MARKETS STREETWISE Crypto’s FTX Moment Shows Danger of Centralized Finance With No Central Bank After Binance agreed to takeover rival FTX, the danger is obvious: There’s no one big enough to rescue Binance Crypto Crashed, Coinbase’s Stock Followed: What Went Wrong YOU MAY ALSO LIKE Crypto Crashed, Coinbase’s Stock Followed: What Went WrongPlay video: Crypto Crashed, Coinbase’s Stock Followed: What Went Wrong Coinbase went public with a highly anticipated listing in 2021, but as the crypto market crashed, the company’s share price dropped by more than 80%. Now it’s working to diversify its revenue. WSJ’s Paul Vigna explains what went wrong. Illustration: Jacob Reynolds By James Mackintosh Updated Nov. 9, 2022 4:49 pm ET Having compressed most of the mistakes made by finance over the centuries into just over a decade, cryptocurrency speculators may finally be discovering the fundamental flaw of trying to build an alternative to government-backed finance: no government backing. This week the founder of the largest crypto exchange, Binance, provisionally agreed to rescue top-five rival FTX after it was abandoned by clients in the equivalent of a bank run. On Wednesday, Changpeng Zhao walked away, saying the problems were too big. FTX’s future now looks grim, with likely knock-on effects across crypto. Even if the deal had gone through, it would have left an obvious danger: There’s no one big enough to rescue Binance. Without the deal, a potentially systemic crisis in crypto will be left to play out by itself. Many, including my colleague Justin Baer, initially compared the deal to the 2008 rescue of Bear Stearns by JPMorgan. But even America’s biggest bank had to rely on help from the Federal Reserve, something impossible in the freewheeling government-free world of crypto. Without Fed support, JP Morgan, like Binance, would have walked away. NEWSLETTER SIGN-UP WSJ Crypto Smart and accessible crypto market analysis for investors. Subscribe A better comparison may be the 1907 Wall Street panic, when John Pierpont Morgan, JPMorgan founder, corralled New York’s bankers to provide enough money to restore confidence and end bank runs. Back then there was no Federal Reserve, and there was no one big enough to rescue JPMorgan had it run into trouble. Luckily it didn’t, partly because Mr. Morgan loomed larger than life over American finance. But there’s an obvious danger of relying on a single person, even Mr. Zhao, known as CZ. After all, until this week it was Sam Bankman-Fried, FTX founder, who was lauded as a modern-day J.P. Morgan for his rescues of smaller crypto crashes. Back in 1907 the need to rely on Mr. Morgan and his colleagues in what was labeled a “money trust” was the catalyst needed to start the process of setting up a central bank. The Fed was created by law six years later with a mandate to supervise banks and lend against good assets, among other things. It’s impossible to create a central bank of cryptoland, because the whole point of cryptocurrencies is that they are independent of the government. “If you go there, you’re on your own,” Stefan Ingves, governor of Sweden’s Riksbank, the world’s oldest central bank, told me on Wednesday, before Binance walked away. There was no Federal Reserve when John Pierpont Morgan managed to restore confidence and end bank runs during the 1907 Wall Street panic.PHOTO: BETTMANN ARCHIVE This leaves crypto with no backstop against banklike runs if there’s a loss of confidence in its exchanges, which are really a combination of banks and brokerages, many with little or no regulation. The exchanges themselves often make things worse by being secretive about the risks they are taking, while reusing customer assets to boost profits. CZ told employees on Wednesday that the confidence of crypto users was “severely shaken,” and Binance “must significantly increase our transparency, proof of reserve, insurance funds, etc.” But even if crypto exchanges were perfectly transparent, they would still be susceptible to runs so long as they don’t have the ready cash to repay in full customers who lose faith and pull their assets. The problem here isn’t crypto in itself. If everyone hewed to the suggestion made by the pseudonymous Satoshi Nakamoto in crypto’s 2008 founding document, all would be fine (if much less exciting). Nakamoto set out the case for a decentralized, trustless blockchain where everyone held their own account and transactions were verified by anyone who wanted to take part. The trouble with the bitcoin Nakamoto created is that transactions are slow, expensive and hard to scale up. Instead the crypto boom has largely led to customers trading and holding crypto on exchanges, avoiding the need to interact directly with the blockchains. The reliance on trust that Nakamoto was trying to avoid has been reintroduced—and one of the biggest lessons of financial history is that where there’s a need for trust, there are also dire consequences when trust breaks down. Mr. Bankman-Fried experienced that firsthand this week as his attempts to reassure clients were ignored. The fundamental flaw of centralized finance is that it needs central banks to end chaotic bank runs, and crypto has reinvented centralized finance. As a result, FTX and the broader crypto ecosystem now face serious uncertainty, and maybe disaster. FTX founder Sam Bankman-Fried was previously lauded for his rescues of crypto crashes.PHOTO: SARAH SILBIGER/BLOOMBERG NEWS Write to James Mackintosh at james.mackintosh@wsj.com
FTX demonstrated the idiocy of handing your assets over to someone else for safe keeping. The blockchains are just fine. The only people losing are the ones that transferred their crypto out of their wallet to the exchanges and then left them there. It also appears FTX was not insolvent. They just had a liquidity problem we are told. And that is Sam's fault. It looks like his liquidity problem hit the wall and then actually may have turned into a solvency problem.
He did. No different than what your bank does with your money. But he totally mismanaged the liquidity requirements. Enough so that I think we can call him a child who was way in over his head.
That's like saying someone is not dead. He just had his head decapitated. Any company who has liquidity issues, definitely can be considered insolvent. There are multiple ratios such as the quick-ration/acid test which are commonly used by even amateur investors as the liquidity is so very vital in business. It doesn't matter what your over-all assets are, if you run into liquidity problems. Many companies (some very highly profitable growth companies) find this out the hard way, and have to file for bankruptcy despite they had a high probability to be blue-chip.
I guess. It's like owning the family farm worth $10 million but being unable to make enough money to pay the taxes on it.