Not long ago, FTX was one of the largest cryptocurrency trading platforms in the world. The Bahamas-based crypto exchange, which was founded in 2019, rose to prominence quickly and was valued at more than USD 30 billion earlier this year.
Everything has shifted in the last two weeks. First, there were questions raised concerning connections between FTX and an asset-trading firm named Alameda Research, including allegations that customer cash had been transferred from FTX to Alameda.
A few days later, competing firm Binance (the largest crypto exchange) stated it will sell its holdings of FTT tokens, a cryptocurrency that purportedly accounts for a large portion of Alameda’s assets. Customers panicked and raced to withdraw funds from FTX, and the company is now on the verge of bankruptcy, with a banner message on its website announcing that it is “temporarily unable to process withdrawals.”
This isn’t the first time we’ve seen such a quick implosion in the unregulated world of cryptocurrencies, and it’s unlikely to be the last. Sam Bankman-Fried, the majority owner of both FTX and Alameda, had rescued other ailing cryptocurrency startups earlier this year. He is now desperately seeking an investor with a sluggish $8 billion to save his companies.
Many companies have already written down the value of their FTX holdings. As a result, it will be difficult for Bankman-Fried to find new investors. Binance considered taking over the troubled company entirely. It decided against it, citing concerns about allegations of misconduct and a US Securities and Exchange Commission investigation.
The cost of FTT has now dropped dramatically. A week ago, it was worth USD 24. It is currently less than USD 4. Trading in “assets” with no underlying fundamental value on illiquid exchanges is always a high-risk proposition. Many people are likely to cry as a result of it.
Different types of assets exist. The fundamental value of a company’s shares is based on the dividend (or, at the very least, an expected future dividend) paid from the company’s profits. The fundamental value of the real estate is reflected in the rent earned by the investor.
A bond’s value is determined by the amount of interest it pays. Even gold has some practical applications, such as jewelry, dental fillings, or electronics. However, cryptocurrencies such as Bitcoin, Ether, and Dogecoin do not have such fundamental value. They’re a pass-the-parcel game in which speculators try to sell them to someone else before the price falls.
Unregulated financial institutions are vulnerable to the equivalent of a “bank run” of the 1930s. When doubts about their soundness arise, each person has the incentive to be the first in line to withdraw their money before it runs out. Bankman-Fried described his business model in a recent interview, which appears to rely heavily on funds injected by new investors rather than on future returns based on the intrinsic value of the assets themselves.
Impact on cryptocurrency
These incidents have eroded trust in the cryptocurrency ecosystem even further. Prior to this latest shambles, the “value” of cryptocurrencies had already plummeted from a high of more than USD 3 trillion to less than USD 1 trillion. It is now even lower.
Just as a few dot-com stars emerged from the ruins of the dot-com bubble, it is possible that only a few applications of the blockchain technology that underpins cryptocurrency will have long-term utility. And, in the form of central bank digital currencies, the concept of an electronic form of currency is being realized.
However, as the Bank of International Settlements’ chief economist, Hyun Song Shin put it, “everything that can be done with crypto can be done better with central bank money.” Mr. Bankman-Fried was still worth nearly $16 billion at the beginning of the week. The massive devastation is regarded as one of history’s greatest destructions of wealth.
Bankman-Fried may own assets that are not included in the Bloomberg index. Last year, Alameda made around $1 billion in profits, while FTX made hundreds of millions more.
Sources reported, he has more than $500 million invested in funds managed by Sequoia and other venture capital firms. He is also a shareholder in media startup Semafor. However, if those assets are held by Alameda, their value may be wiped out by its losses. Bankman-Fried is being investigated by the US Securities and Exchange Commission for potential securities law violations.
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