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FTX collapse shatters trust in cryptocurrency
The collapse of FTX, which just two weeks ago was the world’s fifth largest cryptocurrency exchange, has raised serious doubts regarding the trustworthiness of the already contentious asset class.
Founded by Sam Bankman-Fried and headquartered in the Bahamas, the exchange entered Chapter 11 bankruptcy proceedings in the US last week after allegedly misappropriating customer deposits.
The origins of the exchange’s downfall source back to trading firm Alameda Research, also owned by Bankman-Fried, which had taken out loans to make private equity and crypto investments. When the loans were recalled due to falling crypto prices, Bankman-Fried allegedly used customer funds from the exchange to satisfy lenders.
The funds were secured against FTT, a token issued by FTX. The misappropriation claims stem from a report published this month by CoinDesk revealing Alameda’s reliance on the token for collateral and consequent solvency concerns.
When the chief executive of Binance, another crypto exchange, said it would liquidate US$580 million in FTT, investors panicked and rushed for the exit, causing a run on FTX. The exchange did not have sufficient assets to satisfy redemptions, with the gap estimated to be as high as US$8 billion. Customers are now unable to withdraw funds.
FTX’s downfall adds to a growing list of cryptocurrency casualties this year, including the TerraUSD stable-coin, crypto lenders Celsius Network and Voyager Digital, and hedge fund Three Arrows Capital.
Trust evaporates
The meltdown has reverberated throughout the entire crypto landscape. Bitcoin is down 20 per cent. Ethereum has fallen 22 per cent. The chief executive of Crypto.com, another exchange, hosted a live stream to address customers’ concerns over liquidity.
Notwithstanding the risk of contagion, the bigger talking point goes right to the heart of crypto itself: is decentralisation truly a better way to establish trust?
The primary appeal of crypto is its decentralised nature. No one person or institution controls the system. It takes power away from incumbent financial pillars such as monetary authorities, banks and governments and puts it into the hands of users.
However, the events at FTX have only strengthened the argument for regulation according to S&P Global, which says more rigorous oversight is on the horizon.
“The rapid deterioration of one of the largest crypto exchanges will likely sharpen policymakers’ resolve to address investor protection, market conduct and financial stability,” the ratings agency said in a November 10 report calling the FTX collapse a “severe blow to the crypto industry’s credibility”.
Locally, the Australian Securities and Investments Commission is already closely scrutinising funds available to retail investors. Last month the the corporate regulator issued interim stop orders on three cryptocurrency managed funds after finding target market determinations were noncompliant.
Noelle Acheson, former head of research at Genesis Trading, acknowledged the FTX debacle is a stain on the broader crypto industry but believes crypto will reemerge stronger. She highlighted firms working with policymakers to draft better disclosure rules and institutions stepping away from ‘radical innovation’.
“Several platforms have announced that they will publish proof of reserves, a combination of cryptographic and traditional audit that enables users to independently verify that a platform’s assets match or exceed customer deposits,” Acheson wrote in her Crypto Is Macro Now newsletter.
Investor scrutiny
S&P Global also said the importance of governance will again come to the fore. FTX was one of the most well-regarded institutions in the space. Bankman-Fried himself was a leading force in advocating for more regulation.
Despite this, the FTX board consisted of just three members: Bankman-Fried, a now-former FTX employee and an attorney based in Antigua and Barbuda.
The role of investors will also come into question given in January FTX raised US$400 million at a US$31.6 billion valuation. Prior funding rounds were supported by a host of blue-chip institutions including SoftBank, Tiger Global, Sequoia, Singapore sovereign wealth fund Temasek and Canadian pension fund Ontario Teachers’ Pension Plan.
“In the future, venture capital investors, some of whom will have a bit of uncomfortable explaining to do over the coming weeks, will become more rigorous in their due diligence, at least until the next hot fad comes along,” Acheson said.
