How exceptional is the fall of crypto marketplace FTX? According to Teunis Brosens, economist at ING who specializes in digital money, not at all. “The mechanisms you see are all known in the traditional financial world.”
FTX filed for payment deferral on Friday after the crypto marketplace ran into major liquidity problems the weekend before. Many FTX customers wanted to request their credits at the same time. Brosens: “What probably happened – the dust has yet to settle but this seems plausible to me – is that a sister company of FTX suffered some losses after the company launched a number of bailouts of other marketplaces in the spring. Those losses appear to have been covered with money from FTX customers. If they get wind that something is not right, everyone will ask for their money. Actually a kind bank run.”
“The well-known mechanism that you then see is that things that seem to have no correlation in good times, suddenly go down simultaneously in a crisis situation.” He is referring to the way in which FTX guaranteed customers that the funds were covered. The marketplace did this through its own issued cryptocurrency, the FTT token.
“Connoisseurs have always been critical of this, that collateral consisted of crypto coins. Prices are going in all directions. The answer from marketplaces that nevertheless took the cryptocurrency as collateral was that they did not ‘just’ hold collateral that was worth ‘only’ 20 percent more than the credit, but 200 percent. That sounds very solid, but if prices fall more than 80 percent in a crypto crisis, you still have nothing.”
Last weekend, a competitor of FTX, Binance, announced that it was selling all FTT coins. When the FTT’s price plummeted, a huge funding gap arose at FTX. It would be about 8 billion dollars (8 billion euros). In order to repay the customers, FTX had to monetize the crypto coins on its own balance sheet. “That causes a sell-off in a market where everyone is already in a slight panic.”
Don’t be blind to new technology
Teun Brosens ING
After Binance pulled out as a rescue acquirer, FTX founder Sam Bankman-Fried had to throw in the towel on Friday. It marks yet another crisis in the crypto world, following the fall of stablecoin TerraUSD and crypto credit bank Celsius earlier this year. According to Brosens, the mechanism seen in the crypto world is exactly what happened during the credit crisis in 2008 and 2009. “Where we then had blind faith in mathematical models that could turn junk mortgages into triple-A investment products, now in crypto the blind faith is that algorithms and smart contracts can turn volatile tokens into something stable.”
What doesn’t help, according to Brosens, is that crypto companies are not regulated and not transparent. “It takes place outside the regulated domain. That was also the case in 2008, when large banks and other financial institutions shadowed each other.” Brosens warns investors that a fancy new term does not suddenly make something financially and economically new possible. “Don’t focus on technology, but remember that human behavior that influences economic processes also simply affects crypto. Greed, the danger of investing with borrowed money, correlations that only exist in crises.” But that also means that you do not suddenly have to write off all crypto developments due to this crisis, says Brosens. You can do good things with it and bad things. Just like in the traditional world.”
He thinks that the largest and oldest cryptocurrencies, bitcoin and ethereum, just keep spinning. “You have to see that separately from the crypto companies and hedge funds that have emerged in recent years. Confidence in those companies is going to take a huge blow. As far as I’m concerned, the solution to this is transparency, which is partly enforced by regulation. Many crypto companies will say that they also benefit from this. Then the good and healthy can distinguish themselves more easily.”
A version of this article also appeared in the newspaper of November 12, 2022