The author is an independent financial commentator
The sudden collapse of crypto exchange FTX raises serious questions about the state of the crypto ecosystem. Even becoming part of the existing mainstream financial system is difficult without significant changes in how it works.
The FTX crisis, and before it crypto lenders Celsius, Voyager, hedge funds Three Arrows Capital, and digital tokens terraUSD and luna, have little to do with crypto as technology. Rather, it reveals what the financial system looks like when checks and balances are inadequate. The crypto people lash out at central banks and regulators, but they exist for good reason.
It’s still unclear what went wrong with FTX. The company’s chief executive, Sam Bankman-Fried, said it was simply a liquidity failure. But Binance, which initially agreed to buy FTX to bolster its liquidity, pulled out of the deal after looking at its books.FTX has a balance sheet hole of about $8 billion. There is a report that FTX will eventually file for bankruptcy unless someone is ready to put in a lot of capital. Investors are preparing for the worst. Sequoia Capital has already cut its investment to zero.
More worryingly, it appears that customer funds are at risk. In fact, it’s hard to understand how a balance sheet hole of this magnitude could have developed if the exchange hadn’t loaned out its customers’ money.
According to Reuters, FTX lent customer money to Alameda Research after being hit hard by the collapses of Three Arrows Capital and Voyager in May of this year. Also, the US Department of Justice and US regulators are currently investigating FTX’s relationship with Alameda, including whether customer funds may have been misused.
Unless Bankman-Fried succeeds in finding a buyer who pays close to the full amount if the customer’s money is lent out (which seems like a tough order), customers on FTX’s international exchanges will have a significant share of the money. seems to lose As FTX attracts retail traders and encourages the public to deposit wages into their accounts, some — perhaps many — will suffer hardships as a result.
FTX is not the first crypto company to go bankrupt amid allegations of token collapse, bank run and use of customer funds. show similar characteristics. Underlying these failures are her four major weaknesses in the crypto ecosystem.
• Inter-firm interrelationships in the form of cyclical lending practices such as opaque cross-holdings and rehypotheses. Rival crypto exchange Binance held a significant stake in FTX’s native token, FTT. When we announced that we were going to sell our holdings, people rushed to sell FTT and try to withdraw money from FTX.
• Relying too much on individuality. Cryptography was supposed to eliminate the need for trust between people.”Don’t trust, verify” was the motto. But the whole system now seems to rely on a few big people trusted by thousands, Bankman-Fried being one of them. He has built a huge empire in a short period of time and has provided a lot of money to the cause. He seemed like a nice guy. So people trusted him with money. Investors in particular have shown a surprising willingness to back his venture without the usual financial due diligence.
• concentration. There are not many major cryptocurrency exchanges or banks, and the people who run them all know each other and invest in each other’s companies. Once they board, everything is fine.However, when they fall they can do immense damage. Tweet From the CEO of Binance, spur a run to beat your biggest rival. But that’s what happened.
• Opacity. Crypto was supposed to improve the transparency of financial transactions. However, cryptocurrency companies such as FTX have been largely undisclosed about their financial situation. This is far less than you would expect from a traditional bank. Uncertainty for Bankman-Fried companies FTX and Alameda was exacerbated by complex corporate structures, intercompany transfers, and the reported use of native token holdings to boost their balance sheets.
These problems are familiar to anyone who has studied the history of financial panics and banking crises. They seem to be unique to the financial system. Ciphers showed it was the same.
For cryptocurrencies to have a future as mainstream financial instruments, they need to embrace the regulations and controls that make the financial system safe for investors, creditors and depositors.
