For crypto investors, this entire week has been a rollercoaster ride. The market first felt despair on the news of FTX’s liquidity crunch. Then market participants hoped Binance-FTX would push the market to a rally, but the opposite has happened. Whether the deal will eventually fructify or not is still unclear but Binance is less likely to buy FTX, given its poor financial performance. Resultantly, FTT token has suffered a precipitous drop, losing close to 73% of its value.
Silver lining amid free fall of Bitcoin, other currencies
Last time Bitcoin touched the $17,500 mark was November 2020. The market cap of this leading cryptocurrency has gone down to around $336.6 billion, a far cry from it’s all-time high of $1.28 trillion. Having said that, there is a silver lining in the clouds as well. Bitcoin took just a year to jump to an all-time high of $69,000 from its November 2020 low prices.
Heavy shorting is prevalent in the market and more than 402,000 traders have ended up losing over $870 million since November 8. Apart from Bitcoin investors, Ethereum (ETH) traders were down $233.2 million while Solana (SOL) traders became poorer by $56.6 million. Meme cryptocurrency DOGE fell nearly 7% amid the crash while BNB, the native cryptocurrency of Binance, dropped nearly 10%. Currently, the dominance of Bitcoin is around 41% and Ethereum’s is occupying close to 14%.
The Alameda Research meltdown hit Solana hard
The news of Alameda Research, also founded by Sam Bankman-Fried winding down trading operations, added more despair. As evidence emerged that FTX used FTT Token for $4B Bailout of Alameda in September, traders found their confidence thinning. Alameda Research going down hit Solana particularly, which has close ties with FTX, thanks to the exchange’s investment in the blockchain network.
CoinDesk reported on June 30 that 40% of Alameda’s balance sheet was made up of a $5.8B stash of FTT, including $2.2B used as collateral for some of its $7.4B in loans. In the light of such revelations, it wasn’t surprising that SOL nosedived 43% in a very short time.
Holes in FTX business model
Pundits are out analyzing what went wrong in the FTX business model. It will be useful to see what Changpeng Zhao had to say about it. CZ, as everyone calls him, highlighted two weaknesses in FTX’s business model. These were to use their own token as collateral and borrowing. Had FTX got a proper large reserve, the meltdown wouldn’t have happened.
Interestingly, it was Bankman-Fried, who had warned about some crypto exchanges that were secretly insolvent. He was the one who helped troubled digital currency platforms BlockFi and Voyager Digital keep floating. Bankman-Fried had taken an altruistic stand then, stating that he was willing to do a somewhat bad deal for the sake of stabilizing things. But some viewed him as a smart capitalist, who was trying to make his profits in a beleaguered crypto market.
Lack of regulatory foresight leads to self-harming behaviour in crypto enterprises
Apart from the Big Four exchanges – Binance, Coinbase, FTX, and Kraken – there are around 600 crypto exchanges round the globe in a largely unregulated environment, which makes them vulnerable to scammers. KuCoin, Seychelles-based exchange, was breached for $275 million in 2020, while in December 2021 Cayman Island-based Bitmart lost $200 million. Back in 2016, Bitifinex was hacked to the tune of nearly 120,000 bitcoin worth $2.5 billion now.
As Forbes reported, the digital asset exchange business has no internal mechanism to certify a new entity that joins their platform. There is no regulatory oversight of their own functioning or the reserves they maintain. This culminates into a faulty ecosystem where project owners might go overboard with their growth plans or a third party might exploit the vulnerability. When projects fail, it might lead to a bloodbath as happened in the case of Binance-FTX.
Exchanges and even crypto projects in general tend to create and draw the euphoria of rising crypto prices. Talking about exchanges, they usually up the ante by offering customers generous yields for deposits. BlockFi and Voyager were doling out yield payments to customers, which was often upwards of 12% per year. Exchange raised the funds needed by charging more interest to borrowers or working the money towards decentralized finance or DeFi applications. The strategy clicked when crypto was steadily going up. But when winds are not favorable, such policies could result in projects leaking money.
Regulatory oversight and institutional adoption of crypto
Framing in an adequate regulatory environment will help create an environment where projects following legitimate practices get rewarded and violators punished. It will discourage project owners from following short-sighted policies that might help them in the long run. Governments taking a positive approach to the budding cryptoverse and a cooperative industry is an ideal scenario for all stakeholders.
Proper regulatory environment will also lead to institutional adoption of crypto, which is so important for crypto going mainstream. This development will unlock the value potential of crypto. It will result in business organizations exploring ways to integrate crypto assets into their ecosystems. Stock exchanges adding digital currencies will bring in unprecedented levels of liquidity.
What the future holds
Crypto prices have always been unpredictable and the Binance-FTX saga is only going to add to the uncertainty quotient. There is little time left in 2022 and a recovery is unlikely. How it will turn out depends on a string of factors, particularly the approach of regulators and institutional adoption of cryptocurrencies. Investors are expected to position defensively unless there are clear signs of a rally.
Sharp declines in crypto prices notwithstanding, as the industry is witnessing now in the FTX saga, digital assets will have great acceptance in the coming days. The speed of adoption will be faster in countries that are willing to assimilate innovation, while conservative countries will take longer to accept digital assets. Having said that, one can reasonably predict that cryptocurrencies will launch a comeback.
The author is Founder & Chief Associate, CDP Tech Tweeters
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)