Crypto meltdown

FTX underlines the risk of unregulated markets

The meltdown of the FTX cryptocurrency exchange has set some sort of record in terms of sheer speed. It may put more pressure on an already bearish cryptocurrency market. A week or so ago, the founder of FTX, Sam Bankman-Fried (SBF), was reckoned to be worth several billion due to his holdings in FTX and in crypto hedge fund Alameda Research. In the wake of the bankruptcy, SBF’s fortune has just evaporated and he may also be criminally liable. In January this year, FTX had over a million registered users. It was the second-largest crypto-trading exchange trading billions of dollars daily. Apart from trades in over 80 cryptocurrencies, it offered popular, innovative derivatives such as perpetual futures, and bets on real-world events like elections. It also used to issue a cryptocurrency FTT, run on an Ethereum blockchain. FTT could be redeemed in fiat. It saw rapid value inflation and rising popularity because FTT-denominated trades received big discounts on service charges.

Meanwhile, Alameda, supposedly an entirely separate legal entity, suffered heavy losses in June, and needed a large fund infusion. FTX had around $15 billion of customer funds in deposits and is believed to have lent more than half of that amount to Alameda. In early November, the balance sheet of Alameda was leaked. This loan, and the co-mingling of other assets controlled by FTX, became publicly known. Binance, which is the world’s largest crypto-trading exchange, then decided to redeem a large position in FTT. Other nervous investors did the same. FTX did not have the liquidity to meet FTT redemption demands and there was a run. Binance then made an abortive bid to buy FTX and pulled back after due diligence. Since then, it’s been a free fall for FTX. The exchange’s collapse and its filing for bankruptcy have led to every cryptocurrency asset taking a hammering. Bitcoin, which traded at above $69,000 in November 2021, is now down to $17,000. Ethereum, which was traded at above $4,600 a year ago, is now at $1,260. Other cryptocurrencies have suffered equally dramatic pullbacks or more.

The crypto market turned bearish in 2022 after it became apparent the Fed and other central banks were going to tighten money supply and traders sought less risky assets. The spike in crude oil and gas prices caused by the Ukraine War has also meant power shortages and higher power tariffs. This has affected the creation of Bitcoin and other cryptocurrencies, since the “mining” process is power-intensive. Thus, along with mundane commodities such as chips and industrial metals, the supply chain in virtual currencies has been disrupted. The past three years have been a roller-coaster for cryptocurrencies. Traders embraced these assets during the pandemic while central banks kept interest rates low and thus encouraged risk-taking. It appeared for a while as though crypto was a hedge against uncertainty.

But the moment interest rates started rising, traders sold these assets down, indicating that these virtual assets are not really a hedge against inflation, whatever else they are. The speed of the collapse also indicates the lack of “anchor” to any real asset leads to higher volatility. The FTX meltdown was triggered by malfeasance — financial exchanges are not supposed to lend out customers’ assets. But the ensuing turmoil may lead to a sober and pessimistic reappraisal of crypto as an asset class.