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Crypto’s Dot Com crash: FTX is not too big to fail

Liquidity concerns and a botched takeover from rival Binance have prompted the apparent collapse of FTX, one of the world’s largest crypto exchanges. But the ramifications could be much more severe.

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 At least from a professional standpoint, its pressures are unlikely to top those experienced by the co-founder and CEO of FTX Sam Bankman-Fried who appears to be facing possible bankruptcy and the evisceration of his c.$30bn crypto empire.

The news has rocked FTX, one of the most important crypto exchanges, leaving its users unable to access funds, as well as leading many to call an end to the crypto boom as we know it. 

What began with news on Monday that investors were pulling large sums from their FTX accounts only to be stopped by the platform refusing new requests led to a jaw-dropping potential acquisition by FTX’s early investor and long-term partner-turned-rival Binance on Tuesday.  

By yesterday the deal looked to be a last-minute liquidity lifeline for FTX that would create the world’s largest exchange by a long way in the form of Binance. However, by the day’s end, the deal was off.

Bankman-Fried, known as SBF, is still exploring “all options” for the firm, according to the latest report from news agency Reuters which quotes an email to staff. 

"I'm working, as quickly as I can, on next steps here. I wish I could give you all more clarity than I can," said Bahamas-based Bankman-Fried.

Whether or not a new deal, emergency fundraising or another route out of the mess is possible, the chaos is bad news for crypto, which has already lost two third of value since a peak last year, falling to just over $1trn in its market capitalisation. 

Ratings agency Moody’s says the failed acquisition of FTX is ”credit negative” for the crypto market as a whole. This is because it leaves FTX, one of the largest crypto market participants, and its customers “in limbo”. 

With thousands shut out of their accounts and unable to realise portfolio holdings, coupled with FTX’s size, this scandal in crypto land has left many questioning if the situation is analogous to the fall of Lehman Brothers bank in 2008 or the Dot Com crash in 2000 in terms of its long term ramifications for the wider financial ecosystem, 

“Crypto losses so far by retail and digital asset institutional participants have largely remained contained within the crypto sphere, a credit positive for banks and evidence of banks’ fairly cautious approach to crypto in light of the uncertain regulatory environment,” said Fadi Massih, Vice President, Financial Institutions Group, Moody’s Investors Service. 

 “However, should leverage again build substantially in the crypto finance system, it could unsettle the banking system, even if banks continue distancing themselves from direct interaction with the crypto economy,” Massih added. 

Opacity vs transparency 

Regardless, of the outcome for the broader financial system, the pressure on crypto markets is building. A key fact at this stage in terms of what it means beyond the price drops seen by Bitcoin and Eth is how FTX’s opaque structures and complex relationships hold up as the web unravels. 

“The general risks of crypto finance closely match those of traditional financial institutions, but the sector's opacity makes them harder to measure,” said Fabian Astic, Global Head and MD, DeFi & Digital Assets, Moody’s Investors Service. “The extension of credit in the crypto space is akin to traditional “balance sheet usage.”

FTX made a lot a multitude of loans to failing crypto companies in recent months and become something of a ‘lender of last resort’ in many’s eyes. 

Timo Lehes, co-founder of Swarm, a regulated DeFi platform, says the recent events highlight the lack of transparency as a centralized phenomenon. 

“It was those monitoring on-chain activity who pointed out strange ongoings with FTX wallets, prompting the rumour mill on Twitter to unfold and putting pressure on the FTX team for answers. Had there been more transparency and less convolution around FTX's operations, perhaps this would have caused less FUD and put SBF and his team in a stronger position,” Leches said. 

Dr. Ganesh Viswanath Natraj,  Assistant Professor of Finance at Warwick Business School meanwhile notes that the concentration of liquidity is now increasing in the crypto space with Binance and Coinbase the two largest centralised exchanges able to service customers.

“One implication of the near-collapse of FTX is that as Binance increases its market share of crypto trading, additional liquidity on Binance means centralised exchanges continue to dominate decentralised exchanges like Uniswap. These exchanges rely on different models, with Binance having a limit order book, and Uniswap having algorithms to execute transactions,” he said. 

Graham Cooke, author of 'web3 - the end of business-as-usual' puts the fall of FTX down to “greed, bad management, poor risk controls and a lack of regulation.” 

It will likely mean more regulatory oversight for exchanges but insists it’s not the end of crypto.  

"This is a disaster but it's not the end of the crypto market.  This is the 2001 DotCom crash for crypto - that saw huge financial disruption in an industry but today tech is one of the most important parts of the global economy,” he said. 

“It is - hopefully - the end of opaque and poorly executed crypto business," he added.

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