Contact: Pat Pemberton

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SAN LUIS OBISPO — As Americans commence with their annual viewing of “It’s a Wonderful Life,” the 1946 Frank Capra Christmas classic, starring Jimmy Stewart, provides a valuable lesson about banking and the cryptocurrency implosion, according to a Cal Poly finance professor.

“In addition to being a holiday favorite, ‘It’s a Wonderful Life’ reminds us why trust in financial institutions is vital for the functioning of the markets and what may happen when that trust is eroded,” said Ziemowit Bednarek, whose research interests include asset pricing and macroeconomics.

While nothing fundamentally changed in the burgeoning cryptocurrency market last month, he added, an investor panic related to alleged mismanagement at cryptos giant FTX caused widespread uncertainty and huge losses that could not be recovered. When FTX did not receive any emergency cash infusions, FTX pursued bankruptcy — and a ripple effect that has been coined the Crypto Winter.

“This showcases inherent risks associated with cryptos,” Bednarek said. “I believe a substantial part of market participants chose to stay away from cryptos for that reason.”

Cryptocurrency is a digital, encrypted and decentralized medium of exchange. But unlike the dollar, there is no central authority that regulates crypto. The first cryptocurrency was Bitcoin, which surfaced in 2009. Since then, thousands of new cryptos have been distributed and used.

Transactions are recorded via the blockchain.

“In simple terms, blockchain is a digital ledger, a list of transactions, which is immutable — you cannot make any changes once a transaction is recorded — and public,” Bednarek said.

While celebrities, including Matt Damon and Tom Brady, endorsed the virtues of cryptos, others had concerns — including, what are cryptos actually worth?

“Their value doesn’t represent cash flows produced by real assets, as is the case with stocks,” Bednarek said. “Because of that, finance theory does not give us answers as to what the value of cryptos should be, at least not yet. Valuation models for digital assets are in their infancy.”

For stocks, he added, we can look at the present value of future cash flows.

“We cannot apply this method for valuing cryptos,” he said. “Hence, because people do not know the actual value, prices of cryptos are largely driven by behavioral (psychological) or other unobservable factors. This makes them very volatile, as we have seen in recent years.”

That volatility became apparent in November when Binance, a crypto giant, backed out of a planned buyout of FTX after a review of FTX’s books allegedly revealed that CEO Sam Bankman-Fried had allegedly mishandled customer funds. That revelation prompted masses of FTX investors to bail.

For many, the very appeal of cryptos — removing intermediaries from the equation — is where the trouble lies.

“What makes cryptos more risky is the fact that they are unregulated,” Bednarek said. “Unlike traditional currencies, which are governed by complex sets of regulations, we are still very much in the Wild West when it comes to cryptos. For example, if you deposit U.S. dollars with a traditional bank, usually your money will be federally insured. If the bank goes bust, your money will be safe.”

It was a point famously made by the fictional character George Bailey in Hollywood’s holiday staple “It’s a Wonderful Life.” When rumors circulated that Bailey’s small-town building and loan bank with a mortgage business was about to fail, Depression-era customers panicked and sought to withdraw money — what is known as a bank run.

“Financial institutions do not hold all the deposited money, but rather use it for investments — for example, mortgages, as in the movie,” Bednarek said. “When customers panic and attempt to withdraw their deposits, whatever the reason, the result is the same.”

When customers began to withdraw from FTX, Bankman-Fried reportedly sought emergency investments but ultimately fell short.

“When a bank or any other financial institution is not able to meet obligations on short notice, it will declare bankruptcy unless there is an emergency cash infusion,” Bednarek said. “Much like George Bailey using his own $2,000 to fully or partially meet the demand for cash and stave off a financial collapse.”

At least customers of Bailey Building and Loan would have had protections: Banks have been insured by the Federal Deposit Corporation (FDIC) since 1933 legislation. Cryptocurrency, while vulnerable to sudden market fluctuations, has no such insurance.

“A person known in the crypto world made remarks about FTX mismanaging the funds, and its customers panicked.” Bednarek said. “People rushed to withdraw their crypto holdings, much like in a bank run. Except this time, unlike for a traditional well-established bank, the funds were not federally insured.”