Not long ago, FTX was one of the world’s largest cryptocurrency trading platforms. Founded in 2019, the Bahamas-based crypto exchange enjoyed a meteoric rise, being valued at more than $30 billion earlier this year.
All this has changed in the last two weeks. First, concerns emerged about links between FTX and an asset trading firm called Alameda Research, including suggestions that clients’ funds had been transferred from FTX to Alameda.
A few days later, rival firm Binance (the largest crypto exchange) announced that it would sell its holdings of FTT tokens, a crypto that reportedly comprises much of Alameda’s assets.
Panicked customers rushed to withdraw money from FTX and the company is now on the brink of collapse, with a banner message on its website announcing that it is “currently unable to process withdrawals”.
This isn’t the first such rapid disintegration we’ve seen in the loosely regulated world of cryptocurrency, and it’s unlikely to be the last.
No rescuers in sight
The majority owner of both FTX and Alameda, Sam Bankman-Fried, had bailed out other troubled crypto companies earlier this year. Now he is now desperately looking for an investor with a lazy $8 billion to save his companies.
Many firms have already written down the value of their holdings in FTX. So it won’t be easy for Bankman-Fried to find investors willing to put in new funding.
Binance was thinking of taking over the troubled company outright. It decided against, citing concerns about allegations of misconduct and an investigation by the US Securities and Exchange Commission.
The price of FTT has now fallen. A week ago it was trading for $24. Now it is under US$4.
Careful lessons
Trading in “assets” without underlying fundamental value on loosely regulated exchanges will always be a very risky venture. For many, it will probably end in tears.
Read more: What is Bitcoin’s Fundamental Value? That’s a good question
Other types of assets are different. The company’s shares have a fundamental value based on the dividend (or at least an expected future dividend) paid out of the company’s profits. Property has a fundamental value that reflects the rent the investor earns (or the owner saves). The value of a bond depends on how much interest it pays. Even gold has at least some practical uses, for jewelry, dental fillings, or electronics.
But so-called cryptocurrencies such as Bitcoin, Ether and Dogecoin (and thousands of “alt-coins” and “meme-coins”) have no such fundamental value. They are a game of sending the package, where speculators try to sell them to someone else before the price collapses.
Unregulated financial institutions are at risk of what amounts to a Depression-style “bank run.” When doubts arise about their soundness, each person has an incentive to be early in line to withdraw their money before it runs out.
Read more: Cryptocurrencies are great for gambling – but lousy at freeing our money from big central banks
In a recent interview, Bankman-Fried described his business model as appearing to rely heavily on funds injected by new investors, rather than on future returns based on the intrinsic value of the assets themselves.
Impact on crypto
These events have further eroded confidence in the crypto ecosystem. Before this latest fiasco, the “value” of cryptocurrencies had already fallen from a peak of more than $3 trillion to $1 trillion. It has now fallen even lower.
Just as a few stars like Amazon emerged from the wreckage of the dot-com bubble, it is possible that only a handful of applications of the blockchain technology that underpins crypto will have lasting utility.
And the idea of an electronic form of currency is realized in the form of central banks’ digital currencies. But as Hyun Song Shin, the chief economist of the Bank of International Settlements, put it, “anything that can be done with crypto can be done better with central bank money”.
