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Korok Ray is an associate professor at the Mays Business School Texas A&M University and Founder of the Mays Innovation Research Center. He teaches The Bitcoin Protocol at Texas A&M and advises the Texas A&M Bitcoin Club.
If indeed all the reports are true — that the cryptocurrency exchange FTX lent out billions of dollars in customer deposits for risky bets without their consent — then the world should celebrate its swift demise. Markets are ruthless in rewarding success and punishing failure. And FTX’s fall from grace over just a few short days shows the market’s remarkable ability to deliver economic justice. This is by far the most effective means of raising awareness among investors and customers, and of ensuring long-term viability of the cryptocurrency economy, far more than any government regulation could ever achieve.
Many have called the FTX bankruptcy “our Lehman moment.” But there is a key distinction. No government was involved in deciding whether to bail out FTX. This by itself should be a cause for celebration. Had the collapse occurred more slowly, and government regulators had more time to debate among themselves how best to intervene, we could have found ourselves in a repeat of the horrible mess of 2008, where government officials decided on their whim which banks to let live and which to let fail. I know because I was there, serving as the financial economist on the Council of Economic Advisers in the Bush White House from 2007-2008. And despite my repeated exhortations not to bail out the banks, the bailout mentality ossified into standard practice.
This has not happened yet in the cryptocurrency economy, and we must ensure that it never does. Any talk of bailouts should be flatly discarded, as such forms of government assistance create what economists call moral hazard: They induce the very risky behavior that the regulation seeks to avoid. In the long term, the only true form of economic justice will come from the free market, where customers can choose between multiple vendors and vote with their feet. The only real way that customers can learn these harsh lessons is through trial by fire, by observing situations like the FTX collapse and exercising more discretion in the future to whom they trust their financial assets. I feel empathy for those unwitting customers who lost their life savings in what is likely a massive fraud architected by Samuel Bankman-Fried and his cronies. There is no joy in witnessing the financial pain of innocents. However, we must take a longer view, and understand that this is a necessary process for the market to self-regulate.
The FTX collapse should provide a bevy of lessons for all. First, retail investors will be more careful in blindly relying on centralized exchanges. Existing exchanges have already come forth to clarify their own lending practices. Many have made public pronouncements on whether they are full reserve exchanges, which do not touch deposits without customer consent, thereby allowing customers to withdraw from the exchange at any moment. Second, the events should provide greater scrutiny on professional investment management companies, like BlackRock and Sequoia, who charge exorbitant fees for supposedly managing risk. Their limited partners — institutional investors like university endowments, sovereign wealth funds and pension funds — must now pay more attention to where they are investing their assets, rather than blindly allocating capital on faith.
Third, regulators must recognize the power of the market in delivering economic justice and aligning long-term incentives, and adopt the Hippocratic oath to first do no harm when they conceive of their role in future financial markets. Fourth, the world must learn the deep differences between centralized entities and decentralized protocols. Bitcoin is the only true decentralized technology in the cryptocurrency economy. The last decade has seen the establishment of centralized coins and exchanges, with all the governance problems and opacity that centralization entails. The bitcoin community has much work to do to educate the broad public about its principles of individual sovereignty, of incentives over mandates, of decentralized networks over central authority and of transparency over opacity.
The free market is the most powerful agent for rewarding innovation and penalizing fraud that mankind has ever developed. Let’s acknowledge and embrace its power in ensuring a better, more prosperous and more just financial system for all in the future.
