THE CRYPTOCURRENCY CRASH OF 2022

On November 8^th of this year, FTX, a major cryptocurrency exchange, entered into a letter of intent to be sold to Binance, a rival cryptocurrency exchange.  The very next day, Binance pulled out of the deal having had a chance to look at FTX’s books.  On November 11, FTX filed for bankruptcy.  On November 13, certain news organizations reported that much of the money transferred out of FTX in its final hours had disappeared.  On November 14, several government regulators began looking into the activities of FTX to see if criminal liabilities exist.  Earlier this year FTX looked to be a major success story in the cryptocurrency industry.  What led to its downfall?

What is cryptocurrency and how does it work:  A cryptocurrency system is a peer-to-peer payment system that does not involve banking.  Transactions are maintained in a computer driven public ledger known as a block chain, and are maintained in a distributed computer system (one that’s decentralized and involves many different computers).  The transactions are encrypted for security purposes.  The system is not dependent upon banks or governments, and it supplies itself with additional cryptocurrency tokens as needed via an internal algorithmic process.  When a user trades a crypto token, he/she is not trading any kind of a tangible asset.  It’s simply a computerized record of the movement in the block chain of the token from one party to the next.  Even if a crypto token is accepted in payment of a debt, or purchase of a tangible substance, the transaction is handled the same way.  Users must fund an account at a crypto exchange to purchase tokens (Bitcoins, etc.) and maintain them in something known as a digital wallet. 

How do the tokens increase and decrease in value:  When a Bitcoin user pays his money and buys a Bitcoin, the token resides in his digital wallet until traded or cashed in.  As more users send their money to their digital wallets to obtain tokens, the price of the token rises owing to basic rules of supply and demand.  The opposite happens when more users cash their tokens in and take money out of the system.  The overall supply of tokens is managed behind the scenes out of sight by the investing public.  Investors often try to capitalize on the volatility of cryptocurrencies in the same way they would invest in stocks, bonds, or real estate.  The difference is that unlike stocks, bonds, and real estate, cryptocurrency is nebulous—it’s only images in electro magnetic media.  Further, it is not well regulated (that might soon change), and it is not supported by any government or banking system.  It is difficult if not impossible to loan money via cryptocurrency to other parties or entities, as owing to volatility, the value of the repayment of the loan cannot be ascertained in advance. 

What caused the collapse of FTX:  The major issue is centered around loans that involved customer money that were made by FTX to a sister company named Alameda Research.  Alameda Research turned out to be the platform that Sam Bankman-Fried, the major owner of both companies, used for risky crypto wagering.  Alameda’s holdings of FTX tokens amounted to about $5.8 billion dollars at the time.  To make matters worse, Changpeng Zhao, the boss of Binance, tweeted that he would liquidate his firm’s holdings of FTX tokens—a sum worth more than half a billion dollars.  Suddenly, FTX’s value collapsed as those investors who owned tokens bailed out.  Then Mr. Zhao made an intent to purchase FTX only to pull it back out the next day.  With its assets suddenly worthless, FTX no longer had any liquidity and was forced to file for bankruptcy protection. 

Cascade of deleveraging imminent?  Up to this point in the thirteen year history of cryptocurrency, only a nominal number of crypto platforms have failed.  The losers have not had much recourse, as the typical firm involved did not have much in the way of assets besides tokens and some cash.  As long as the market was liquid with new investors coming in regularly, there was little danger of contagion.  My sources believe that the collapse of FTX could be the catalyst that ends the love affair that speculators have had with cryptocurrencies.  In the leastways, more regulation should pop up and more transparency to the industry made ready for any future investors who would like to participate.

Conclusions:  To quote Cristine Lagarde, President of the European Central Bank, “Cryptocurrencies aren’t.”  I have to agree—they are not currencies in any form that we are used to seeing.  It looks to me like a stage for major scams, as the tokens are traded in different countries, and the exchanges are not regulated or supported in nearly the same fashion as standard banking is.  Although the block chain activity is encrypted, that hasn’t stop hackers from breaking in at some point or another.  Until worldwide standards are set, and regulations are established and adequately enforced, it’s buyer beware.   As for me?  I wouldn’t touch it with a ten foot pole.

Sources:         Bankman fried, The Economist, November 12, 2022.

What is the FTX scandal?  Usatoday.com, How the celebrity-endorsed crypto giant collapsed into chaos, Bailey Schulz and Riley Gutierrez McDermid, November 16, 2022.

                        Kaspersky.com, What is cryptocurrency and how does it work?

                        Wikipedia.