By Alisa DiCaprio, Chief Economist, R3
Five key blockchain projects failed over the course of 2022. Failures are an inevitable part of any industry, but the collapse of FTX, ASX, Terra/Luna, we.trade and Tradelens in such a short space of time has raised eyebrows, particularly towards the underlying distributed ledger technology (DLT) itself.
Rather than examine each case individually, it’s important to consider the patterns across these projects. By doing so, we can properly assess what went wrong and what these failures mean for the sector in 2023.
- The technology is not the culprit
Blockchain is the clear common denominator between the FTX, ASX, Terra/Luna, we.trade and Tradelens projects. Against a backdrop of growing public scrutiny – with little coverage of the successful blockchain projects happening elsewhere – many sceptics view these collapses specifically as technology failures.
This school of thought, however, runs into problems quickly. These five projects used a range of different protocols, suggesting that blockchain alone cannot be the whole story. They were also a mix of both public and private blockchains – including Hyperledger Fabric (HLF), DAML on VMWare, and Ethereum – with many of these protocols already successfully deployed in other cases. It therefore seems unlikely that the blockchain technology itself was responsible for the failure of these projects.
- Always consider the costs
Both the ASX and we.trade projects cited high costs as a key reason for their collapse.
Designing a solution using entirely new technology can be expensive. Training engineering teams, building an ongoing service relationship with the provider and continuously iterating the solution requires a substantial amount of money from the banks and exchanges behind these projects.
For ASX, these factors meant the final product differed greatly from the initial proposition. This also underlines a related challenge; since cost-recovery depends on adoption, it is difficult to estimate the return on investment of new deployments. Entering unchartered waters also means that costs change as projects evolve.
- Network building is a delicate process
When Maersk began collecting members of the TradeLens network, an entirely new network of container operators (GSBN) was formed of operators who did not want to join TradeLens but who were interested in the types of solutions they were creating. Politics still matters.
Both we.trade and Tradelens suffered from reluctance amongst others in the sector to adopt the solution. Although both created and deployed full solutions used by their members, other entities outside of this circle decided not to engage with their respective services.
FTX and Terra/Luna experienced a different type of network-building problem. The interconnectedness of both cryptocurrencies and exchanges had a domino effect; when their projects failed, they took others down with them.
Networks are the building blocks for widespread adoption, but they can also be a source of fragility. Regulation can help avoid this problem in future.
- Regulation is the key to adoption
Decentralised finance (DeFi) operates in a separate ecosystem from traditional finance (TradFi), and cryptocurrencies lack a coherent regulatory structure. Whilst blockchain itself doesn’t require specific regulations, it does interact with financial regulations in a new way.
Terra and FTX did not violate any regulations but lacked the risk management controls and consumer safeguards associated with traditional finance. This created uncertainty, which made it impossible for regulators to intervene once the problem was realised. Both failed so fast that there was no time to implement traditional stability measures.
Both we.trade and Tradelens produced their own legal structure as a solution to the lack of regulation. However, this in turn created the problem of potential members having to agree upon a new and unfamiliar set of rules, forming another barrier to adopted.
Regulation is therefore a vital ingredient for success, providing firms with the legal and regulatory certainty they need to adopt solutions at scale.
- New systems must integrate with existing infrastructure
Integration with existing infrastructure is expensive, but essential for a blockchain project to succeed. This was the foundation for the failure of ASX, which aimed for a complete system overhaul that ended up being too costly.
For FTX, integration was the key selling point. Centralised exchanges bridge the gap between DeFi and TradFi. Much of the initial success of FTX was due to its interoperability.
The complete lack of interoperability in the Terra/Luna project led to robust industry changes to support projects backed by liquid assets, but this presents further challenges as this isn’t normally part of the design process and only happens after full deployment.
The measure of success
All the blockchain projects mentioned above were start-ups. ASX worked with established consultancies, but the project was still designed on a relatively untested programming language.
This meant that whilst each company interacted to some extent with the traditional financial framework, none of them built the necessary infrastructure and ecosystem of stakeholders to survive, let alone thrive.
The use of blockchain undoubtedly affected the cost and difficultly of deployment in these projects. But from a business perspective, success and adoption ultimately depend on the ability to attract other participants and operate within a regulatory environment.
DLT is already bringing significant efficiency benefits to financial markets across a range of successful use-cases – from the Depository Trust and Clearing Corporation for equities settlement to Spunta for bank-to-bank reconciliation. To fulfil this potential on a widespread level, it must operate within the scaffolding and regulations of the very system it seeks to disrupt.
