What’s next for cryptocurrencies?

Key points to remember

• Trust in exchanges has legitimately disappeared as customers have withdrawn thousands of Bitcoins in the last month
• Proof of reserves does nothing in its current format to trade confidence
• Regulators must intervene because the industry has lost control of itself

November. Not good in cryptocurrency markets.

But as we turn the page on December, what does the future look like?

Business confidence is at an all-time low

First. The collapse of FTX has shown the world how opaque these centralized companies are. The reality is that it is almost impossible for the average customer to know what goes on behind the scenes.

Sam Bankman-Fried (SBF) has been on the cover of Forbes magazine, has spoken before the U.S. Congress, and was President Joe Biden’s second largest donor to his 2020 campaign. If SBF can go down, who is safe?

Customers responded by withdrawing their Bitcoins from the exchanges. Below, I have plotted the net flows of Bitcoins to and from the exchanges since the FTX implosion. The pattern is quite obvious.

I had already analyzed this reaction in detail the week following the implosion.

Will the reserves test save the day?

The answer, led primarily by Binance CEO Changpeng Zhao – he of another acronym, CZ – was to instill proof of reserves in blockchain. For, ironically, blockchain was supposed to be perfectly placed to solve all this.

I sent a tweet to CZ as the debacle began to unfold. To me, besides being painfully ironic, it’s frustrating and sad.

Wouldn’t all the talk of insolvency be solved if FTX had some sort of proof of reserves in the chain?

It seems ironic that in the cryptocurrency industry we are all talking about whether FTX are good or not. Isn’t it intended to be transparent in crypto?

– Dan Ashmore (@DanniiAshmore). November 7, 2022

But the reserve tests now implemented by several exchanges are redundant. They involve the publication of a portfolio address containing funds. Fine. But what good is a reserves test without a liabilities test?

There are also many more questions that are certainly not answered by typing an arbitrary address online. How do we know that the stock market has access to these funds? As Jesse Powell, CEO of Kraken who is about to step down, has said, “auditing proof of reserves requires cryptographic proof of client balances and portfolio control.”

Cryptocurrencies need to grow. This twisted version of an “audit” does not.

CZ said it was working with several people, including Ethereum founder Vitalik Buterin, to address some of these concerns with a more robust Merkle tree reserve system. Let’s hope it comes sooner rather than later.

Cryptocurrencies need regulation

It used to be a blasphemous opinion. Then it became polarized. Now it’s hard to argue against it. Cryptocurrencies need regulation.

I’m sick of seeing people get screwed. Hearing the letter from the investor who lost $2 million in the FTX debacle on the New York Times clown show during an interview with Bankman-Fried was just one incident. There are thousands of other stories like this of people crushed, and it’s heartbreaking.

Regulators are far from the only reason all this has happened, but like it or not, it is incumbent upon them to help give a semblance of reality to what has become a complete Wild West of fraud, scams, and violent risk management. Cryptocurrency has clearly demonstrated that it does not work in its current state.

Let’s start by defining what security is and filtering cryptocurrencies within that framework, rather than leaving everyone in the dark. The loan products that have struggled so much – I recently wrote about their fate here – like BlockFi (now bankrupt), Celsius, Voyager Digital and so many others, were the most important parts of this nebulous legal framework.

Then we can move on to policing the world of cryptocurrencies, once we have defined what it really is. Because it is no longer a niche game played by Internet geeks. One exchange disappeared with $8 billion in customer funds. Which, you know, followed a string of other bankruptcies that also went bust with billions in customer funds earlier this year.

I’ve seen this movie too many times at this point. The reserves test is a step in the right direction, but the way it has been implemented so far is totally unnecessary. Regulators: it’s time to do what you need to do.