Why bitcoin’s most fundamental principle has become crypto’s biggest problem

On November 9, Genesis stated that it had “no material exposure” to FTX or its falling FTT token, and estimated that the fallout from the FTX collapse could cost it around $US7 million ($10.4 million). The next day, Genesis recalled that it had $175 million locked up in FTX, which most would consider at least a a little some material, but that it “would not affect our market-making activities”.

By the middle of the following week, however, Genesis had suspended withdrawals from the lending department, and the following day The Wall Street Journal reported that Genesis was seeking a $1 billion capital injection to help it negotiate a “liquidity crisis”. In a statement, Genesis said it had “no plans to file for bankruptcy immediately”.

For readers for whom a “liquidity crunch” is the result of attempting to eat a Cadbury’s Creme Egg in a single bite (is there another way?), this means Genesis has the money, but it’s in the form of something else that can take a little while to sell. Unfortunately, the same phrase was used to describe FTX’s predicament in the days before it became clear that the illiquid assets on the balance sheet consisted largely of FTT and Solana – tokens that Bankman-Fried and his friends had, to be blunt, settled , and which were not the value base that some people had previously thought they were.

‘Unhackablah blahchain’

There are no indications that Genesis has done anything untoward, but Genesis also has many friends. Its central position as a lender gives it exposure to the wider ill-advised cryptocurrency market: the two biggest borrowers are, a source told Reuters, Bankman-Fried’s bankrupt hedge fund Alameda Research and Three Arrows Capital (also a hedge fund, also now in bankruptcy proceedings). This also means that problems for Genesis are problems for other financial institutions that depend on the lender.

In fact, Genesis has not only friends, but siblings: Grayscale Investments, also owned by Digital Currency Group, is the largest active owner of bitcoin through the original and largest bitcoin investment fund, Grayscale Bitcoin Trust. This also looks a little over the top at the moment, with shares trading at more than a 40 percent discount to the market value of the underlying assets.

Genesis, Grayscale and others are now threatened by the very problem bitcoin was designed to solve: trust.

Crypto-evangelists have spent a decade haranguing people at parties (I’m never invited to these things, but I hear reports) and explaining that in their world the messy business of trusting fallible humans is swept aside by the immutable, unhackable blockchain. But this immutable, unhackablah blahchain is also astonishingly wasteful — a single bitcoin transaction can use as much energy as 1.8 million credit card transactions — and in its early days made trading costly and inefficient. To create a liquid market, they had to bring in all the other things that make modern financial markets fast and efficient: market makers, trading firms, lenders, exchanges and, of course, people.

Trust in people and institutions had not disappeared: it had simply shifted from trust in established banks and regulators to trust in new companies like FTX and people like Bankman-Fried.

The reason many people quickly withdraw their money (or try) from crypto exchanges, and test the liquidity of that market, is that they have realized that there may be several Sam Bankman-Frieds in a system that, let’s face it, looks like it was designed by and for just that kind of person.

It shouldn’t be difficult for crypto markets to overcome this lack of trust. Each exchange, currency provider and asset manager can publish a detailed, independent audit of its assets by a well-known auditor. But few are prepared for it.

It should be easy for Grayscale to demonstrate to investors exactly what and where the assets are (they are, after all, registered on the famously immutable and unhackable blockchain), but on Monday Grayscale declined to do so, citing “security concerns” (the company has since published a letter from crypto exchange Coinbase stating that it has Grayscale’s digital assets, but it did not share any of the “addresses” used to identify those assets).

The biggest “stablecoin” — a cryptocurrency backed one-to-one by real dollars, to facilitate trading — is tether, which similarly has never released a full, detailed audit of its $65 billion in reserves. The largest crypto exchange, Binance, won’t even say where its headquarters are.

The cryptocurrency market is clearly aware of this problem, and companies are belatedly adding “proof of reserves” to their websites in an attempt to reassure investors that they are solvent, but simple faith in crypto technology has been eroded. The crypto community is waking up to the fact that you can be a friend or a creditor, but you can’t be both.

Will Dunn is the business editor for New statesman

New statesman