The crypto industry is struggling for a way forward after the collapse of FTX

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Not long after several Wall Street banks collapsed in 2008, a nine-page document circulated on an obscure mailing list proposing a new kind of financial system that would not rely on a “trusted third party.”

The paper was the foundation for what became the cryptocurrency industry. Using far-reaching, idealistic language, its supporters pledged to conduct business in a transparent and egalitarian manner, rejecting the risky practices of a small number of powerful financial firms that caused the Great Recession.

But last month, the actions of a single crypto company – the $32 billion exchange FTX – plunged the emerging industry into its own version of a 2008-style crisis. Once considered a safe marketplace for people to trade virtual currencies, FTX filed for bankruptcy following the crypto equivalent of a bank run, leaving industry executives, investors and enthusiasts to grapple with how a technology intended to overcome the shortcomings of traditional to correct finances, eventually replicated it .

Executives who enjoyed crypto’s seemingly unstoppable growth just a year ago are now struggling to prove they can learn from the mistakes and recapture the industry’s early ideals. Binance, the world’s largest exchange, announced last month that it would release more information about its finances and hire independent auditors to review those revelations. Coinbase, the largest US crypto exchange, proclaimed that it was committed to a “decentralized system where you don’t have to trust us.”

Many crypto proponents are pushing for more drastic reforms, urging investors not to store their digital assets with big companies and instead turn to more experimental platforms run solely by code.

But for all the promises of change, the collapse of FTX shows just how far crypto is from fulfilling its original goals and gaining widespread adoption. Consumer distrust has increased this year amid large financial losses, criminal investigations and an increasingly skeptical regulatory climate in Washington. At a conference last month, Changpeng Zhao, Binance’s CEO, said the implosion of FTX would set the industry back years.

The stock market downturn added further losses to the virtual currency market, triggered by a devastating crash in the spring that unfolded amid a broader pullback of risky assets. Due to the unrest, some prominent crypto companies went bankrupt. Bitcoin, the original and most popular cryptocurrency, is trading at less than $17,000, down about 75 percent from its high of nearly $70,000 almost exactly a year ago.

“You start going through these problems, and they pile up one after the other,” says John Reed Stark, a former Securities and Exchange Commission official turned outspoken crypto critic. “More and more people are seeing this for the scam it is.”

The crypto industry bounced back from previous crashes and attracted large investors who poured even more money into experimental companies. But FTX’s collapse is widely described as the worst moment in the industry’s short history.

The origins of crypto date back to 2008, when a mysterious figure known as Satoshi Nakamoto published a white paper on Bitcoin, detailing what cryptocurrencies became. The paper outlined the technological foundation of Bitcoin, a publicly visible ledger called a blockchain where transactions would be visible to everyone.

Early enthusiasts thought Bitcoin could become the foundation of a more transparent, egalitarian financial system. Many of the newspaper’s supporters were libertarians who had become disillusioned with traditional finance, especially the concentration of power in a small number of corporations.

Initially, crypto’s primary use was criminal. Thieves and drug dealers used Bitcoin to transfer large amounts of money without relying on a bank or other intermediary to process transactions.

But over the years, law enforcement has gotten better at detecting crypto crime and the technology has evolved to enable more sophisticated financial applications, such as borrowing and lending. People who started their careers on Wall Street — including FTX founder Sam Bankman-Fried, who worked at the Jane Street trading firm — became involved in the nascent industry and wanted to take advantage of the technology.

As the industry grew, it began to take on some of the same characteristics as the Wall Street institutions it was meant to replace. Crypto trading has become increasingly centralized, with a large portion of transactions taking place on a handful of major exchanges, including Binance, FTX, and Coinbase. In the months leading up to FTX’s collapse, the trading volume of cryptocurrencies on Binance alone exceeded the combined totals of its seven closest competitors, according to an industry data tracker.

The original vision for crypto “was an attempt to rewrite financial rules on a global basis,” said Charley Cooper, general manager of the blockchain company R3. “And here we are again — we’re in an even more centralized industry than we’d see in banking.”

Cryptocurrencies surged in value last year and into 2022 – until May. That was when a popular cryptocurrency called Luna crashed, sending the crypto economy into a free fall. Two major lenders, Celsius Network and Voyager Digital, have filed for bankruptcy. Enthusiasts lamented the start of a “crypto winter” of low prices and waning enthusiasm.

During the crisis, FTX was considered a relatively reliable force. Based in the Bahamas, the company served as a marketplace for people to buy and sell cryptocurrencies, offering high-risk but popular trading options that are illegal in the United States. Mr. Bankman-Fried, 30, who built FTX into a $32 billion company, rescued ailing businesses and built a reputation as a benevolent figure willing to provide a lifeline to colleagues.

Last month, a run on deposits revealed an $8 billion hole in FTX’s accounts. The company filed for bankruptcy within a week. The Securities and Exchange Commission and the Department of Justice have opened investigations into whether FTX illegally lent its users’ funds to Alameda Research, a crypto hedge fund that Mr. Bankman-Fried also founded and owned.

The implosion has been described as a “Lehman moment” for crypto, a reference to the investment bank whose implosion helped trigger the 2008 financial crisis. Other companies with ties to FTX began to falter. Last Monday, cryptocurrency lender BlockFi, one of the companies FTX bailed out in the spring, filed for bankruptcy, citing its entanglements with Mr Bankman-Fried.

Some prominent figures in crypto have tried to see FTX’s demise as a positive development, arguing that it will redirect energy to finding practical uses for the technology.

“For us, this is actually a great moment,” said Jeremy Allaire, the CEO of crypto payment company Circle. “We’re delivering real value, and the people who focused on building giant speculative trading casinos aren’t so happy.”

Binance essentially operates the same type of business as FTX, but Mr. Zhao, the CEO, has been careful to distinguish himself from Mr. Bankman-Fried lately, calling his former rival a liar and criticizing FTX’s most dangerous practices. On November 25, Binance announced a new “proof of reserves system,” promising to keep users informed about the amount of cryptocurrency in its accounts and allay fears that it could be vulnerable to the type of run on deposits that FTX destroyed. (But Binance’s plans were tough criticized for missing important information.)

Coinbase has also tried to allay fears of a collapse by publishing a blog post stating that it always holds the same amount that customers have deposited. “There can be no run on the bank at Coinbase,” the post read.

Still, the mere existence of big companies like Binance, Coinbase, and FTX goes against the ideals of crypto, some industry experts argue. Since the collapse of FTX, some crypto enthusiasts have brindle to smaller firms in the experimental field of decentralized finance, allowing merchants to borrow, lend, and transact without banks or brokers, relying instead on a publicly visible system controlled by code.

But DeFi has its own problems, including vulnerability to hackers, who have siphoned off billions of dollars from the experimental projects this year.

“They’ve built it on clunky technology that’s very inefficient,” said Hilary Allen, a financial expert at American University. “They are very vulnerable operationally.”

Surveillance in Washington has also intensified. SEC Chairman Gary Gensler has vowed to prosecute crypto companies for securities law violations. The House Financial Services Committee will hold a hearing on the collapse of FTX on Dec. 13.

Mr. Bankman-Fried has been asked to give evidence. In interviews with The New York Times, he sometimes seemed haunted by FTX’s bankruptcy — and was sometimes strikingly flippant.

“You know,” he said in an interview, “the crypto winter has officially been extended.”

Wasn’t that a bit of an understatement? “Yes,” he replied. “Unfortunately.”

Audio produced by Parin Behrooz.