What to do with this week’s Crypto Meltdown
CEO of FTX Trading Limited Sam Bankman-Fried speaks during a house committee about … [+]
Bitcoin had a relatively stable second half of 2022. Since mid-June, it has even traded up while stocks and bonds mostly fell. That changed this week when the major cryptocurrency exchange, FTX International, ran into solvency problems.
Bitcoin
A trading platform should not have a billion hole in its balance sheet. Sequoia has written down its FTX stake to zero. Binance looked at acquiring FTX amid the chaos, but ultimately declined. Crypto is often volatile, but this has been a particularly bad week.
How did this happen?
The first problem appears to be Sam Bankman-Fried’s trading company Alameda Research which has significant holdings in FTT. FTT is cryptocurrency issued by his trading firm FTX.
Although there was nothing necessarily wrong with such cross-holdings, it creates risk. The revelation of a large cross-holding made other holders of FTT nervous, including apparently Binance. If a major holder of FTT was a partnership firm, and not a diverse set of investors, then perhaps the asset was as robust as it appeared. Selling followed, and FTT’s price plummeted, losing over 90% in just a few days.
Dramatic falls in FTT’s value appeared to cause solvency problems at FTX. This means that FTX took far more risk than you would expect from a customer trading platform. It is also suggested that FTX is under investigation by various US regulators.
When this happened, there was a general decline in other crypto assets and affiliates.
What now?
You might not expect the collapse of a stock exchange to drag down the assets traded on that stock exchange. However, that’s what we’ve seen this week. Partly because FTX also created an important token in FTT and may have had significant stakes in it as well. Sam Bankman Fried, CEO of FTX, is also a key player in crypto. His firms were expected to be pioneers, not failures. Confidence in crypto has been shaken. He often talked about the transparency that cryptocurrency offered, but now his big company may be bankrupt, perhaps due to a lack of transparency.
Much of cryptocurrency is about trust given the emerging nature of the industry. The apparent collapse of FTX, which was a major player in cryptocurrency trading, is raising fears and doubts. It is possible that FTX customers could end up losing money depending on how their accounts were managed.
The fate of FTX US
There is a separate entity FTX US that was used by American investors, based in Miami, while the FTX entity was based in the Bahamas. The final effect on FTX US customers remains to be seen, while FTX is issuing clear warnings to customers not to deposit funds.
More regulation
If customers lose money, further cryptocurrency regulation may come. Cryptocurrencies were founded on the idea of the decentralized trust model that the blockchain offers. However, the case of FTX shows that things can still go wrong. We don’t yet have all the details.
The potential collapse of an exchange should not jeopardize the broader cryptocurrency landscape. Still, it’s easy to see why confidence has been shaken, and the relative size of FTX means that many industry participants are directly affected.
Cryptocurrencies were not having a good 2022 before this, and it only got worse. However, keep in mind that volatility is not uncommon, the last 2 years for Bitcoin have seen 9 months of double digit percentage declines, but also 8 months of double digit percentage gains. This month may seem extreme, but for Bitcoin the volatility is not that unusual compared to recent history.
