The spectacular collapse of a $30 billion crypto exchange should come as no surprise

All that has changed in the last two weeks. First, concerns emerged about the relationship between FTX and an asset-trading firm called Alameda Research, which included suggestions that clients’ funds had been moved from FTX to Alameda.

A few days later, rival firm Binance (the largest crypto exchange) announced that it would be selling its holdings of FTT tokens, a crypto that reportedly comprises most of Alameda’s assets.

Panicked customers rushed to withdraw funds from FTX, and the company is now on the verge of collapse, with a banner message on its website announcing that it is “currently unable to process withdrawals”.

This isn’t the first such rapid disruption we’ve seen in the loosely regulated world of cryptocurrency, and it’s unlikely to be the last.

no rescuers in sight

The majority owner of both FTX and Alameda, Sam Bankman-Fried, rescued other troubled crypto companies earlier this year. Now he is looking for a lazy investor of $8 billion to save his companies.

Several firms have already written off the value of their stake in FTX. So it won’t be easy for Bankman-Fried to find investors willing to invest in the new fund.

Binance thought of taking over the troubled company outright. It decided against it, citing concerns about allegations of misconduct and an investigation by the US Securities and Exchange Commission.

The price of FTT has dropped now. A week back it was trading at US$24. Now it’s under US$4.

careful lesson

Trading in “assets” with no underlying fundamental value on loosely regulated exchanges is always a very risky endeavor. For many, this is likely to end in tears.

Other types of assets are different. Company shares have a fundamental value based on dividends paid out (or at least an expected future dividend) from the company’s profits. Real estate has a fundamental value that reflects the rent the investor earns (or the owner-occupier saves). The value of a bond depends on the amount of interest it pays. Even gold has at least some practical uses, be it for jewellery, teeth fillings or electronics.

But crypto so-called currencies such as bitcoin, ether and dogecoin (and thousands more “alt-coins” and “meme-coins”) have no such fundamental value. They are a game of pass-the-parcel, in which speculators try to sell them to someone else before the price drops.

Unregulated financial institutions are prone to the equivalent of a Depression-style “bank run”. Once doubts arise about their soundness, everyone is encouraged to queue to get their money back before the money runs out.

In a recent interview, Bankman-Fried details its business model that relies heavily on the money poured in by new investors, rather than future returns based on the intrinsic value of the asset.

effect on crypto

These incidents have further reduced trust in the crypto ecosystem. Prior to this latest fiasco, the “value” of cryptocurrencies had already fallen from a peak of over US$3 trillion to US$1 trillion. It has dropped even lower now.

Just as some stars like Amazon have emerged from the rubble of the dot-com bubble, so it is possible that only a handful of the blockchain technology underpinning crypto may have lasting utility.

And the idea of ​​an electronic form of currency is being realized in the form of central bank digital currencies. But as Hyun Song Shin, chief economist at the Bank of International Settlements, put it, “anything that can be done with crypto can be done better with central bank money”.

John Hawkins is a friend of conversation. Senior Lecturer, Canberra School of Politics, Economics and Society, University of Canberra