Is the Crypto Industry at Risk of Collapsing?

Authored by: Nomi Prins

FTX crypto was the brainchild of billionaire Sam Bankman-Fried (aka SBF). And until recently, it was the fastest-growing crypto exchange. In 2021, FTX and its biggest rival, Binance, traded over $7 trillion in volume on their platforms.

Binance held $500 million worth of FTX’s tokens. That is until it decided to sell them a few days ago. Binance’s CEO, Changpeng Zhao (aka CZ), said in a tweet:

Due to recent revelations that have come to light, we have decided to liquidate any remaining FTT [FTX’s token] on our books.

CZ didn’t say what revelations he was referring to. But many speculated it was a leaked balance sheet of Alameda Research. That’s a crypto trading firm owned by FTX’s Sam Bankman-Fried.

That balance sheet revealed the firm was seemingly propped up by FTX’s token, FTT crypto, to the tune of nearly $6 billion. As a result of these revelations, the price of FTT dropped more than 85% as fears over the financial position of FTX escalated. This spelled disaster for FTX.

In the 72 hours following Tuesday morning, there had been roughly $6 billion net withdrawals from FTX. On average, net inflows are in the tens of millions of dollars. In other words, it was facing a bank run.

Then, in a stunning turn of events, earlier this week, Binance said it would acquire FTX, only to back out of the deal yesterday. This effectively leaves the crypto exchange on the brink of collapse or bankruptcy, adding fuel to the fire.

You see, FTX is not just a small, no-name crypto company. The exchange hit a valuation of $32 billion at the start of this year. Blue-chip investors backed it – including BlackRock, Canada’s Ontario Teachers’ Pension Plan, and SoftBank.

Celebrities also showered FTX with support. On that list were supermodel Gisele Bundchen and her husband, famous NFL quarterback Tom Brady.

In an industry called the “Wild West” by Wall Street’s top regulator, many people thought of FTX as one of the better-managed players. Bankman-Fried, its founder, even lobbied lawmakers in Washington regularly.

From $32 Billion to Potentially Nothing

So how does a $32 billion company collapse almost overnight – just because a rival threatens to sell $500 million worth of its tokens? It all comes down to confidence, as the infamous Charles Ponzi would say.

Imagine that I print up 32 sports trading cards. (In some ways, that’s what FTX did when it created its own FTT crypto.) I then somehow manage to sell one of them for $1 billion. My market valuation shows I’m worth $32 billion (32 cards multiplied by $1 billion).

But that’s just the market assuming (or being confident) that I could sell another card for another billion dollars and then another one. So, on paper, most of my net worth is tied to these cards. But what if the market finds out I’ve been printing these cards out of thin air?

Unless I’m the Federal Reserve, I will probably see some confidence crisis. As this realization reverberates through the market and my pool of buyers dries up, demand for my cards craters.

And with no one out there to buy crypto(s) them from me, I’m no longer worth $32 billion. I’m probably worth nothing. Zero. Zilch.

Now I’m not saying that this is precisely what happened at FTX. But it does help explain how the exchange could have gotten into a liquidity crunch.

Bringing It All Together

This company was highly leveraged and potentially dishonest with its reporting. In any sector, including traditional banking and finance, that can spell disaster. I know because I spent 15 years on Wall Street.

I was there in the lead-up to the ’08 crisis. And Wall Street’s penchant for making risky bets with other people’s money is a big part of why I walked away.

Today, this disaster has happened in the crypto world. The industry was already reeling from a 60% drop in the total crypto market cap. That was before the FTX story broke.

The Fed’s aggressive rate hikes haven’t helped crypto this year. And the crypto markets are also coming off a streak of bad events.

I’m not surprised that the level of fear in this market is reminiscent of the uncertainty brought about by the Lehman Brothers collapse back in 2008. Unfortunately, that means things could get worse before they get better.

Especially if no one else comes to FTX’s rescue following the Binance withdrawal. This wouldn’t be surprising given that there’s reportedly an $8 billion gap in FTX’s financials. It would add even more uncertainty to already troubled markets.

What This Crypto Mass Means for Your Money

You might wonder what this means if you own crypto such as Bitcoin. On the one hand, it’s not Bitcoin’s fault that FTX was a poorly managed company.

Unfortunately, even though it wasn’t directly connected to these stories, Bitcoin has suffered even more in the aftermath. It’s down over 20% since the story broke. So, you may be tempted to sell.

But anyone who’s tried their hand at investing will tell you that it’s never a good idea to sell into a panic. Even – or especially – if it seems everyone else is doing it.

Yes, the crypto market is wrapped in uncertainty right now. But we will see Bitcoin rebound from these fear levels eventually. I’m not losing confidence in Bitcoin just because someone gambled with other people’s money.

As I saw during my years on Wall Street, many companies returned even stronger after the initial fallout from some of the mistakes. And history is on Bitcoin’s side. It’s a good inflation hedge.

Earlier this year, the White House acknowledged cryptocurrencies as a legitimate and vital part of American society and the U.S. economy.

The 21 million caps on the number of Bitcoins, plus the ever-decreasing pace at which these are issued, means each Bitcoin will become more and more valuable in time.

So if you currently hold Bitcoin, stay patient and ride out this volatility. And if you’re considering tiptoeing into Bitcoin, I’d wait out this turmoil and see if there are any other FTXs out there first.

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