This year was truly a shock for many, and this is not only about geopolitics but also about the situation in the cryptocurrency market. Crypto investors lost more than $2 trillion in a year. First Terra/Luna, now FTX shock.
I will try to tell you, without panic, what happened, what preceded it, and what can be expected.
Let's start with the fact that the cryptocurrency market is rarely calm, but the storm of 2022 turned out to be brighter than most of the previous ones.
In this regard, many investors immediately lost billions of dollars. Each negative event entailed a wave of new bankruptcies, and the loudest of them was the bankruptcy of the FTX crypto exchange.
Why am I writing about this? Not because it is terrible in itself, this is a business, and in principle, it is impossible for everyone to develop only successfully.
But! These developments undermine confidence in the industry, which, let me remind you, arose precisely because of the loss of faith in traditional financial institutions after the 2008 crisis.
Some investors reacted to the bankruptcies with calls for fair regulation. The rest blame intermediaries and say the recent turmoil should speed up the transition to decentralized platforms.
An Excursion Into History. What Happened to the Cryptocurrency Exchange Rate?
Having peaked in November 2021, the total capitalization of crypto assets fell by 73% over the next 12 months. What do we see now?
In percentage terms, the collapse was less deep than during the 2018 crypto winter (-84%). But he burned far more investor money—over $2 trillion.
What I want to draw attention to in this picture. If previous fluctuations in the cryptocurrency market were caused by problems within the industry itself, then the current chaos began with an external factor.
I mean, a surge in inflation and an increase in interest rates by central banks. This, in turn, reduced investor appetite for high-risk, high-yield assets, in particular cryptocurrencies.
Why Is This Important, and What Does It Entail?
The crisis in the cryptocurrency market has not only deprived someone of some investment but also destroyed the beliefs of many investors that cryptocurrencies, like gold, have the status of a “haven”, since they are allegedly not associated with traditional financial assets.
It turned out that the sharp rise in the rate of cryptocurrencies in recent years rested on a shaky foundation: many investors took out large loans and invested in tokens and crypto projects, and other cryptocurrencies were often used as collateral.
This relationship reinforced the effect of high-profile bankruptcies. This could be my recommendation for prudence when creating an investment portfolio, but that's not what we're talking about now.
What Led to the Collapse?
The collapse of the FTX crypto exchange was preceded by several other major bankruptcies, which led to the fact that investors begin to lose faith in the entire market.
TerraUSD, which has already set everyone on edge, has become the “first sign”. To peg to the dollar, its creator, Do Kwon, used complex links with the mother token Luna.
Next - TerraUSD “killed” Alameda Research, a cryptocurrency trading company founded in September 2017. Attention, by whom? That's right, by Sam Bankman-Fried and Tara Mac Aulay.
They wanted to cash in on the project by shorting Luna. But they dug a hole for themselves, bringing down the entire market and getting their other long positions liquidated.
In turn, companies that invested in TerraUSD-related tokens and derivatives, such as Three Arrows Capital, went bankrupt. Other companies "fell" along the chain, for example, Voyager Digital, which provided Three Arrows with a large loan.
What’s the Deal With FTX?
In November, another shock occurred - the collapse of the crypto-empire of Sam Bankman-Fried himself, the youngest billionaire, who charmed investors, journalists, and government officials.
One of the largest exchanges – his FTX has burst. Now, when analysts are trying to get to the bottom of the reasons for the collapse of the Sam Bankman-Fried crypto empire, everyone is beginning to understand that alarm bells were heard from everywhere.
But no one heard them (or did not want to).
Sam Benkman-Fried's success story was almost perfect. In just three years, FTX has gone from zero to a $32 billion company and is now back to zero.
And in a few days, the man who saved other cryptocurrency projects and became the face of the industry at conferences and on Capitol Hill lost a fortune of $ 15.6 billion. As a result, FTX went bankrupt, as I said, trying to bail out Alameda Research, a trading firm owned by Bankman-Fried.
What did it entail? What can be distinguished from the brightest events? The collapse of FTX caused problems for cryptocurrency broker Genesis, leaving them with a massive $3 billion hole in their balance sheet.
Genesis Trading is one of the big parts of the Grayscale trust equity lending market that has been stuck with debt for already bankrupt 3AC, BlockFi, and Celsius. Sadly, they all went down in history with clients' money.
And they used in their chains schemes with scrolling and re-pledge of ETHE and GBTC shares. And, unfortunately, the dissolution of the Grayscale trusts, which is the largest public BTC hodler in the world, may be required.
What Are the Consequences of the Crisis?
Terra's critics (including me) said the platform was doomed to fail because it attracted investors with unacceptably high-interest rates.
The thing is that Terra and other highly profitable DeFi projects have become another reincarnation of financial pyramids, where the first investors receive huge income by attracting new participants.
The collapse of FTX showed that even seemingly reliable crypto businesses can have hidden flaws.
He also exposed the danger of crosstalk, where the problems of one part of an industry spread unexpectedly quickly to others, causing huge losses.
Unfortunately, all this can temporarily slow down investments in cryptocurrencies and reduce the level of trust in them.
Someone can say that proof of reserves comes to the rescue - a system for confirming reserves. At first glance, it is fine, it shows the number of assets the exchange has, but does not show liabilities to manufacturers.
In my opinion, any exchange that gives APY on credit products above 10% is playing with users' money, because there is nowhere else for such rates to appear.
So, if you see “tasty” annual rates on the exchange, 15-20-30%, please know that at any moment the exchange can lose like FTX, and you need to run from there as soon as possible.
And right now, go to the exchange you work with website, and take a look at how many products and many APY it offers. And after the analysis, if necessary, run away if it isn't too late.
What Does All This Mean for the Cryptocurrency Market’s Future?
Cryptocurrencies arose because people didn't trust Wall Street. But a series of bankruptcies of crypto companies raises a logical question: can cryptocurrencies now be trusted?
A lot of us hope, and I am among those who harbor hopes, that confidence will be restored when the state introduces fair market regulation.
But the FTX bankruptcy appears to have derailed the regulatory bill that Bankman-Fried had lobbied hard for.
This document was opposed by some owners of DeFi platforms, who believed that the law only takes into account the interests of large centralized exchanges, including FTX.
What's next? Conceptually, I am one of those people who see every crisis as an opportunity, no matter how trite it may sound.
I believe that this picture will teach us to weigh the risks (although all of them, of course, cannot be weighed) and provide ground for developing better and more appropriate aspects of regulation.
Sound regulation can eventually make cryptocurrencies a more stable and trustworthy asset.
At the same time, it is not yet clear which part of the industry participants will undergo strict face control by regulators, and what consequences this exit from the market will entail.
Photo by Hadija Saidi on Unsplash