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10 Developments to Watch Following the Collapse of FTX (#124 - 21 November 2022)

The Future of Money with Henri Arslanian
10 Developments to Watch Following the Collapse of FTX (#124 - 21 November 2022)
By Henri Arslanian • Issue #113 • View online
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The FTX collapse has been nothing short of extraordinary. This event will have a serious impact on the future of crypto.
Whilst this development is still constantly evolving, here are 10 things to watch now: 
  • Regulatory and policy scrutiny (and potential enforcement)
We should expect increased regulatory and policy scrutiny. Regulators were already actively looking at the space and the FTX collapse will simply catalyze new regulatory efforts. 
We should also not be surprised to see regulatory and legal enforcement.
Whilst many have called this the Lehman Brothers moment of crypto, it’s probably more of a Bernie Madoff or Enron moment, especially as fraud seems to be involved.
Many in the crypto ecosystem are actually quite surprised that no arrests have been made so far. If the alleged “serious fraud and mismanagement” that the liquidators have mentioned turns out to be true, it may be only a matter of time.
  • Potential contagion to the crypto ecosystem
We should not be surprised to see contagion to the broader ecosystem.
Players like Genesis and BlockFi have already halted redemptions, and more could follow.
This could also impact FTX portfolio companies, with many being pressured to return capital not due to legal reasons but as part of a PR exercise due to growing public pressure as the investment they have received will be seen as FTX depositors funds.
  • The Chapter 11 process will take years
The Chapter 11 insolvency process (or whatever other type of insolvency proceeding) will take years so unfortunately, we will not see a short-term solution here.
Comments from FTX’s new CEO, Mr. John J. Ray II who oversaw the Enron liquidation process, paint a terrible image of the company. 
His quote says it all:
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here. From compromised systems integrity and faulty regulatory oversight abroad to the concentration of control in the hands of a very small group of inexperienced, unsophisticated, and potentially compromised individuals, this situation is unprecedented.”
But there are perhaps some silver linings that could come out of this mess.
  •  Governance, controls, and transparency will be key
The situation at FTX was so bad that this will force a complete overhaul of the industry, accelerating the efforts of many of the large crypto firms to get their independent SOC or IASE certifications or an audit from the Big 4.
Many in the crypto ecosystem have been experimenting with “proof-of-reserves” to try to provide some level of comfort. Although these are a good step in the right direction, there are some flaws, from the lack of industry accepted definition on what “proof-of-reserves” actually means to the fact that these are often a snapshot in time.
There are numerous best practices, especially when it comes to governance, controls, processes, and procedures that traditional finance has implemented in recent decades that are quite effective and could be equally helpful in crypto.
However, the big question is whether the Big 4 will want to onboard many of these firms now as we should expect the client acceptance and engagement acceptance to be way more stringent thus creating a barrier to entry for many new players.
  •  The role of VCs during due diligence will be questioned
Many believed that FTX had proper governance or internal controls due to the extensive due diligence that they expected large equity investors had done.
For example, Temasek stated that they had done extensive due diligence for eight months. And many of the large VC investors, from Sequoia to Softbank, used to talk about their experience and expertise in the sector.
But the fact that none of these gaps were raised as a red flag will bring into question the level of due diligence that such investors are expected to conduct and are actually conducting in practice.
This should create good business opportunities for consulting firms and due diligence specialized firms, as it is unlikely that any crypto deal will get approved in the upcoming months or even years at any investment committee without being sure that thorough due diligence was done.
And as very few investors have the in-house expertise (or such expertise is not trusted anymore), external specialized help will be sought by any investment committee before signing off on such a deal.
  • Self custody will be sexy again
Many in the crypto ecosystem moved away from self custody in recent years as they trusted the large centralized players like FTX or Celcius. Whilst many institutional players are not allowed to self custody, this should act as a catalyst for a broader segment of the crypto user population to start exploring self custody again.
Whilst in the past, many of the hardware wallets were not user friendly and required a descent amount of technical skills, the offerings have become more simplified and user friendly in recent years.
Not surprisingly, crypto hardware provider Ledger reported record number of sales in the days following the FTX debacle.
  • Counterparty risk will come on top of the agenda (again!)
Following the 2008 financial crisis, counterparty risk rose to the top of the agenda in the traditional finance world. Prime brokers and investment banks started being transparent about how their assets were custodied, their legal set-up and what would happen in the event of an insolvency. We should expect the same thing to take place here.
This will be positive for the industry long term. Whilst you can never eliminate risk, it will ensure that what happened this month with FTX does not easily happen again.
  • Experience and maturity will be respected again
SBF was famous for wearing his sneakers, shorts, and t-shirt everywhere, including on stage with former political leaders. 
This was seen as “cool” by the crypto community (and it seems to many investors as well). But moving forward, we should expect (and hope) that investors will appreciate and expect individuals with relevant experience and expertise for senior roles. 
Moving forward, any large crypto firm that has only “kids running the show” will be seen as a risk. Whilst the right balance will need to be found, we should hope that no investor will write a large equity ticket into a large crypto firm without ensuring that people with experience, maturity and expertise are in place in key roles with power to make decisions.
  • The flight to quality will continue
Whilst the turbulence in crypto markets will continue for some time, we should expect to see some of the players who have spent the time and money to build a best in class business to benefit.
Some of the players that were seen as boring before will become sexy again. This will take place across the crypto ecosystem, from exchanges to custodians.
  • The impact on web3 investments could be potentially short term
Whilst this will slow down the entry of institutional investors in the crypto space, the impact on web3 projects could be short-term, as these recent events showed the flaws of having large centralized players custody funds whilst highlighting the permissionless benefits of DeFi and decentralization.
Volumes on DeFi exchanges have already reportedly increased since the FTX collapse.
This showed some of the strengths of DeFi. Despite all the recent events, DeFi continued to operate as it should and this is positive for the web3 ecosystem.
Combined with some of the enhanced traceability tools that are available in the market now (that could reduce the risk of dealing with sanctioned entities for example) this could ironically be a boost to the ecosystem.
This could also encourage some institutional players to start experimenting with DeFi. For example, we recently saw banks like J.P. Morgan and DBS conduct government bond and FX transactions on DeFi as part of Project Guardian. The FTX events could ironically be a catalyst for more similar experiments.
The same logic applies for broader Web3 projects, from metaverse to gaming projects.
Nobody knows how the coming weeks will turn out for crypto. But one thing is sure: the crypto ecosystem will be very different moving forward.
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Henri Arslanian
*Please note that this newsletter reflects Henri’s personal views and not those of any organisation he is involved with. This newsletter is for educational purposes only and none of its content should be construed as investment or financial advice of any kind. 
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Henri Arslanian

Future of Finance and Money - PwC Global Crypto Leader, Best Selling Author, Keynote Speaker, University Professor, Host of Crypto Capsule™ - Views are my own

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