Crypto Market Rout Explained

The crypto world was rocked yesterday, with BTC (BTCUSD) hitting a year low after one of the world's largest crypto exchanges had to come to the rescue amidst liquidity concerns. FTX, the alleged cryptocurrency exchange, was pending listing on the stock exchange and issued a letter assuring its finances were in good condition on Tuesday. 

As FTX roiled the markets, Bitcoin dropped almost 13% on Tuesday, while ETH (ETHUSD) was down 18.2%. A competitor to ETH, Solana (SOLUSD), dropped even further, a little over 26%, as it was connected with FTX, receiving substantial backing from the company’s founder.

The episode brought vivid memories of the collapse of another crypto network less than six months ago. That's when cryptocurrency Luna wiped out around $60B in assets, among concerns around volatility and liquidity in the sector. Once again, tight liquidity conditions were seen as the primary culprit of the collapse of a significant network and its associated tokens.  (Source:Forbes)

Before the Competition Intensified

Rumours of FTX's fall may sound surprising to a few, considering it had rescued other crypto firms in the past. Especially since the company had multiple celebrity endorsements, and its CEO, Sam Bankman, was considered a celebrity and a crucial political door in his field.

However, we must go back a few years to fully understand what happened. That is when FTX and its eventual rescuer, Binance, started offering cryptocurrency trading. Initially, the two companies were quite friendly, each having its respective strengths. Binance had an extensive global investor network, while FTX was able to raise capital in the US. When FTX started to move towards going public, Binance was one of its first major investors. It bought an undisclosed equity stake, plus a significant position in FTX's native token, which would eventually be worth close to $2B.

FTX's token is an in-house alternative (altcoin) token that users can trade for trading benefits and other perks. Investing in the token essentially amounts to faith in the company's longevity. Binance's acquisition of a large number of tokens was seen as supporting the company. Both firms went on to whether the massive drop in cryptos at the start of 2021 as central banks worldwide hiked interest rates.

The Details of the Recent Bout

Nonetheless, trouble between the two companies started earlier, in 2020. A year after taking a significant stake in FTX, Binance - led by Changpeng Zhao (or "CZ" as he's most well known in the crypto space) - suspended trading FTX's token. Then last year, Bankman-Fried bought out Binance's equity stake in his company, citing regulatory crackdowns, showing the companies had decided to go their separate ways. The parting was said to be cordial, which appeared to be its end. The companies would go on as competitors.

That is, until last Sunday when Zhao tweeted that he would be dumping FTX's holdings. The tweet cited “risk management”. It's speculated that this refers to a leaked memo from one of Bankman-Fried's other ventures, Alameda Research, which allegedly had substantial holdings in FTX's tokens. It claimed to have $6.1B in FTX's token when FTX was saying there was only $5.1B in total circulation.

Rumours quickly spread that FTX was insolvent, and the company issued a statement trying to dismiss the claims. However, repeated assurances from a company that its financials are "fine" apparently didn't reassure investors, as they rushed for the exit. As FTX customers flash-sold their assets, cryptos across the board were dragged down as comparatively few people were buying. (Source:CoinDesk)

Liquidity Problem Solved, But will it Last?

To stem the flow, not only did Binance commit to not selling its assets, but CZ stepped in to offer to buy FTX in a bailout. The operation to buy out Binance's chief rival in distress raised speculation that it was all a move to take out the competition. The deal does allow Binance discretion to withdraw from it, but for now, the merger of the two largest crypto dealers into the largest crypto platform in the world seems to have calmed the waters.

The fast evolution of the affair - from Binance's initial tweet on Sunday to offering to buy FTX by Wednesday - leaves a lot of open questions. There hasn't been a full public accounting of FTX's finances to determine its financial position. Nor has the discrepancy between Alameda's figures and FTX's been clarified. The emergency move to stabilise the situation has led to estimates that Bankman-Fried could lose about 94% of his multi-billion dollar fortune.

What's Next for the Market?

FTX was one of the largest crypto exchanges that suffered a sudden loss of confidence among its users, who tried to withdraw their funds in a rush. But after its main rival, Binance, stepped in to provide liquidity, the deal went to regulators for approval. Although it offers a short-term solution to the liquidity crunch, it does so without alleviating concerns about the crypto market's future.

What happens going forward is still unclear. While the situation for FTX seems settled, the saga has again drawn the attention of regulators, and the deal could meet anti-trust hurdles as the union of the exchanges might cause competition concerns.