FNext bankruptcy From one of the world’s largest cryptocurrency exchanges, FTX, the price of bitcoin (BTC) has fallen again. now it’s about $16,500 – a far cry from the all-time high of $66,000 just a year ago.
Why such a big drop in value? It is due to the highly toxic combination of an exchange (an electronic platform for buying and selling) called Binance, a stablecoin (a cryptocurrency whose price is pegged 1:1 to the US dollar or other “fiat” currency) called a peg, and the Skilled professional traders running high frequency algorithms.
Unlike stocks, Bitcoin can be traded on many different exchanges, but Binance has more than 50% of the entire crypto market, and as a result sets the price of bitcoin and other cryptocurrencies. To buy cryptocurrency, traders need to convert fiat money into a stablecoin like Tether. Bitcoin-tether has by far the largest volume of any commodity on Binance, and because one dollar generally equals one tether, trading in bitcoin-tether sets the dollar price of bitcoin. But when Bitcoin fails, so does the entire crypto ecosystem.
The problem is that Binance is only “self-regulated”, which means that it is completely unregulated by traditional market regulators such as the US Securities Exchange Commission or the UK Financial Conduct Authority. This is a great attraction for professional traders because they can implement high frequency price manipulation algorithms on Binance, which are illegal on regulated markets. These algorithms can cause rapid price movements up and down, making Bitcoin extremely volatile.
Binance does its own clearing and settlement of trades, just like all other “self-regulated” crypto exchanges. This means that losing counterparties (those on the other side of profitable trades) often have their positions auto erase without notice.
Unlike normal exchanges, “self-regulated” crypto exchanges are not required to raise the alarm when a trade has lost so much money that collateral needs to be replenished on the account. Instead, traders are solely responsible for funding their accounts by continually monitoring something called the settlement price. This is done automatically by the algorithms that professional traders run, but it is tiring for regular players like you and me, who must remain very vigilant whenever manipulation is used to create the volatility that professional traders use to increase their profits.
When professionals trade with each other, it is called a toxic flow, because the chance of making a profit is more like 50-50 if their algorithms are equally fast and effective. Professional traders prefer their counterparty to be an ordinary investor.
This is concerning because Binance has been extremely successful in attracting mainstream investors. The commissions it earns from these types of investors have financed its rapid expansion; it is now branching out with its own stablecoin, blockchain, and NFT marketplace. Binance is consolidating its role as the Amazon of cryptocurrencies, following a very effective business model.
In some ways, one can compare the current circumstances in the crypto markets to the bursting of the dotcom bubble in 2001-2. The venture capital that had been invested in Internet start-ups in 1999-2000 suddenly dried up, as many companies went bankrupt. This year, Capital of the three arrows, one of the largest cryptocurrency hedge funds, defaulted on its loans, and major cryptocurrency lending firms Celsius and Voyager filed for bankruptcy when the bitcoin price crashed, following some shocking and unexpected attacks on a new type of stablecoin called Terra. Following the bankruptcy of FTX, several other exchanges such as Geminiand lending platforms (shadow banks) that include Genesis they are preventing customers from withdrawing their funds.
We will see much more of this contagion, precipitating widespread bankruptcies among startups now that venture capital has dried up in the cryptocurrency sector. More exchanges and lending platforms, as well as blockchains, NFT markets, data aggregators, and analytics firms, will bite the dust.
Binance could emerge from this chaos with a monopoly. But right now, this non-domiciled, self-regulated company still needs fee income from ordinary investors, and it needs market makers (professional traders akin to hostile stock market stall owners) to conduct its business.
The danger is that everyone is very scared now, so the only way to attract ordinary investors is to increase the price of bitcoin again. This would tempt people to get back into the cryptocurrency game, only to have their savings wiped out as the cycle of volatility continues.