It's been a tough few weeks for crypto. While investors should not be easily rattled, the recent events surrounding the FTX crypto exchange have caught many offguard.
Ongoing turbulences in crypto currency winter - Image produced using Dall·E 2 (https://openai.com/dall-e-2/)
What is FTX?
Until recently, Bahamas-based FTX was one of the largest crypto trading platforms in the world. It was founded in May 2019 by Sam Bankman-Fried, who was not yet 30 at the time and was backed by the venture capital unit of the largest crypto trading platform Binance, among other notable VC investors. Prior to FTX, Bankman-Fried had founded crypto trading firm Alameda Research, which started with Bitcoin arbitrage but gradually moved into riskier transactions.
The close financial ties between FTX and Alameda were ultimately the catalyst for FTX's subsequent implosion.
Quick overview of main events concerning FTX until 11 November
- On 2 November CoinDesk reported that Alameda's assets were largely made up of illiquid FTT tokens that were issued by FTX (the reason allegedly being that FTX had to cover Alameda's trading losses, including with customers' assets).
- Binance's VC entity, still owning large amounts of the FTT token from the past sale of its shareholding in FTX, started to divest.
- When this was confirmed on 6 November by Changpeng Zhao, the current head of Binance, the FTT token took a nosedive.
- Despite all assurances by Bankman-Fried that customers' assets were secure, a bank run followed, forcing FTX to suspend all payments and transfers.
- The hoped-for rescue, Binance's letter of intent to acquire FTX, was withdrawn a little over a day after initial due diligence findings.
- On 11 November, FTX, including more than 130 affiliated companies, had to file for bankruptcy.
Immediate consequences of the FTX insolvency
Like similar events in the past, the FTX crash sent many crypto-assets tumbling. Bitcoin, Ethereum and particularly Solana all fell in the double digits. Solana fell deeper and harder than other cryptos due to its well-known relationship with Bankman-Fried and the fact that Alameda owned approx. 10 % of Solana's market cap.
Decentralised exchange trading volume has shot up 152 % during the last seven days, amounting to a collective trading volume of USD 31bln and signaling that more and more people are leaving centralised exchanges for decentralised ones.
Many centralised crypto exchanges felt compelled to reassure their customers in order to prevent any form of snowball effect. For this reason, you will find many public statements from various crypto exchanges confirming their regulatory status and assuring customers that unlike FTX, their assets are neither invested nor loaned.
Calls for strict regulation from regulators and industry leaders have also followed since then. It remains to be seen whether these will fall flat, as they so often do, or whether the time is ripe for new approaches to global crypto regulation and transparency.
The exchange's custody of customers' crypto-assets
From a legal point of view, there are various ways to structure the custody of customers' crypto-assets under Austrian law, the main two being: (a) via a custody agreement in the terms & conditions, or (b) as mere obligatory claims against the crypto exchange.
If the crypto exchange becomes insolvent, customers will in case of (a) have a right of segregation (Aussonderungsrecht) to claim their assets (if custody is structured under Austrian law and depending on the specifics), or in case of (b) likely lose their assets and only receive a quota. For this reason, we advise crypto investors to read the terms & conditions carefully before deciding to invest through a particular centralised exchange.
It remains to be seen what the full aftermath will be and what this means for the crypto industry. One thing is for sure: the crypto winter will be a long one.