The crypto markets have been relatively tranquil, but recent events have thrust them into chaos. In a swift and dramatic sequence of events, FTX, the second-largest global crypto exchange, crumbled, highlighting the capricious nature of the crypto industry.
Let’s rewind and understand the tumultuous situation that unfolded. A CoinDesk report raised questions about Alameda Research, a company affiliated with Sam Bankman-Fried. The concern centered around the inflation of Alameda’s balance sheet through FTT tokens, issued by FTX, its sister company. In essence, this ingenious scheme created a new token, funneled to the sister company, which then used these tokens as collateral for colossal borrowings. The entire framework hinged on the FTT token’s price remaining high; otherwise, the entire system would collapse.
Chaos ensued when FTX competitor, CZ, declared that Binance, his exchange, would release its entire stash of FTT tokens into the market. Binance held roughly $500 million in FTT tokens they’d received when separating from FTX. The announcement, given Binance’s substantial 17% control of the free float, cast a shadow on the FTT token’s value.
The FTT token promptly nosedived, and fear rippled through the market regarding Alameda Research’s financial stability. Still reeling from the recent collapses of Celsius and Voyager, investors engaged in a frenzied rush to withdraw their funds from FTX. If Alameda was in jeopardy, how could FTX be trustworthy? FTX, in response, reassured customers that their funds were secure, but the relentless withdrawal requests continued. In just days, more than $6 billion exited FTX. Desperate, Sam Bankman-Fried sought assistance from Binance to rescue FTX. Binance tentatively agreed to acquire FTX, but the outcome remains uncertain. Rumors are already swirling that Binance might abandon the deal after delving into FTX’s inner workings.
Contagion Risks
Major collapses in the crypto world bring numerous contagion risks. For example, BlockFi and Genesis extended loans to Alameda, unlikely to be repaid. Several significant market makers have their funds trapped on FTX. Other entities loaned money to these market makers and now find themselves in dire straits. Additionally, several crypto projects or altcoins had their holdings on FTX. The intricate web of connections between these entities causes a cascading effect, with struggling parties liquidating assets, pressuring the Bitcoin price, and distressing Bitcoin miners. It’s a full-blown crypto winter!
The Road to This Point
In the coming weeks, the mystery of FTX’s downfall will unravel. Since withdrawals were halted, it’s clear that FTX has lost customers’ funds. Did they use customer money to make market moves? Did they recklessly gamble these resources away? Or did they lend coins from customers, seeking higher returns? To whom were these loans extended, and can they repay? Did FTX finance sister company Alameda due to the collapse of other entities recently? The answers will emerge soon.
Had FTX prudently safeguarded customer funds and assets, withdrawals could have proceeded smoothly, and no rescue would have been needed. In a manner akin to traditional fractional reserve banking, FTX engaged in activities with customer funds, hoping that not everyone would simultaneously request withdrawals. A classic bank run spelled doom for FTX.
Proof-of-Reserves
CZ, Binance’s CEO, has already pledged to implement a new reporting system. The Merkle-tree proof-of-reserves will validate an exchange’s possession of customer coins and confirm they haven’t been lent out. It’s an effort to rebuild the shaken trust in cryptocurrency exchanges. Nonetheless, this method doesn’t shed light on an exchange’s outstanding obligations, so some uncertainty persists.
As a result of the FTX debacle, pressure will mount on other exchanges to adopt similar measures. Who would dare to entrust an exchange without them? The industry is in for a thorough shake-up.
Which Crypto Exchanges Can You Trust?
For those in the crypto space, trust issues with exchanges are all too familiar. Trusting a platform to securely manage your digital assets can be a challenging endeavor. Luckily, Bitcoin’s design inherently promotes self-custody, allowing you to take control of your assets without relying on third parties.
So, if you’re storing a substantial amount of cryptocurrency on an exchange, it’s time to consider transitioning to your personal hardware wallet. Leaving your bitcoin on an exchange exposes it to various risks: from hacking to mismanagement where your funds may be wagered without your knowledge. Self-custody involves safeguarding your private keys, a task made more accessible through hardware wallets like the Belgian NGRAVE, in which we have a vested interest. Read our NGRAVE ZERO review.
How Can You Spot the Warning Signs?
It’s not always straightforward to detect exchanges that may not have your best interests at heart. Nevertheless, some telltale signs can raise red flags and warrant a cautious approach.
1. Proprietary Tokens: Be wary of exchanges that issue their own tokens, as exemplified by FTX. These tokens can be precarious when used as collateral for loans. Many such tokens lack substance and merely inflate the exchange’s balance sheet. With crypto prices being so unpredictable, a token’s plummet could drag the exchange down with it.
2. Generous Giveaways: Some exchanges, like Crypto.com, have been known to shower users with giveaways during bullish periods. These giveaways often come in the form of their native tokens, CRO. Now, you’ll have to lock up coins before receiving these rewards, but the question lingers: where does all this largesse come from? If it’s fueled by their own token, it could be an illusion, pure hot air.
3. High-Interest Payments: Be cautious when an exchange offers sky-high interest rates for locking up your crypto. Such platforms must take substantial risks to sustain these returns. The attractive rates are a compensation for the risk that your funds may not be returned, a scenario vividly illustrated by the collapse of Celsius. Exchanges that dabble in high-interest services are often on the lookout for returns, which might lead them to stray from their primary function: safeguarding customer assets. Therefore, when seduced by appealing interest rates, don’t be blinded by the numbers – it’s crucial to weigh the accompanying risks.
In a Nutshell
As a user, it’s virtually impossible to definitively assess whether an exchange is free from vulnerabilities or internal mismanagement. The chance of hacks and the potential misallocation of customer funds remains. Nevertheless, you can navigate these challenges by using exchanges solely for transactions and then transferring your holdings to a personal hardware wallet. This strategy ensures you maintain control over your assets and dodge the uncertainties associated with exchange operations.
