3 events that will determine the fate of cryptocurrencies

It was touted as the future of finance. Today, the world of cryptocurrencies is in disarray.

The fallout from the catastrophic collapse of crypto exchange FTX is spreading, and a so-called "crypto winter," which has dragged on for months, shows no signs of letting up. The value of bitcoin is down almost 70% from its all-time high hit on November 2021.

It's a big change from a year ago. Back then, crypto companies were shelling out tens of millions of dollars to market their trading platforms during the Super Bowl broadcast, with celebrity endorsers like Tom Brady, promising they would democratize finance.

But today, there are growing doubts about the future of crypto.

"The industry is facing this crisis of legitimacy," says Madeline Hume, an analyst at Morningstar.

Here are three things that will determine the fate of crypto in the year ahead.

The continued fallout over the collapse of FTX

Founded by 30-year-old Sam Bankman-Fried, FTX was valued at an eye-popping $32 billion a year ago.

Today, the company is bankrupt, and hundreds of thousands of customers are desperately trying to recover money that seems to have disappeared. Wall Street's top cop, the Securities and Exchange Commission, alleges Bankman-Fried "orchestrated a years-long fraud."

Now, Bankman-Fried faces eight criminal counts, and if a jury finds him guilty, he could spend the rest of his life in prison. Bankman-Fried denies wrongdoing, and he pleaded not guilty at a hearing earlier this month.

FTX's collapse has laid bare how interconnected the crypto industry is. Some companies with exposure to FTX have been hurt, including BlockFi, a crypto lender that collapsed last year.

Other companies have suffered, including Silvergate, a bank that caters to crypto companies. In the fourth quarter, it posted a net loss of $1 billion.

In 2023, we'll learn more about what led to FTX's implosion as prosecutors and regulators sift through transaction databases and reams of documents.

Ultimately, according to Hume, the downfall of FTX showed how risky crypto really is.

"There really is a lack of proper investor protection and risk management," Hume says. "Even just down to simple brass tacks of accounting and compliance."

Regulators are alarmed — and lawmakers are too

The SEC, concerned with protecting amateur investors in cryptocurrencies, is cracking down on companies across the sector.

Last week, the SEC charged troubled crypto bank Genesis and its sister company, Gemini, with failing to register its lending program with the regulator, in violation of U.S. securities laws.

FTX's downfall also alarmed lawmakers, many of whom responded with calls for new legislation focused on crypto.

But there's still a lack of clarity when it comes to cryptocurrencies. There is even disagreement over defining whether cryptocurrencies should be categorized as securities.

Currently, the two big financial regulators, the Securities and Exchange Commission and the Commodity Futures Trading Commission are also engaged in a turf war over who should regulate what — a decision that will fall on Congress.

Cryptos were pummeled. Can they recover?

Although bitcoin's backers suggested they would be a good hedge against high inflation, that didn't pan out at all.

Instead, crypto currencies slumped with other investments such as stocks last year as inflation surged to its highest annual rate in around 40 years, forcing the Federal Reserve to raise interest rates aggressively.

Whether bitcoin and other cryptocurrencies recover will likely depend on how broader markets behave.

And for crypto broadly, it may be a matter of survival.

Alkesh Shah, a global crypto and digital asset strategist at Bank of America, says crypto is undergoing what he calls "a really healthy reset."

"There's about 22,000 tokens traded on about 170 exchanges globally, and most of these tokens have virtually no intrinsic value," he notes.

Shah expects a severe winnowing that could bring down the number of tokens, to just around 50.

Morningstar's Hume points out that crypto has weathered downturns before, and it's unlikely it goes away entirely.

But, she acknowledges, it has a difficult path forward.

"When you look at crypto, and what needs to happen, in order to regain confidence, it's going to be brick by brick," Hume says.