The FTX disaster has set back crypto by ‘years’ — here are 3 ways it could reshape the industry

The collapse of FTX, once a $32 billion crypto exchange, has shattered investor confidence in cryptocurrencies. Market players are trying to gauge the extent of damage it has caused — and how it will reshape the industry in the years to come.

Sam Bankman-Fried, FTX’s former boss who stepped down on Nov. 11, was arrested in the Bahamas last week. He has been charged by the U.S. government with wire fraud, securities fraud and money laundering.

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FTX connected buyers and sellers of digital currencies like bitcoin, as well as derivatives. However, the company did more than that, allegedly dipping into client accounts to make risky trades through its sister firm Alameda Research.

“It’s hugely disappointing for investors, or more so devastating for investors,” said Louise Abbott, a partner at law firm Keystone Law who specializing in crypto-asset recovery and fraud.

It’s clear the FTX drama could radically reshape crypto in the years to come. Here are three big ways the industry could change.

For one, the disaster will looks certain to stir regulators into action.

Crypto as an industry is still largely unregulated, meaning investors don’t have the same protections they would have placing their funds with a licensed bank or broker.

That may be about to change. Governments in the U.S., European Union and the U.K. are taking steps to clean up the market.

The EU’s Markets in Crypto-Assets is the most comprehensive regulatory framework to date. It aims to reduce the risks for consumers buying crypto, making exchanges liable if they lose investors’ assets.

But MICA is not due to start until 12 months from now. Keystone Law’s Abbott said it’s important that regulators act quickly.

“People need to see that there’s steps being taken to regulate it. And I think If we are able to offer some regulation, we will build confidence,” she said. “If there’s no regulation, the investors are left without that protection that they need.”

The saga has set back adoption of crypto assets by “one or two years,” according to Evgeny Gaevoy, founder and CEO of crypto market maker Wintermute.

“Everything that failed this year, if you look at Celsius, Three Arrows, FTX now — all those guys were taking the worst of both worlds because they were not completely decentralized, and they were not properly centralized either,” he said.

For Kevin de Patoul, CEO of crypto market maker Wintermute, the biggest lesson from FTX’s bankruptcy is that “you cannot have complete centralization and lack of oversight.”

“We are evolving to a world where you are going to have both centralization and decentralization,” he said. “When you do have that centralization, you need to have proper oversight and a proper balance of power.”

Many new companies and projects emerged in the years that followed the 2018 crypto winter — FTX among them. The expectation now is that fewer firms and coins will exist in the years to come.

Contagion from the FTX saga is already playing out.

Crypto lender BlockFi, which earlier sought financial assistance from FTX, has entered bankruptcy. Now, attention is turning to other trading and lending firms, like Gemini and Genesis.

“The challenge for the whole space when you think about contagion is that FTX and Alameda were extremely active investors in this space,” Peter Smith, CEO of Blockchain.com, said in a CNBC-moderated talk at a crypto conference in London.

Near Foundation, which is behind a blockchain network called Near, was among the firms that took investment from FTX. Marieke Flament, Near’s CEO, said the firm had limited exposure to FTX — though the collapse was still “a surprise and a shock.”

“I don’t think all the dominoes have fallen out from the contagion,” Flament said. “The impact that this will have is that a lot of projects actually are not going to have the funds, and therefore the resources, for them to continue and develop.”

Fears have risen over the financial health of other major crypto exchanges after FTX’s failure. Since early 2020, about 900,000 bitcoins have flowed out of exchanges, according to data from CryptoQuant.

Binance, the world’s largest exchange, is facing questions about the reserves it holds to backstop customer funds. The company saw billions of dollars in outflows in the past week.

Currently, there is no reason to suspect Binance faces any risk of bankruptcy. But exchanges like Binance and Coinbase face a bleak market backdrop ahead amid falling trading volumes and account balances.

Experts believe they’ll continue to play a role — though their survival will be determined by how seriously they take risk management, governance and regulation. 

“There will be exchanges that are doing things the right way and that will survive,” said Abbott.

As for tokens — bitcoin, being the longest-living digital currency, may be better positioned than its smaller rivals.

“My bet would be that bitcoin and DeFi [decentralized finance] are decoupled from the rest of crypto and actually start to have a life of its own,” Gaevoy from Wintermute told CNBC.

Despite the depressed state of crypto markets, and the toll it’s taken on investors, the digital asset industry is likely to pull through.

Proponents of “Web3,” a hypothetical blockchain-based internet, expect 2022’s crypto winter to pave the way for more innovative uses of blockchain, rather than the speculative uses crypto is associated with today.

“What we’re seeing a lot is companies having digital innovation arms or metaverse innovation arms,” Flament said. “They understand that the technology is here. It’s not going to go away.”

NFTs, or nonfungible tokens, could alter users’ relationships with properties in games and events, for example. These are digital assets that track ownership of unique virtual items on the blockchain.

“Digital assets will be an increasing part of our lives, whether that is a collectible, a ticket, value, identity,” Ian Rogers, chief experience officer at crypto wallet firm Ledger, told CNBC. “Identity could be membership … [people] using NFTs they own to get access to a particular event or something like that.”

But for many, there’s still a learning curve to overcome. “It’s hard creating wallets and storing keys and going through different platforms,” Cordel Robbin-Coker, CEO of mobile games firm Carry1st, told CNBC at the Slush startup conference in Helsinki, Finland.

Robbin-Coker compared Web3 today with the internet in the early 90s. “It was clunky. You had dial-up, it took four minutes to get on, the original web browsers were not very intuitive,” he said.

“It’s really the early adopters that really engage at that stage. But over time, companies build smoother interfaces. And they cut steps out of it.”