What the FTX debacle means for crypto's attempt to become a legitimate asset class

Published Wed, Nov 9 20228:51 AM EST

It's easy to say that for stock and bond investors yesterday's crypto debacle was a sideshow that did not affect them, but judging by the action midday yesterday, that is not exactly the case. Many investors in stocks and bonds who are leery of cryptocurrency have nonetheless taken the advice of many advisors and put 1%-5% of their assets there, often in the form of ETFs that invest directly in crypto-related stocks (FDIG, BITS, DAPP) or bitcoin futures (BITO). To get a better handle on the read-through for stock investors, I spoke with Mark Palmer, Head of Digital Assets Research at BTIG. This conversation has been edited for space and clarity: Briefly, what happened? FTX, the world's largest crypto exchange, experienced what was effectively a bank run after someone leaked what was purportedly a snapshot of the balance sheet of Alameda Research, a crypto trading firm with which it is affiliated. The snapshot showed several loans collateralized by FTX's native token, FTT. This gave rise to speculation that Alameda had defaulted on some of these loans and was unable to return capital loaned to it by FTX, creating a liquidity crunch. In the face of that crunch, FTX reached out to Binance to sell itself and to thereby protect customer assets on its platform. What happens to other crypto platforms like Coinbase? There has been a scramble since Tuesday morning to see how much FTT is held by various platforms, since the value of the token has plunged and could fall further. Coinbase came out and said its exposure to FTT is minimal. While Coinbase shares initially plunged after the FTX news emerged, it could benefit from the episode if FTX.us [the company's U.S.-regulated arm] is weakened as a result. A key to Coinbase's story is the build-out of its institutional crypto platform, and FTX.us has been one of its biggest competitors. What about FTX? They have a relationship with major league sports, there is a stadium with their name on it (FTX Arena in Miami). Will all the goodwill and branding they created get crushed? It certainly seems so. All of that branding with Major League Baseball, Tom Brady, etc. was aimed at building its retail business, and that brand is now associated with a firm that needed a bailout. That creates an opportunity for centralized, regulated, retail-focused crypto platforms (like Coinbase). What does this mean for the crypto space? The FTX news, on top of the crypto winter, adds insult to injury. We believe the episode is likely to accelerate regulation of the crypto space in the U.S. and elsewhere. Without it, many retail investors will be leery of crypto and most institutions will do little more than dip a toe. But the crypto anarchist community want little or no regulation. Doesn't this blow a hole in that argument? While the crypto anarchists want nothing to do with the government or regulation, the FTX saga demonstrates why regulatory oversight and consumer protection exist. Crypto tends to lean libertarian, but if you are going to have wholesale adoption of crypto you are going to need more regulation. While crypto and decentralization are a religion for some, the reality is that institutional investors as a whole don't care about the ethos. For them, it's another asset class, not a religion, and they will only get involved in a big way if there are guardrails in place. What form does regulation take? The single biggest question is which tokens are securities and which are not. Bitcoin has already been determined to be a commodity and not a security, but other crypto tokens may be deemed to be securities. That determination needs to be made on a token-by-token basis, and until that happens we will see institutions view it as a dangerous space. The other question is how decentralized platforms will be treated. Coinbase is a centralized exchange that is subject to government regulation, so it is different. But there are many decentralized platforms, as well as centralized ones such as Binance, that offer no regulatory protection for consumers and there is no way for the government to monitor whether the company is doing things legally. What's the implication for the broader stock market? Investors who own crypto-related stocks like MicroStrategy, Marathon Digital or Riot Blockchain, or ETFs that hold them, are taking a hit. But to the extent that regulation is an issue, those bitcoin-related ETFs like ProShares Bitcoin Strategy ETF (BITO) may fare better over time, because bitcoin has been clearly affirmed by regulators as a non-security. So if a process occurs through which various tokens are sorted out as securities and non-securities by Congress or by regulators, then holders of bitcoin and of the vehicles whose value depends on the price of bitcoin would not have to deal with the uncertainty faced by the holders of other tokens.