Investors are questioning whether they should trust the “trustless” crypto system.
It’s easy to understand why. The world of crypto has been shaken by one scandal after another.
FTX, a crypto exchange, has recently filed for bankruptcy after reports claimed that the company didn’t have enough liquidity and that its founder, Sam Bankman-Fried, was allegedly misusing clients’ funds.
It was a big deal. At its peak in July 2021, FTX had over one million users and was the world’s third-largest crypto exchange.
After it became clear that FTX didn’t have enough funds to match its clients’ deposits, it suffered a “bank run,” or a wave of withdrawals. Reuters reported that over $1 billion in client funds vanished from FTX’s accounts.
It’s being investigated by US regulators now.
FTX started a domino effect.
On Monday, BlockFi, which is a cryptocurrency lender and a financial services firm, also filed for bankruptcy.
BlockFi said it had “significant exposure” to FTX.
Others may follow.
We will know the full extent of the problem months, if not years, from now.
But investors can’t wait that long. So what conclusions can you make based on what’s been happening in the crypto world?
Any System Can Have Bad Actors
A lot of people insist that the collapse of FTX has nothing to do with crypto itself.
The argument goes like this: the technology itself isn’t corrupted, but it’s used by corrupt individuals who make the whole industry look bad.
It’s true. In its pure form, crypto is quite decentralized and almost impossible to hack.
But in reality, large chunks of the crypto world are centralized, and hacks happen all the time.
They are exploited by people and companies who endorse crypto as a promising technology but then insert themselves in the crypto ecosystem to make profits at others’ expense.
There are at least nine types of crypto-related scams people fall victim to, from bitcoin investment schemes to phishing, Ponzi schemes, fake exchanges, and others.
From the beginning of 2021 until June 2022, according to the Federal Trade Commission, scammers stole over $1 billion from about 46,000 people.
The reality is that as long as people don’t completely understand the crypto world, scams will continue happening.
It’s impossible to separate this technology from people running the crypto infrastructure and exploiting its weaknesses.
Regulation won’t help. Rules are always one step behind.
As a result, investors need to get used to doing their due diligence and being careful about relying on any intermediary in the crypto world.
Crypto Isn’t Completely Decentralized and Hack-Proof
You may have heard about the Defense Advanced Research Projects Agency (DARPA). It’s the research organization that invented the internet.
This year, DARPA commissioned a report that investigated some of the claims crypto enthusiasts make about its decentralization and safety.
The conclusions weren’t optimistic.
(You can read the report here.)
Blockchains (or distributed ledgers) have what the report calls “unintended centralities.” It means that they are not as secure as they may sound.
For example, more than 20% of bitcoin nodes are running an old version of the bitcoin core client, which is known to be vulnerable.
Keeping your software up-to-date is classic security advice. But when it comes to running a network that handles payments and investments, security is key. Turns out, the bitcoin network suffers from the same problem as any other software: users don’t update their buggy versions.
And it doesn’t take too much to disrupt the whole blockchain. The report says that you need just four for bitcoin, two for Ethereum, and less than a dozen for other networks.
As an investor, you need to know these facts.
Crypto is a promising technology, but in the real world, it’s not the only way to either handle payments or invest.
It may not die as a result of the scams and scandals that are plaguing it.
But when it comes to trust, crypto is going through a full-blown crisis that it may never recover from.
Thank you for your loyal readership,
The Financial Star team