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Friday, December 9, 2022

Why You Shouldn’t Be Surprised That FTX Collapsed

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Not long ago, FTX was one of the world’s largest trading platforms for cryptocurrencies. Founded in 2019, based in the Bahamas crypto exchange had a meteoric rise to fame, and was valued at over US$30 billion earlier this year.

That has all changed in the past two weeks. First, concerns emerged about links between FTX and an asset trading company called Alameda Research, including: suggestions that customers’ funds have been transferred from FTX to Alameda.

A few days later, rival firm Binance (the largest crypto exchange) announced it would sell its holdings of FTT tokens, a crypto that reportedly comprises a large portion of Alameda’s assets.

Panicked customers rushed to withdraw funds from FTX, and the company is now on the brink of collapse, with a banner post on its website announcing that it “cannot process withdrawals at this time”.

This isn’t the first like this rapid disintegration we’ve seen in the loosely regulated world of cryptocurrency, and it’s unlikely it will be the last.

No rescuers in sight

The majority shareholder of both FTX and Alameda, Sam Bankman Fried, had bailed out other troubled crypto firms earlier this year. Now he’s desperate now looking for an investor with a lazy $8 billion to save his companies.

Many companies have already written off the value of their interest in FTX. It will therefore not be easy for Bankman-Fried to find investors who want to bring in new financing.

Binance was thinking about acquiring 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 at US$24. Now it’s at less than US$4.

careful lessons

Trading “Assets” with no underlying fundamental value on loosely regulated exchanges will always be a very risky business. For many, it will probably end in tears.

Other asset types are different. Company stock has a fundamental value based on the dividend (or at least an expected future dividend) paid out of the company’s profits. Real estate has a fundamental value that corresponds to the rent the investor earns (or the owner-occupant saves). The value of a bond depends on the amount of interest it pays. Even gold has at least some practical uses, for jewelry, dental fillings or electronics.

But crypto currencies like Bitcoin, Ether, and Dogecoin (and thousands of other “alt” and “meme” coins) don’t have such fundamental value. It is a game where speculators try to sell them to someone else before the price collapses.

Unregulated financial institutions are prone to the equivalent of a depression-style ‘bank run’. Once doubts arise about their soundness, each person has an incentive to line up early to withdraw their funds before they run out.

In a recent interviewgave Bankman-Fried a description of his business model which he seems to rely heavily on funds injected by new investorsrather than on future returns based on the net asset value of the assets themselves.

Impact on crypto

These events have further eroded confidence in the crypto ecosystem. Prior to this latest fiasco, the “value” of cryptocurrencies had already fallen from a peak of over US$3 trillion to US$1 trillion. It now has fell even lower.

Just as a few stars like Amazon have emerged from the wreckage of the dotcom bubble, only a handful of uses of the blockchain technology underlying crypto may have lasting use.

And the idea of ​​an electronic form of currency is realized in the form of central bank digital currencies. But as Hyun Song Shin, the chief economist of the Bank of International Settlements, put it“Everything that can be done with crypto, can be done better with money from the central bank”.

This article was republished from The conversation under a Creative Commons license. Read the original article.

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