Benjamin Powers
The sudden demise of the cryptocurrency exchange FTX, which filed for bankruptcy Friday, has stunned the crypto world — and its effects are already rippling into traditional financial markets.
The stunning developments will almost certainly lead to further regulatory scrutiny of the industry. The collapse is also likely to reset the increasing investment and interest in crypto from investment banks, pension plans and other actors in traditional finance. The investors in FTX included the Ontario Teachers’ Pension Plan, the Japanese conglomerate SoftBank and the U.S. venture-capital firm Sequoia Capital.
The question now is how bad things will get. The Securities and Exchange Commission is investigating the matter, and regulators in the Bahamas have frozen the assets of FTX Digital Markets, a key FTX subsidiary based there.
“You have asset managers, investment funds and other entities that have investments in crypto companies and crypto-related companies marking those assets down,” said Howard Fischer, a former senior trial counsel at the SEC and a partner at law firm Moses and Singer. “The investors in those companies have seen their assets decrease, and there’s the potential ripple effect that will cause many people and companies and investors to be pressured to liquidate other assets to make up for the shortfall from FTX.”
The fall
The first sign of trouble at FTX came on Nov. 2, when CoinDesk broke the news that Alameda Research, a trading firm also headed by Bankman-Fried, was holding large amounts of a coin created by FTX on its balance sheet. Those large and previously undisclosed financial ties between the companies made investors uneasy and prompted a sell-off of FTX’s own cryptocurrency, FTT — which quickly spiraled into a bank run on FTX.
By Tuesday of this week, FTX had halted customer withdrawals.
The beginning of the end came Thursday, when an even larger crypto exchange, Binance, decided against bailing out its rival after signing a letter of intent to buy the company on Tuesday, pending due diligence. Binance ditched the deal after reviewing FTX’s balance sheets to determine whether the overall worth of the exchange outweighed the $6 billion hole on its balance sheets.
The relationship between FTX and Alameda has been murky for years. But on Thursday, the Wall Street Journal reported that Alameda borrowed $10 billion of FTX customers’ funds and invested them in risky propositions, creating the liquidity crisis exposed by the recent bank run on FTX.
Unlike a traditional commercial or savings bank, FTX was not insured by the Federal Deposit Insurance Corporation — a layer of protection created in response to widespread bank runs during the Great Depression. For FTX customers, this meant there was never any guarantee the exchange would have funds on hand to withdraw when those customers wanted them.
FTX investors have lost millions, and customers are selling off the balances of their frozen accounts for pennies on the dollar — and some might never see their funds again, despite Bankman-Fried’s assurances that all funds are safe.
In addition to Sequoia Capital, other major financial firms such as Galaxy Digital, Amber Group, Tiger Global and Genesis Global Trading all lost funds or have them frozen on the exchange. Edward Moya, senior market analyst at OANDA, an online multi-asset trading services, currency data and analytics platform, said that before the FTX crisis, cryptocurrencies were on a path toward legitimacy — and becoming a standard part of trading portfolios.
A reset on the horizon?
Now that’s all coming undone.
“It’s becoming clear that there was not enough regulation put in place,” said Moya. “The shutdown seems to be driven by making risky bets using clients’ money. And that story is not going to go away any time soon.”
“I’m not saying this is not all like a Lehman [Brothers] moment for everyone, but for crypto it is,” said Moya, referring to the shocking collapse of the long-standing financial services firm during the 2008 subprime mortgage crisis.
Fischer said the full effects won’t be known for some time, since the FTX situation is far from settled. “There’s going to be downward price pressure on those other assets, and they could be crypto assets or non-crypto assets,” he said.
To Howard, one of the ironies of all of this is that it will likely hasten stricter regulation of the cryptocurrency industry.
“If this was a regulated product, and this industry was treated as other financial services industries were, then regulators might have gone in the books, looked at the risk, looked at the assets and liabilities, and been able to determine that there was an issue long before it became a catastrophe,” he said.
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