Where next for cryptocurrency after FTX Collapse?
Aftershocks from the FTX collapse in the trillion-dollar crypto market continue to rattle this week. Prices of digital currencies continue to fall as investor sentiments are adversely hit. Bitcoin, the world’s biggest cryptocurrency, plummeted by 65% over this year, while Ether, the world’s second most valued crypto currency, fell by 20% over the last week. Bitcoin and Ethereum (Ether) make more than half of the digital currency market.
Crypto giant FTX filing for bankruptcy, along with the fall in the value of Bitcoin and Ether, have raised concerns regarding the future of cryptocurrencies and blockchain technology.
Cryptocurrencies are an alternative to money, free from the control of the governments and the central banks. They are underpinned by blockchain technology. But this industry has seen many challenges over the years. Bankruptcies have come fast and furious in the recent months. The industry which was once valued three-trillion dollars is now valued at 900 billion dollars."Dr Anandadeep Mandal - Associate Professor in Finance, University of Birmingham
So, what does this collapse mean for the crypto market and the investors?
The cryptocurrency prices have been sliding all year, but the collapse of FTX adds to it. Crypto currencies witnessed a surge and popularity since 2009. Today more than 20,000 cryptocurrencies are in use. Cryptocurrencies are an alternative to money, free from the control of the governments and the central banks. They are underpinned by blockchain technology. But this industry has seen many challenges over the years. Bankruptcies have come fast and furious in the recent months. The industry which was once valued three-trillion dollars is now valued at 900 billion dollars.
What went wrong with FTX?
FTX had more than five million users worldwide and traded more than 700 billion dollars’ worth of crypto last year. The key issue was bad governance. FTX had been secretly syphoning funds to Alameda Research, co-founded by FTX founder, Sam Bankman-Fried. FTX was reinvesting in much higher product categories, thus the collapse of FTX was a combination of multiple errors.
Where do we go from here?
Several crypto exchanges are now actively verifying the proof of funds., but these proofs of reserves are a snapshot in time. What would benefit the investors if these reserves can be shown over a period in real-time. One of the reasons for the drop in value of other cryptocurrencies is because of the increased uncertainties in understanding where the liabilities are and having interlinkages with FTX. The long-term implications are likely to be in the form of regulations. Investors expect aggressive government regulatory norms in place to protect what has been going on in the crypto market. Institutional players that are in this space are expected to revalue their expectations and risks involved. Retail confidence has suffered a bigger setback.
The greatest strength of cryptocurrency was the realisation that a decentralised form of currency will prevail soon and end the hegemony of the banking sector and the government. But the latest incident of 370 million dollars being syphoned from FTX to another company (Alameda) has pushed this world to rethink about the risk involved in investing in the crypto market. There is bound to be a growing lack of trust in this market.
Cryptocurrency over the years has been showcasing itself as a path to more equitable financial system. In the decentralized financial system, we aim to establish a hyper efficient mechanism of capitalism through various technology and transparent peer-peer lending using blockchain mechanism. In a traditional finance industry, the regulators have a good grasp of what is happening, but in the crypto space there isn’t any regulation to see what is happening behind the scenes.
The crypto market is bound to get cold because of contagion amongst its players and investors. FTX might be the first amongst a couple of others which might be badly hit for various reasons. We are set for turmoil over the next few months, but the only silver lining is that FTX was just a trading exchange. All being said, decentralization of the financial market is probably the best financial innovation over that last decade or so since the advent of derivatives. There is a lot of potential, but sustainable regulations need to make it happen in the correct way.
Dr Anandadeep Mandal - Associate Professor in Finance, University of Birmingham