Learnings from the latest crypto crash and how to evaluate and invest in modern crypto businesses

As we examine the cutting-edge companies attempting to change the current ecosystem fundamentally, we can draw important lessons from the breakdown of the FTX exchange founded in 2019, which was regarded as one of the most reputable companies in the cryptocurrency space with over a million users and a 32 billion dollar market valuation earlier this year.

It may sound futuristic to replace how things have always been done, but systems developed over decades are packed with useful lessons. In this article, Mark Tencaten explains that companies should, at the very least, master them before breaking the established conventions of how things are done.

Mark Tencaten begins to explain what we should already know. Customers could swap digital currencies for conventional currency or other digital currencies on the cryptocurrency exchanges FTX and Binance. They conducted the vast majority of cryptocurrency trades worldwide between the two of them. Sam Bankman-Fried, CEO of FTX, oversaw quantitative trading through Alameda Research (SBF).

A cryptocurrency publication revealed that 5.8 billion dollars of the 14.6 billion dollars in assets shown on Alameda's financial sheet were coins produced by FTX itself (known as FTT). As Alameda traded complicated derivatives, FTT was used as security for loans obtained from many sources. In light of recent findings, Binance CEO Changpeng Zhao declared on November 6 that he would ditch the company's FTT token, which is worth roughly 580 million dollars. FTT cost about 25 dollars back then, but since then, the price has decreased by about 90%.

Customers of FTX raced to leave after Changpeng Zhao's remarks, and the exchange was hit with 5 billion dollars in withdrawals. An exchange ought to be able to handle every client's withdrawal request. SBF acknowledged that FTX has only 4 billion dollars in liquid assets to compensate them. The windows closed on November 8, and consumers had trouble withdrawing money. Currently, billions of dollars worth of assets—including half the money of Galois Capital, a hedge fund whose owner is recognized for predicting the demise of cryptocurrency Luna—are locked on FTX.

Benefits of turning to cryptocurrency

The origin of the cryptocurrency hype is that traditional finance is dominated by a small number of institutions and has a large number of rent-seekers. A straightforward credit card transaction incorporates a central bank controlling credit, a local bank evaluating credit, merchants controlling payments, and high fees levied by this ecosystem to maintain control. Mark Tencaten explains that cryptocurrency can be used to empower people through peer-to-peer (P2P) digital exchanges that do not involve a third party, thus decentralizing the financial system. Absolute freedom will result when central banks are unable to control people, and local banks (or payment networks) are unable to exploit people by charging exorbitant fees.

Thus, a Decentralized Finance (DeFi) system that does away with middlemen is created. Utilizing software that records and validates financial transactions in decentralized financial networks using blockchain technology, anyone who has internet access can loan, trade, and buy. DeFi does away with the need for middlemen. The majority of exchanges (Binance, FTX, Coinbase, etc.) start out centralized and aim to become decentralized over time because complete decentralization incurs high expenses. However, doing so necessitates storing cryptocurrency in the exchange's internal wallets. 

That is where the FTX situation really boils down to.

FTX combines the stockbroker, the exchange, the clearing company, the custodian, and, most significantly, the bank into a single entity. Crypto traders can keep their coins either at the exchange or in hardware or web-based digital wallets, but since all significant exchanges, including FTX, are centralized, they must keep their coins in the internal wallet of the exchange. There was reportedly more than 16 billion dollars worth of cryptocurrencies stored at FTX at the time of its bankruptcy filing.

Given the lack of regulation surrounding cryptocurrencies, it is reasonable to expect that most of them will disappear. The largest financial scam in the history of the brokerage industry may have resulted from what initially started as a plan to reduce the rent-seeking hegemony's costs. Institutions that try to bend the rules of conventional centralized finance should have first understood the advantages it offers, then addressed it in advance before moving on to disrupt it.

Conclusion:

Mark Tencaten explains that this case contains crucial lessons. It is critical for people as investors to determine whether the promoters of new-age enterprises that want to interrupt the current ecosystem have a thorough understanding of the industry. It is simple to fall victim to the "in thing" otherwise. And as we can see, if they fail, there is little margin for error.