Deep Dive: Crypto Market Bailouts
The cryptocurrency industry’s own JP Morgan (the individual, not the bank) has been on a bit of a tear recently — offering up and walking away from numerous bailout deals for a wide range of distressed, or outright insolvent, cryptocurrency companies. While this is all fine and dandy for the purpose of ensuring that customers may be able to gain access to funds that have been locked up, not many have stopped to ask the deeper questions: are these bailouts good for the industry? Are bailouts in general a good thing? In this article, we aim to investigate and present both sides of the story so that you can decide for yourself.
First, let’s be crystal clear about some terminology. When we are talking about bailouts, we mean private market bailouts — not government bailouts. Discussion around the merits or harms of government bailouts can be saved for another time. In this case, nobody is willing or able to simply print money in order to plug the holes in affected balance sheets like we saw during the 2008 Global Financial Crisis. In a way, this gives a private market bailout much more gravity than a government bailout: whoever is doing the bailing out actually worked for that money and will be less likely to spend it willy-nilly like a government who can print it. In this sense, bailouts like we have seen from Sam Bankman-Fried (SBF) of FTX and Alameda Research fame — alternatively known as the Super Bailout Fund — are much less likely to support a business that is truly failing.
On the other hand, if free market economists are to be believed, then the fact that these businesses failed in the first place is telling us something: these businesses do not have a viable business model and, in hindsight, they deserved to fail. And so, understanding this, why try to save them in the first place? Decentralised finance (DeFi) fared well throughout this whole debacle. So why try to save centralised finance (CeFi), instead of simply advocating for DeFi? This line of questioning brings up more questions than answers, given the realities we are faced with.
One potential answer could also be the simplest: moral hazard and financial incentives. Moral hazard is defined as a “lack of incentive to protect against risk where one is protected from the consequences”. The reasoning goes something like this: wouldn’t it just be easier to pretend that none of this happened in the first place and return to business as usual, without fundamentally changing how a business operates? If you are SBF, you want to seem like a good person and you have billions of dollars of liquid capital extracted from the very same people who use the services that you are going to save, then absolutely!
SBF is also no stranger to financial incentives. The “effective altruism” hat that he wears in order to justify his business practices is fundamentally built upon these. So, think to yourself, how does SBF make the most money in the shortest amount of time in this scenario? Would it be better for SBF to allow free market forces to remove irresponsible actors from the ecosystem, leading to a slow and painful death march in cryptocurrency market capitalisation? Or would it be better for SBF to step in, backstop the industry with a measly couple of billion dollars, then continue to rake in even more once the market is back to business as usual? If you understand financial incentives and the type of businesses SBF runs, the answers should be clear to you.
Now it’s time to address the massive, multi-billion dollar elephant in the room that frankly supersedes any theoretical argument: the fact that regular, every day retail investors are the ones who were hurt most by the actions of these now-insolvent entities. These investors presently have their assets locked behind an impenetrable wall, guarded by somebody they used to trust. While certainly irresponsible, many people had their life savings locked up in these services based on the promise of high returns. Who could blame them, given some of the messaging from these companies? There has been, and will continue to be, a very real human toll that these events will take on those affected. Knowing this, how could anybody possibly argue against these businesses being bailed out? If nothing else, a bailout provides those affected with a means of recovering some of their assets, as well as feeling that they haven’t been left to fend for themselves by society at large.
All things considered, how do you feel about the bailouts that we have seen in the crypto space? Are they warranted and for the benefit of those affected? Or are they a dangerous practice that disregards the core problem, in exchange for a short-term feel good solution? The truth lies somewhere in between and it’s the decision of each individual to form their own opinion, as well as to safeguard themselves against anything like this happening in the future. After all, cryptocurrency was designed to prevent this type of event from happening in the first place.