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Finance

Five takeaways from the FTX crypto exchange collapse

Published 15 November 2022 in Finance • 4 min read

The collapse of the digital assets group exposes some of the structural weaknesses of crypto exchanges but may also focus attention on the more positive applications of cryptocurrencies that are revolutionizing our financial system, says Professor Arturo Bris.

The crypto winter that started earlier this year with the invasion of Ukraine by Russia has turned into a catastrophe with the default last week of crypto exchange FTX.  With rumors flying that the fund founded by industry icon Sam Bankman-Fried was not able to satisfy its creditors, a massive sell-off by users of the platform accelerated both the firm’s demise and an additional crash in the prices of some of the world’s top cryptocurrencies. Bitcoin itself lost 25% of its value in a couple of days; today it stands at less than $15,000. A year ago, it was trading at $60,000.

While the final outcome for FTX remains unclear, here are five key takeaways on what its collapse means more broadly for the digital asset market.

1. Unlike traditional financial institutions and exchanges where investors and depositors’ money is protected, crypto exchanges are much riskier. The reason is that, given the nature of cryptocurrencies, exchange users need to transfer ownership of their holdings for their trade to take place (meaning they are no longer depositors, but creditors). This is why crypto traders should never keep their holdings in an exchange such as Binance or Coinbase. Given the volatility of cryptocurrencies, when prices drop significantly investors sell rapidly, this may render the exchange unable to satisfy liquidation demands by investors – meaning users could have a difficult claim on their crypto holdings.

2. FTX is not just broke – it has sought protection under Chapter 11 in the Delaware bankruptcy court, which favors a reorganization with the objective of satisfying creditors’ (in this case mostly traders’) claims. The bankruptcy filing was preceded by a week of panic over the exchange’s financial health and a surge in withdrawals which only made things worse. The final outcome remains unclear.

3. The FTX episode may mark another step into the once-and-for-all collapse of these permissionless, privately issued cryptocurrencies. There was certain optimism in the last month that once the dark clouds on the horizon caused by the pandemic and the war in Ukraine vanished, prices of crypto assets would rebound. Now, there is seemingly something more structural going on, revealing that their – given that, in the absence of full acceptance of cryptocurrencies, their price only depends on investors’ willingness to hold them.

4. There is, however, some good news to come from FTX’s collapse: The revelation that cryptocurrencies might not be the golden hen for unsophisticated investors is a positive development for markets. In market microstructure these investors are called “irrational traders”, which are usually taken advantage of by more informed traders. In the past, irrational traders have had too important an impact on prices, which is not desirable for an efficient market to work. Once they are gone, we can end up with a market that prices crypto assets for what they are truly worth

5. This brings me to an additional point. Bitcoin, the most popular cryptocurrency, does not have a business model and hence its price (and its value) is in the eye of the beholder, and as such is always determined by the intersection of demand and supply. But the others (Ether 2.0, Cardano, Solana) should be considered utility tokens much more than cryptocurrencies. In this sense, they facilitate decentralized finance (DeFi) transactions, allow non-fungible tokens (NFTs) to have a value, and ultimately are the currency of new Metaverse applications. They are the future. The good news is that we can start to see these tokens as sources of value and not as cryptocurrencies in the proper sense. To provide a useful analogy, we are now in a similar situation as we were right after the burst of the internet bubble in 2001, where the true business models based on the internet could finally come up to the surface.

Despite the collapse of FTX, it is my view that blockchain technology remains healthy and is the reality of many interesting initiatives that are revolutionizing our financial system and our economies. Applications in financial markets, blockchain solutions to price carbon emissions, utility tokens that disrupt traditional internet platforms, smart contracts, and digital assets as financial solutions for individuals and companies: these are only a few of the applications of the technology that will hopefully receive the attention they deserve.

Authors

Arturo Bris - IMD Professor

Arturo Bris

Professor of Finance at IMD

Arturo Bris is Professor of Finance at IMD. Since January 2014, he has led the world-renowned IMD World Competitiveness Center. At IMD, Bris directs the Strategic Finance and Navigating Fintech Innovation and Disruption programs. He also previously directed the flagship Advanced Strategic Management program between 2009 and 2013.

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