Crypto failed under capitalism. They might have failed each other as well. No, I’m not attempting to defend Sam Bankman-Fried or anyone who has abused trust and undermined confidence in the sector.

And I’m not a Communist, either. Like any sane student of history, I firmly think that market economies allocate capital much more efficiently than centralized ones.

I want to say that capitalism doesn’t always produce the outcomes we want. The market must be free and competitive for its “invisible hand” to function. Economic actors need reliable, dynamic price signals to make well-informed investment decisions. Thus, there must be enough knowledge about the variables influencing supply and demand circumstances to determine such prices.

Such transparency did not exist, at least not to the extent necessary for the crypto market to benefit from reliable price signals until 2022 and, more crucially until the collapse of FTX highlighted a gaping mismatch between image and reality.

It’s not Just FTX; it’s the Entire Industry

I’m not only referring to FTX’s bizarre accounting procedures (or lack thereof). I’m talking about what we knew—or didn’t know—about the factors that led to the skyrocketing token prices that drew millions of retail users to various crypto exchanges and lending platforms, inflows that generated billions of dollars in fees, and, as a result, attracted a ton of venture capital funding to those businesses.

We are shocked to learn that Celsius Network was valued at $3.5 billion before it failed and that FTX, now practically worthless, was once valued at $32 billion. But the investments and deposits that came into exchanges like Binance, Coinbase, Kraken, Crypto.com, and others should also be the subject of comparable inquiries. I don’t mean to imply that they are also about to go bankrupt or are under investigation for fraud, but rather that we should consider the exaggerated hopes for future growth that attracted the flood into the entire sector.

Investors were duped by a headfake of capitalism. For a while, venture capitalists believed that these centralized rent-extracting machines were the companies they should be investing in due to the spectacularly outsized profits they were producing. They were on the right track if you believe the market’s logic. Market sentiment was “this is the future.” 

Tragically, we now understand that this indication was fake. There was nowhere to be found. A significant portion of the token exchange and loan industry was founded on a house of cards, an intricate web of leveraged positions spread throughout the crypto ecosystem and maintained by a general conviction that “numbers go up.” It was a poisonous concoction of rehypothecation, opportunism, and momentum trading. It was never enduring.

The triple-digit rates advertised on numerous decentralized finance (DeFi) networks during boom times in 2021 were not only wildly high in comparison to traditional finance but also lacked the real-world utility to justify them, something we should have recognized from the start. The same might be true of the charges gathered by centralized trading and financial platforms.

There needed to have been far more investment in the underlying real-world use cases for tokenized value exchange, like in decentralized energy, for there to have been enough base-level usefulness to support the trading prices higher up the chain. However, the market wasn’t indicating where investors should put their money. On FTX, Celsius, and their ilk, it was advising investors to “go all in.”

Fixing information asymmetry

We need more trustworthy information about the crypto firms and industries, not just statistics on how profitable exchanges and lenders are in the short term but also in-depth information about the underlying causes of such returns and how sustainable they are over the long run.

With that knowledge, venture capitalists may avoid speculative short-term prospects in favor of legitimate, long-term enterprises.

But Silicon Valley is still responsible for this issue. Given that venture capitalists can now exit their investments much sooner than the five-year liquidity lockups they were previously required to, they may still be compelled to ignore signs of long-term difficulties and keep betting on short-term bubble moments because they know they can always pass their bags to the next bigger fool. They can accomplish this because they are granted early access to private “data rooms ” during funding round transactions,” providing them a competitive advantage over smaller investors who arrive later.

This “information asymmetry” issue is what securities rules are meant to prevent. The participants in every later-stage investment round can be likened to it: the investable firm itself, which is fully informed; the early investors, who are well-informed but not fully informed; and the potential targeted investors, who are much less informed. One of the primary sources of the distortions in price signals is this form of asymmetry. Securities regulations that require disclosures close the knowledge gap.

Regulate or Self-regulate?

 It should be clear by now that stricter regulation, including registration with the Securities and Exchange Commission, is necessary for CeFi exchanges like FTX. How far should such regulation extend is the question.

Despite this, there is still a compelling case that excessive regulation, such as the harsh legislation Senators Elizabeth Warren (D-Mass.) and Roger Marshall (R-Kan.) filed this week, may quickly backfire by stifling innovation. If securities rules are unfairly applied to the software developers of DeFi initiatives for which there is no discernible centralized authority, there are very significant hazards.

The industry must save itself in this situation. It’s time to encourage industry leaders who genuinely want technology to support a thriving, sustainable economy with tangible benefits to unifying standards to improve transparency.

There is a lot that the members of this community can do to encourage reciprocally beneficial disclosure requirements on one another, whether it be a widely accepted method for proving reserves, rating agencies that use on-chain and other records to evaluate the risks of various assets, or protocols, or similar standards for software audits and bug bounties.

Either do that or never take advantage of capitalism’s advantages

Read More:

• It’s time for the crypto ice age. It can deteriorate further.
• Investors now Dread Recession More than Inflation, Which is Why the Stock Market is in Freefall.