To report is to trust: How to navigate the crypto winter

Reuters/Dante Carrer

On January 3 in Manhattan federal court Sam Bankman-Fried pleaded not guilty to the criminal charges that he cheated investors and looted billions of dollars from FTX, the infamous cryptocurrency exchange.

This will inevitably start a lengthy legal process to ascertain responsibility and the truth of what happened. But the damage has been done.

The market value of cryptocurrency has fallen from a peak in 2021 of $3 trillion to barely $800 billion today – just 40 per cent of Apple’s valuation. Shares in Coinbase, the only listed crypto exchange, are down over 85 per cent from their Initial Public Offering in April 2021.

The crypto winter is here and it doesn’t look like it’s thawing anytime soon. 

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In my previous column, I argued that FTX’s demise was the result of a straightforward liquidity crisis which unmasked a fraud – identical to the way Madoff’s Ponzi scheme was uncovered following the financial crisis in 2008 which caused an avalanche of investors seeking redemptions. So, what now for crypto? 

Any security or asset class requires trust to become investible. If you consider listed securities such as shares, trust is generated by compliance to listing rules that not only set the initial listing requirements (at IPO) but determine the ongoing performance update schedules.

These reporting windows are typically every three months. Knowing that you are only three months away from any update directly from the company ensures that performance is always updated, monitored by investors, suppliers, employees and others, and is available publicly. This is combined with regular independent audits to validate. 

This transparency drives trust.

Could crypto exchanges follow the same blueprint? Yes, but not yet. It requires the auditors to become experts on crypto and create appropriate audit rules. Such advisors may be attracted by fees, and as the value of crypto falls and exchanges close there is less incentive for auditors to invest in a crypto practice. 

One solution would be for exchanges to adopt blockchain for their internal transactions – that way they would have an internal audit log they can share with their auditors. So why hasn’t this happened so far? Simply, because of cost. 

Using a public blockchain to record internal transactions incurs gas fees, which are costs to record the transaction on the blockchain. These fees would be substantial and can be very volatile.

This is probably why it is impossible to unpick the transactions within the FTX group, as these were internal movements. Aside from the fact that its general record keeping seemed at best chaotic and at worst non-existent. 

Furthermore, FTX was the principal exchange for FTT, its proprietary token. FTT’s internal accounts were opaque, making any reliance on its value challenging.

There could be a hybrid approach – recording external crypto transactions on a public blockchain, while internal transactions could be recorded on a permissioned blockchain network (ie. a closed blockchain that is not publicly accessible or has an access control layer).

If blockchain’s raison d’etre is cryptos then are we at the end game. Fortunately, this is not the case. 

Blockchain technology could be transformative for the way we do business and trade throughout our ecosystem. Supply chain visibility is the killer application. 

Supply chains that have struggled with accurate information exchange can now have full transparency on the data flow, backed with an audit trail particularly for applications connected with ESG strategies.

Today, enterprises are opting for private permissioned blockchains which not only solve real pain points, but can also ensure that data is kept within a framework, for example all suppliers for a particular product. Surely the same technology could be used by a crypto exchange? 

Public blockchains have a future if they can find a “real world” use case. Decentralised finance and NFTs remain an exciting proposition, but as the market value has fallen (linked to crypto), it is more likely to spend 2023 looking in the rear view mirror to what could have been.

Central bank digital currencies (CBDCs) are also an exciting innovation and this year is likely to see more experimentation. However, CBDCs will run on independent blockchain ledgers run by the central bank. 

Blockchains are here to stay and are already adding value. Crypto enthusiasts may have to wait for a few more years to see if the spring brings a budding regulatory environment to power Crypto 2.0. 

Nish Kotecha is a serial tech entrepreneur and board professional. He is the chair and co-founder of Finboot