As the FTX avalanche rolls down the hill, fintechs worldwide hope to stay out of its destructive path.
Technologists who called crypto the future celebrated as venture capitalists that poured billions into the fledgling industry now turn to fintech practitioners for advice. The biggest question for them is: will we be wiped out next?
Mike Cagney, the founder of Figure, said that investors had voiced their concern about potential contagion.
“Our investors have excellent visibility to understand we were not in crypto trading, and we didn’t have any exposure related FTX, but they brought questions from their LPs to us: there is some general concern,” he said.
The contagion ends with crypto; go figure
Cagney said there was nothing to fear; Figure was not exposed to FTX or FTX Ventures.
Cagney was the Co-Founder and former CEO of SoFi, who exited in 2017 and went on to found Figure in 2018, quickly raising a unicorn valuation.
Cagney told investors and those concerned that FTX blew up because of the ongoing collapse of crypto leverage trading that saw Celsius, Three Arrows Capital, and Voyager burn to the ground. He said the crypto industry talked smack about traditional banks that traded on margin and fractionalized assets, and then many exchanges did the same thing.
“You had a system that lambasted fractional reserve banking embrace fractional reserve balance sheets, but without the benefit of the Fed and a prudent liquidity policy,” he said. “I think you’re looking at something that isn’t done yet and is probably going to take a while to play out in terms of the real ramifications, and it’s unfortunate.”
He said there would be definite consequences but this is a chance for the industry to look beyond crypto as a speculative toy and build an institutional adoption future. Although he doesn’t believe there will be any immediate regulatory changes.
Regulation, ain’t it
It turns out, Cagney said, that even a significant crash won’t lead to major regulation. He said most of the money and industry effects were within the alternative finance space, outside regulators’ purview or interest.
“I just wrote our investor letter and said, I think there are two things that will come from this; one is there’s this view that it’s going to lead to significant and immediate regulation,” he said. “I don’t think that’s what’s going to happen because the regulators don’t have legislation to regulate the industry. The lawmakers don’t know enough about the industry to write the laws to legislate it.”
The industry is now stuck in a weird sort of no person’s land. He did say that he thinks the outcome of the Ripple lawsuit with the SEC will provide some insight into the feeling, but overall, regulators don’t have or want the tools.
Blockchain as a solution
After this bear run, he said the major shift is that institutions will finally look at blockchain as a usable solution and no longer just for token trading and speculation.
“The problem with the blockchain industry is that it has never passed up an opportunity to shoot itself in the foot. We’ve had the ICO debacle, algorithmic stablecoins, fractional reserve balance sheets, and liquidity constraints,” he said.
There have been endless cycles and problems in crypto, and the recent leveraged trading and crypto lending debacle is not the first. He said this time around. The cascading issues started with the current crypto bubble. NFTs skyrocketed in value alongside altcoins, and crypto companies made loans with volatile assets.
Cagney said that the loans went upside down because the coins went down, and lenders made accounting mistakes or violations to try to make the loans whole again.
“One of the things that a lot of the blockchain lenders are discovering right now, and this is part of why there’s this significant knock-on effect,” he said. “When they were lending, they were collateralized against bitcoin and eth, but never perfected a lien in bitcoin or eth, and the borrower went bankrupt. They effectively did a fraudulent conveyance when they sold the collateral to make the loan whole.”
Fraudulent conveyance is a civil issue where a creditor moves a debtor’s assets in a harmful way. In this case, Cagney said FTX moved customer funds around from FTX to Alameda Research in the alleged transfer of $10 billion to cover a hole in the Alameda balance sheet as if it was theirs to spend. The Wall Street Journal reported that Alameda CEO Caroline Ellison said top executives knew about using customer funds in a company video call over the weekend.
What about general investor pullback?
There will be a short-term capital pullback from crypto and payments, but Cagney said this would look like a great time to rebuild in the medium to long term.
“Most seem to realize this is an opportunity for them to move their position, platform forward,” Cagney said. “I think the banks we work with understand the value, bilateral transactions and in particular with the value of stablecoins.”
“Bank-issued stablecoin is probably the most disruptive technology we’ll see. It’s going to blow out ACH, Fedwire, and upend interchange.”
He said a regulated stablecoin compares favorably to the wild west of crypto right now.
The wallflowers will say how much they hate blockchain and knew how bad the exchanges were, but Cagney said financial services could see beyond the noise.
“I think we’re past that,” he said. “I think people that have had exposure understand that this is probably the most transformative technology to hit the market in anyone’s lifetime. It’s been misused, not been allocated to a useful social utility.”
The carnage started when there was a general pullback across the industry, and gas prices shrank back. Cagney said everyone realized networks were not worth what they thought, and betters realized they had bet too high.
“It’s like the 2008 financial crisis, but it’s not impacting everyday consumers here, which is why you don’t have the Fed or Treasury stepping in with extraordinary measures.”
It’s ironic, Cagney said, that many crypto firms railed against the fractional reserve banking ecosystem and then embraced the same thing themselves and imploded. He said the industry has to get off this high horse that “DeFi is going to kill the banks.”
“This is a transformative technology, and by the way, banks are one of the best beneficiaries of this technology,” he said. “We’ve been through this 10 years ago when we discussed how peer-to-peer lending would disintermediate the banks and connect sources and use of the capital more efficiently. We got six months into it and realized we needed the banks.”