The exchanges also allow you to trade directly on the exchange, which makes them somewhat like brokers. Some even offer leverage. And, as we now know, FTX had what looks like an uncomfortably cosy relationship with its trading arm Alameda Research – a set-up with echoes of the old proprietary trading desks at big investment banks.
As DeFi grew and cryptocurrencies soared in value it attracted more speculators who were less concerned with philosophical underpinnings of the technology than they were in making money. The result has been less emphasis on the “De” and more on the “Fi” and system that grew to resemble that which it sought to disintermediate.
Now we appear to be seeing the whole edifice collapse under the weight of its own contradictions. So, if DeFi is beginning to look like traditional finance and smell like traditional finance, should it be regulated like traditional finance?
Yes, according to Sir Jon Cunliffe. In a speech on Monday, the deputy governor of the Bank of England argued that crypto exchanges should be more tightly regulated before they become a risk to the financial system. He specifically cited the fact that the likes of FTX bundle together services that traditional financial institutions must keep separate.
Michael Barr, the US Federal Reserve’s vice-chairman of supervision, and Gary Gensler, the head of the Securities and Exchange Commission, have made very similar noises on the other side of the Atlantic in recent days. The collapse of FTX is the kind of event that leads to demands for something to be done: increased regulation is something, ergo it should be done. Such compulsions would best be resisted. It pays to be mindful that thousands of retail investors have in some cases lost huge amounts of money. It’s possible there may need to be small tweaks to ensure consumers are better protected. However, FTX’s implosion serves as the best possible warning that these are not assets suitable for “widows and orphans”.
The key issue here is whether the ructions in the cryptosphere pose a systemic risk that threatens wider financial stability. Fingers crossed, but so far the signs are good. One of the world’s largest cryptocurrency exchanges has, to all intents and purposes, instantly vaporised. Some other crypto firms are suffering in the fallout. The value of most cryptocurrencies has taken a hit. But the contagion appears to be contained.
If, as seems possible, a fraud may have been perpetrated, the miscreants can be prosecuted under existing laws. What’s more, there’s a danger tighter regulation would confer legitimacy that, on the face of it, isn’t warranted. Far better to, in the words of business school professors Stephen Cecchetti and Kim Schoenholtz: “Just let crypto burn.”
Crypto evangelists have, in fairness, long been aware of what Vitalik Buterin, one of the co-founders of Ethereum, calls the “blockchain trilemma”. Cryptocurrencies aim to be decentralised, scalable and secure. The issue is that you can only have two of those attributes at once.
The situation with FTX isn’t directly analogous but the principle is instructive. Bankman-Fried appears to have focused on just one part of the triumvirate: scale. Both decentralisation and security were sadly lacking.
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