“Buy when there is blood in the streets.” That’s what they say.
Well, the avenues of cryptotown are knee-deep in gore today. The market is suffering following the recent explosion in the crypto exchange FTX. It turned out to be unable to return funds to customers and, at the time of writing, a bid to rescue it looks to be failing. The exchange is heading towards bankruptcy.
This has shaken investor confidence in crypto and many are heading for the exits, accepting whatever market price is current. As the next chart shows, almost every token and coin is in the red over the past 5 days.
The most recent fall follows a long, slow decline in crypto since its peak, almost exactly a year ago. Collapses in tokens have damaged the market like in the case of Terra.. A crypto investment fund collapsed too (Three Arrows). Now the collapse of an exchange, a token and an investment fund (all linked) is hurting even more.
Bitcoin has lost 74 per cent of its value in the past year vs the US dollar. Ethereum too. Solana is down 94 per cent. Recent price action in Solana is a good reminder that, just because something has fallen a lot, doesn’t mean it can’t step down further.
The questions on everyone’s lips: Is it time to get in yet? Is this peak blood? How low can these assets go?
One answer: It depends how many more collapses are coming.
Rising official interest rates means more traditional assets like stocks and bonds are finally paying decent returns. That is soaking money away from crypto, slowly, slowly. A slow loss of support can cause a slow sinking, but sometimes it also causes a big, dramatic fall - like today.
One big problem for FTX is that its own token – FTT - makes up the majority of its assets, as well as the assets of the related investment company, Alameda Capital. If an entity, like FTX, owns assets that are falling in value and has liabilities that are stable (or falling in price more slowly than their assets), solvency can become a problem.
Also by Jason Murphy:
Crypto exchanges shouldn’t be affected by falling crypto prices if they do their job properly.
One problem is that, in crypto, a lot of loans have been made against assets that aren’t worth as much any more. A bit like how mortgages were backed by houses in the USA that weren’t worth so much, back in 2007. In some cases, the assets held are “tokens” issued by other players in the crypto space.
How many more crypto institutions are stuffed with crypto assets that don’t cover their liabilities? We don’t know, but a good guess is: more today than yesterday, seeing the price action. If more collapses happen, crypto might have further to fall.
On the other hand the above is all very obvious. It is easy to imagine a wider contagion scenario, but that doesn’t mean it will happen.
Can the crash make crypto stronger in the long run?
What’s more, if you think crypto is strengthened by shaking out the bad apples, then events like these can make crypto stronger. The wild west days of pretending risk and return aren’t correlated are moving into the past. There are fewer and fewer big exchanges left. The ones that remain are the more prudent ones.
Every exchange is presumably now frantically moving to make sure it has more than enough capital to meet customer demand. The 2007/08 crisis made the global financial system stronger in the end. It meant banks were so strong we got through the pandemic without a financial crisis. Likewise, this crisis in crypto could lead to strengthened practices that make the exchanges safer and the asset class safer.
Also, official interest rates are probably now closer to their peak than their trough. Australian interest rates have risen from 0.1 per cent to 2.85 per cent. That’s 275 basis points, or 27 times higher, depending on how you want to look at it.
The market expects official interest rates to hit about 4 per cent - up another 115 basis points or 40 per cent higher. That means the process of drawing money away is closer to its end than its beginning.
And a final point: failures in exchanges don’t say anything about the coins themselves. Bitcoin has survived dozens of exchange collapses, going all the way back to MtGox.
New dawn for crypto could be coming.
While crypto may get stronger and more viable, how will you know when that time has arrived?
I started this article with a quote, which is often attributed to famous investor Nathan Rothschild. A variation of it is “buy to the sound of cannons, sell to the sound of trumpets”. However, there’s no evidence he ever said either. Several historians argue he never did, and the attribution is probably made up. Attributions of the quote to Rothschild start after 1970.
Despite this, Rothschild is famous for trading the result of the battle of Waterloo but he didn't buy the dip and hope. He knew England had defeated Napoleon eight hours ahead of everyone else in London and bought up big, making an enormous fortune.
The real lesson of Nathan Rothschild, it turns out, is not the value of contrarianism, nor of courage. It’s the value of information.
So, it’s important to mention that this story from last week seems to have kicked off the collapse in FTX. Finding out the whole system rested on a house of cards – the FTT token – was enough to cause a huge crypto collapse.
Information is key, so keep reading.