I'd be interested in researching this a bit more as we all know how the FTX situation ended for the market. If we're starting to see obvious cases of entities using paper Bitcoin and not being able to cover client holdings, it is time to say goodbye to the market for a couple years.
Would a repeat of the FTX scenario necessarily play out to the downside?
I would think so. If a company holding a lot of coins on behalf of users turned out not to have them, it would set off an investigation as well as bankruptcy. Assets that were being held by the company would be frozen and users would have themselves trapped in a long legal battle in hopes to recover anything. The market would see this as a breakdown and a lot of people speculating on the price of Bitcoin would view this as a sign to exit the market. It's best if everything is functioning as advertised.