 bill.

Eventually, it is likely that many other countries will follow China’s lead. But the most important player, the United States, with weak and fragmented crypto regulation, is unlikely to adopt a bold strategy anytime soon. FTX may be the biggest scandal in crypto to date; unfortunately, it’s unlikely to be the latter.

Kenneth Rogoff is a professor of economics and public policy at Harvard University. He was the chief economist of the IMF in 2001-03.

© Project Syndicate

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