Today there is nothing left but 1m furious creditors, dozens of shaky crypto firms and a proliferation of regulatory and criminal probes. The high-speed implosion of FTX has dealt a catastrophic blow to an industry with a history of failure and scandals. Never before has crypto looked so criminal, wasteful and useless.

The more that comes out about the demise of FTX, the more shocking the tale becomes. The exchange’s own terms of service said it would not lend customers’ assets to its trading arm. Yet of $14bn of such assets, it had reportedly lent $8bn-worth to Alameda Research, a trading firm also owned by Mr Bankman-Fried. In turn, it accepted as collateral its own digital tokens, which it had conjured out of thin air. A fatal run on the exchange exposed the gaping hole in its balance sheet. To cap it all, after FTX declared bankruptcy in America, hundreds of millions of dollars mysteriously flowed out of its accounts.

Big personalities, incestuous loans, overnight collapses—these are the stuff of classic financial manias, from tulip fever in 17th-century Holland to the South Sea Bubble in 18th-century Britain to America’s banking crises in the early 1900s. At its peak last year, the market value of all cryptocurrencies surged to the giddy height of almost $3trn, up from nearly $800bn at the start of 2021. Today it is back at $830bn.

As at the end of any mania, the question now is whether crypto can ever be useful for anything other than scams and speculation. The promise was of a technology that could make financial intermediation faster, cheaper and more efficient. Each new scandal that erupts makes it more likely that genuine innovators will be frightened off and the industry will dwindle. Yet a chance remains, diminishing though it is, that some lasting innovation will one day emerge. As crypto falls to Earth, that slim chance should be kept alive.

Amid the wreckage of the past week, it is worth remembering the technology’s underlying potential. Conventional banking requires a vast infrastructure to maintain trust between strangers. This is expensive and is often captured by insiders who take a cut. Public blockchains, by contrast, are built on a network of computers, making their transactions transparent and, in theory, trustworthy. Interoperable, open-source functions can be built on top of them, including self-executing smart contracts that are guaranteed to function as written. A system of tokens, and rules governing them, can collectively offer a clever way to incentivise open-source contributors. And arrangements that would be expensive or impractical to enforce in the real world become possible—allowing artists to retain a stake in the profits from the resale of their digital works, for instance.

The disappointment is that, 14 years after the Bitcoin blockchain was invented, little of this promise has been realised. Crypto’s frenzy drew in talent from bright graduates to Wall Street professionals, and capital from VC firms, sovereign wealth and pension funds. Vast quantities of money, time, talent and energy have been used to build what amounts to virtual casinos. Efficient, decentralised versions of mainstream financial functions, such as currency exchanges and lending, exist. But many consumers, fearful of losing their money, do not trust them. Instead, they are used to speculate on unstable tokens. Money launderers, sanctions dodgers and scammers abound.

Presented with all this, a sceptic might say that now is the time to regulate the industry out of existence. However, a capitalist society should allow investors to take risks in the knowledge that they will make losses if their bets go sour. Even as crypto has imploded, the spillovers to the wider financial system have been manageable. FTX’s backers included Sequoia, a Californian VC firm; Temasek, a Singaporean sovereign-wealth fund; and the Ontario Teachers’ Pension Plan. All have lost money, but none catastrophically.

Moreover, sceptics should acknowledge that nobody can predict which innovations will bear fruit and which will not. People should be free to devote time and money to fusion power, airships, the metaverse and a host of other technologies that may never come good. Crypto is no different. As the virtual economy develops, useful decentralised applications may yet appear—who knows? The underlying technology continues to improve. An upgrade to Ethereum’s blockchain in September radically reduced its energy consumption, paving the way for it to handle high transaction volumes efficiently.

Instead of over-regulating or stamping out crypto, regulators should be guided by two principles. One is to ensure that theft and fraud are minimised, as with any financial activity. The other is to keep the mainstream financial system insulated from further crypto-ructions. Although blockchains were explicitly designed to escape regulation, these principles justify regulating the institutions that act as gatekeepers for the cryptosphere. Requiring exchanges to back customer deposits with liquid assets is an obvious step. A second is disclosure rules that reveal if, say, a gargantuan and dubiously collateralised loan has been made to the exchange’s own trading arm. Stablecoins, which are meant to hold their value in real-world currency, should be regulated as if they were payment instruments at banks.

Tulip bulb or light bulb?

Whether crypto survives, or becomes a financial curiosity like the tulip bulb, will not ultimately depend on regulation. The more scandals ensue, the more the whole enterprise and its aspirations become tainted. The lure of innovation means nothing if investors and users fear their money will disappear into thin air. For crypto to rise again, it must find a valid use that leaves the dodginess behind.

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