FTX collapse further underlines cryptocurrency risks

What is FTX Trading and what led to its collapse?

FTX Trading was one of the largest cryptocurrency exchanges. Founded in 2019 by Sam Bankman-Fried, the exchange enabled users to trade a range of products, including over 300 cryptocurrencies, as well as leveraged tokens, derivatives, options and volatility products in the cryptocurrency markets. FTX, headquartered in the Bahamas, reached a peak valuation of $32 billion at the start of 2022, making Bankman-Fried the richest person under the age of 30 at the time.

FTX collapsed last week because of a ‘liquidity crunch’. The company did not have enough liquid funds to meet $5 billion of investor withdrawals. In fact, the company had only around $900 million of assets that could be easily sold, versus $9 billion of overall liabilities. This gap between assets and liabilities was caused by FTX loaning out customer funds to another company – Alameda Research, a trading firm also owned by Bankman-Fried. The collateral for this loan was a token created by FTX called FTT, the price of which was heavily supported by FTX itself, which used a third of its fees to buy tokens. When the price of FTT plunged there was insufficient collateral and a liquidity crunch ensued when there were big withdrawals from FTX.

Crash of a cryptocurrency

How the price of FTT tokens plummeted from just over $22 on 7^th November to less than $2 on 15^th November

Why is this important?

The case for cryptocurrencies is based on decentralisation and freedom from regulation. However, in our view this crisis has proved regulation is indeed needed in the sector. Some crypto enthusiasts may argue that this crisis occurred because of centralisation in the market, thus proving that centralisation is a weakness. However, it is difficult to see how the market can be widely accessible without some degree of centralisation – and, in our view, where there is centralisation there must be regulation.

The number of large exchanges available to trade cryptocurrency was already limited before the bankruptcy of FTX. Confidence in the cryptocurrency will be damaged by the crisis, which has, once again, highlighted how cryptocurrencies only have value because people believe in them. Once people lose faith in a cryptocurrency such as FTT, it loses all value.

The episode has also highlighted the risks of interconnectedness between cryptocurrency exchanges – and the potential for conflicts of interest. Rival crypto exchange Binance had a significant holding of FTT, worth at least $580 million. When it announced it was selling the holding, other investors rushed to do the same, causing a collapse in the price. Later, when FTX announced bankruptcy, Binance signed a letter of intent to buy FTX, but later pulled out. Binance therefore played a part in the downfall of one of its biggest competitors.

What is likely to be the impact?

Customers of FTX are likely to lose a considerable portion of their funds. This will damage confidence in other cryptocurrency exchanges and the wider cryptocurrency market, which was worth more than $1 trillion as of August 2022. The collapse is likely to lead to tighter regulation and has already led to questions about the safety of client funds held by other exchanges. In response, Binance, Crypto.com and other exchanges have said they will provide proof their reserves cover their liabilities to customers.

FTX’s financial backers will also lose out. They include Softbank, Sequoia Capital, Ontario Teachers’ Pension Plan and Tiger Global. Softbank and Sequoia Capital have already said they have marked their FTX investments down to zero.

What are we doing?

Since FTX Trading was not a listed company, none of the funds we hold have exposure to it. We have long been conscious of the risks associated with cryptocurrencies and keep a very close eye on the exposure funds have to this area of the market.

Ben Jones, Investment Analyst, 14/11/22

Risk Warnings 

Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. The funds may have exposure to bonds, the prices of which will be impacted by factors including; changes in interest rates, inflation expectations and perceived credit quality. When interest rates rise, bond values generally fall. This risk is generally greater for longer term bonds and for bonds with higher credit quality. The funds invest in other currencies. Changes in exchange rates will therefore affect the value of your investment. The funds may invest a large part of its assets in other funds for which investment decisions are made independently of the fund. If these investment managers perform poorly, the value of your investment is likely to be adversely affected. Investment in other funds may also lead to duplication of fees and commissions. In certain market conditions some assets may be less predictable than usual. This may make it harder to sell at a desired price and/or In a timely manner. All or part of the fees and expenses may be charged to the capital of the funds rather than being deducted from income. Future capital growth may be constrained as a result of this.

Regulatory Information 

This material is for distribution to professional clients only and should not be distributed to or relied upon by any other persons. It’s provided for general information purposes only and is not personal advice to anyone to invest in any fund or product. Information taken from trade and other sources is believed to be reliable, although we don’t represent this as accurate or complete and it shouldn’t be relied upon as such. Calls will be recorded for training and monitoring purposes. 
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