The collapse of FTX is not simply the failure of yet another crypto exchange. It indicates the time for the crypto industry to mature, acknowledge, and accept its value. The value confusion has arrived.
FTX was the second-largest cryptocurrency exchange in the world. It is now a meme for the death rattle of absurd sums of money poured into refurbished centralized business models cloaked in faux decentralization.
“Only when the tide goes out do you discover who’s been swimming naked,” legendary investor Warren Buffet famously said. This cycle appears to have had more than a few naked bathers. But haven’t we seen this before? No, not entirely.
Bitcoin appeared at the start of the world’s longest financial market bull run. In the best of times, the industry it spawned proliferated. But all good things must come to an end. Crypto is now confronted with the unfortunate confluence of worsening macroeconomic conditions and regulators eager for control.
Meanwhile, traditional markets are seeing a return on cautious, value-based investment. The reason is simple: money was free when interest rates were at rock bottom. It’s no longer the case. The dizzying ascents of Ubers, Airbnbs, and DoorDashes were possible because businesses that generated it were undervalued when money was free. However, promises are no longer sufficient. Before putting up their increasingly expensive capital, investors will demand proof of value.
With the demise of FTX, crypto markets will be subject to value-driven investment for the first time. And, no matter how much we ignore its lessons during boom times, economics is unmistakably true. There is both supply and demand. Markets function when they are in balance. Markets do not function if they are not.
We now know that centralization in cryptocurrency markets does not work. There are far too many opportunities for profiteering charlatans to prey on those unfamiliar with complex technologies. The result? Illusions of those who believed in the pot of gold at the end of the crypto rainbow have been shattered. But, among the rubble, there is a glimmer of hope: the value schism.
What exactly is the value schism?
In industry parlance, cryptocurrency is undergoing a “hard fork.” Those who remain after the FTX dust settles can either seek out the value that can be harvested and delivered to users, or they can continue with naked bets based on finding a “greater fool.” Some will choose the latter option. Old habits die slowly. They will, however, fade as investors demand more. Meanwhile, we will see more Web3 projects that add value by returning to basic commerce.
The rewards for those who succeed will be enormous. The end will come quickly for those who offer only empty cheerleading from the past.
Getting to know a new paradigm
Within the value schism, there are two guideposts to consider. The first refers to cryptocurrency as a financial asset, while the second refers to the blockchain as a technological scaffolding.
The difficulty in evaluating crypto as a financial asset class is that there is no working model for valuing protocols — not surprising in such a young industry. There were no yardsticks to evaluate these networks in their early stages. For mature markets, retrofitted versions were built.
Since then, cryptocurrency has evolved. We now better understand the various ways decentralized finance (Defi) protocols are used, allowing us to categorize networks.
Bitcoin is a widely distributed proof-of-work chain — it is slow but secure. We can see how many Bitcoin wallets exist and how those wallets interact with the chain.
Calculating the value moving across the secondary transaction layer, the Lightning Network is possible.
Ethereum is a proof-of-stake cryptocurrency. It is the beating heart of Defi, albeit more centralized than Bitcoin. With Defi came a tool for determining value: total-value-locked calculations. Despite their limitations, emerging advanced financial indicators outside of traditional institutions are of great interest. Traditional finance believes so, as evidenced by the increased regulatory scrutiny.
The point is that trading Ether or Bitcoin felt similar in 2016. We now have a variety of data-driven gauges to assess these networks as they become more differentiated. Cryptocurrency is developing into a real, quantifiable asset class.
The emergence of functionals
Functionals are non-financial Web3 assets: blockchain-delivered products and services.
Consider the zero-knowledge (ZK) proof. A homebuyer wishes to demonstrate to a real estate agent that they have sufficient funds to cover their purchase without disclosing the contents of their bank account. They can pay for this service to be performed by a ZK. In this case, they are only paying for a privacy-preserving service and are not speculating on an asset — they are not holding or trading it.
Many data-handling projects are sprouting up, providing services such as identity tooling, cloud storage, and search and indexing. Because of their decentralized infrastructure, they are priced very competitively compared to their centralized counterparts.
The demise of FTX is not unique, and it is far from over. Contagion spreads throughout the system, made more difficult by downward pressures exerted by macroeconomic forces.
But, in the end, FTX will become a growth ring in the cryptocurrency narrative, evidence of a fire that passed through, leaving hardened systems that will drive value.
The value schism will force blockchain ecosystems to choose between using hype cycles to generate speculative profits and building models that surface real user value.
Just as personal computers evolved from hobbyist garages to desks and pockets worldwide, blockchain-based systems are finally maturing.