What To Make Of This Week’s Crypto Meltdown

Bitcoin was having a relatively stable second half of 2022. Since mid-June it even traded up while stocks and bonds broadly fell. That changed this week as the major cryptocurrency exchange, FTX International, hit solvency issues.

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lost about of quarter of its value. FTX International is now in jeopardy. Earlier this year FTX was airing Superbowl ads starring Larry David, included Tom Brady among its high-profile investors and was valued at over $30 billion. Now it’s rumored to have a major hole in its balance sheet. A banner across the international crypto trading site reads “FTX is currently unable to process withdrawals. We strongly advise against depositing.”

A trading platform should not have a billion dollar hole in its balance sheet. Sequoia have written down their FTX stake to zero. Binance were looking at acquiring FTX in the midst of the chaos, but ultimately declined. Crypto is often volatile, but this has been a particularly bad week.

How Did This Happen?

The initial issue appears to be Sam Bankman-Fried’s trading firm Alameda Research holding significant holdings in FTT. FTT is cryptocurrency issued by his trading firm FTX.

While there was nothing necessarily wrong with such cross-holdings, it creates risk. The disclosure of a large cross-holding made other holders of FTT nervous, including apparently Binance. If a major holder of FTT was a partner firm, and not a diverse set of investors, then maybe the asset wasn’t as robust as it appeared. Selling ensued, and FTT’s price fell precipitously losing over 90% in just a few days.

Dramatic falls in FTT’s value, then appeared to cause solvency issues at FTX. This implies that FTX was taking far more risk than you would expect from a customer trading platform. There also suggestions that FTX is under investigation from various U.S. regulators.

As this was occurring, there was then a general decline in other crypto assets and associated companies.

What Next?

You might not expect the collapse of an exchange to drag down the assets that trade on that exchange. However, that’s what we’ve seen this week. In part because FTX also created a major token in FTT and may have had substantial holdings in it too. Also Sam Bankman Fried, CEO of FTX, is a key player in crypto. His firms were expected to pioneer, not fail. Confidence in crypto has been shaken. He frequently talked about the transparency that cryptocurrency offered, but now his major firm may be bankrupt, perhaps due to lack of transparency.

Much of cryptocurrency is about confidence given the emerging nature of the industry. The apparent collapse of FTX, which was a major player in cryptocurrency trading increases fear and doubt. It’s possible FTX customers may end up losing money depending on how their accounts were managed.

The Fate Of FTX US

There is a separate entity FTX US which was used by U.S. investors, based in Miami, whereas the FTX entity was based in the Bahamas. The ultimate impact on FTX US customers remains to be seen, whereas FTX is issuing clear warnings to customers not to deposit funds.

More Regulation

If customers do lose money, then further cryptocurrency regulation could be coming. Cryptocurrencies were founded on the the idea of the decentralized model of trust 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, shouldn’t jeopardize the broader cryptocurrency landscape. Still, it’s easy to see why trust has been shaken, and the relative size of FTX does mean that many industry participants are directly impacted.

Cryptocurrencies weren’t having a good 2022 prior to this and it just got worse. However, remember that volatility is not unusual, the past 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 isn’t too unusual compared to recent history.