As stocks rise, here’s what’s behind the latest crypto crash

Tuesday was generally a good day on Wall Street. The shares were somewhat volatile, however Dow Jones Industrial Average (^DJI 1.02%), S&P 500 (^GSPC 0.56%)and Nasdaq Composite (^IXIC) everyone managed to finish higher. Investors were largely in wait-and-see mode as they await the latest readings on consumer prices.

Data source: Yahoo! Finance.

Although major stocks posted solid gains, cryptocurrencies performed extremely poorly on Tuesday. News of yet another potential problem among crypto exchanges helped spur a major merger, but it didn’t reassure anyone about the seriousness of the situation.

Moreover, the latest episode raises a simple question: How many more examples of unusual circumstances involving digital assets will investors endure before they give up on a ton of cryptocurrencies once and for all? Read on to learn more about Tuesday’s crypto crash and its causes.

Fall of an empire?

The most dramatic news in digital assets centered on Sam Bankman-Fried, CEO of digital exchange FTX. Bankman-Fried also runs a cryptocurrency trading firm, Alameda Research, which fell victim to concerns about a liquidity crisis.

Although Alameda was well capitalized, a significant portion of its assets consisted of the digital asset linked to FTX, The FTX token (FTT -73.32%). When rival digital exchange giant Binance reported over the weekend that it intended to sell its holdings of the FTX Token, it raised concerns whether a resulting drop in the token’s price could cause Alameda’s liabilities to exceed the value of its assets.

Indeed, that’s how things played out, with the FTX token falling from $22 less than 24 hours ago to as low as $3.33 in the early afternoon, before recovering to around $6 by 5pm ET. But there was an added twist, in that Binance agreed to buy FTX, thereby potentially shielding exchange members from the full brunt of any liquidity crisis that could otherwise end up involving Bankman-Fried’s assets in contentious disputes related to Alameda.

A domino effect

When a stock plunges due to company-specific situations, it often has minimal impact on the overall stock market. But the ripples of what’s happening with Bankman-Fried are still spreading across the digital asset landscape. Consider:

• Bitcoin (BTC -7.65%) was down more than 10% to around $18,500, after falling below $18,000 earlier in the day.
• Ethereum (ETH -14.25%) fell 16% to $1,325.
• Solana (SUN -29.83%) fared even worse, falling 23%.

The reason crypto assets are so interconnected is that when there is a funding problem that threatens a wholesale liquidation of available assets, they almost always include holdings in some of the biggest digital tokens. In fact, many large crypto companies hold Bitcoin and Ethereum specifically to assure creditors that they will be able to handle any claims from customers or creditors as they arise.

But if the digital asset space wants to differentiate itself from other niche markets, it will eventually have to find ways to shield investors who want more conservative exposure to the industry. That is clearly not the case when even the cryptocurrencies with the longest track record of performance cannot avoid large moves lower when a single company faces a liquidity event.

There is a huge amount of innovation happening in cryptocurrencies right now, with thousands of projects aiming to find strong uses for digital assets to improve the world. When economic events like this create systemic risk, it puts all the work these projects have done at risk. Also, for some, it essentially makes cryptocurrency unworthy of an investment.