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December 1, 2022updated 15 Dec 2022 10:06am

How the FTX ‘contagion’ has spread among crypto investors

By Katharine Swindells

Crypto exchange FTX filing for bankruptcy has created a wave of panic that could permanently destroy investor confidence in digital assets

A series of crises across the cryptocurrency economy did nothing to stop wealth management firms waxing lyrical about the growth of crypto in recent months.

A quarter of family offices revealed their clients were planning to increase their allocation to crypto in October, while 2022 has seen keen demand among UHNWIs for digital assets.

But everything changed in early November, when leading cryptocurrency exchange FTX announced it was filing for bankruptcy.

‘At the moment, digital assets look very much like a land of contagion with investors asking themselves which platform is going to fail next,’ comments Carsten Menke, head of Next Generation Research at Swiss wealth management firm Julius Baer.

‘The confidence in cryptos is more shattered than ever.’

How FTX folded

Concerns about FTX’s undisclosed financial relationships with partner firm Alameda Research rumbled in September.

Then, on 6 November, rival exchange Binance’s CEO Changpeng Zhao announced it would sell its holdings of FTX’s native token, FTT.

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This action, along with the resulting Twitter spat between Zhao and FTX CEO Sam Bankman-Fried, sparked a surge in demand for customer withdrawals. A bank run of sorts.

Daily FTT shares, which had never surpassed $500 million, went over $3.3 billion on 8 November. By close of play on 9 November, the price of FTT had plummeted to less than $2.50, down 90 per cent within two days.

Three days later, FTX and over 100 affiliates filed for bankruptcy, while Bankman-Fried announced his resignation.

How cryptocurrency investors are changing the world of wealth

The damage wasn’t only to FTX itself, but across the cryptocurrency space. The price of Bitcoin fell 15 per cent between 7 November and 10 November, while Coinbase, another cryptocurrency exchange platform, saw its shares fall 10 per cent in the same period.

As November drew to a close, US crypto-firm BlockFi filed for bankruptcy due to an outstanding FTX loan of $275 million.

And BlockFi might not be the last casualty of the failed exchange. Morgan Stanley analysts have compiled a list of 63 companies - lenders, traders exchanges and investors - that may be exposed to losses due to FTX’s failure.

These include Singaporean state investor Temasek Holdings, which has written off $275 million holdings in FTX, and Sequoia Capital, which has already apologised to investors for a loss of $150 million.

But, the collapse of FTX didn’t come from nowhere.

The past few years, Menke says, has seen a 'mushrooming' of crypto companies and projects due to a boom in venture capital investment, all with very little reporting transparency.

In 2022, this has culminated in a series of crises in the crypto space.

Bitcoin's price reached record highs in the pandemic, but has dropped rapidly in the past year. Crypto coins terraUSD and LUNA collapsed in May 2020, causing a reported $300 billion in losses to the crypto economy. Industry-wide chaos led to the bankruptcy of crypto lender Celsius Network as a result.

The collapse serves as a warning over the 'illusory' dangers of unregulated digital currencies, say specialist lawyers.

'The difficulty is you can set up a very great website, you can have a lot of positive press, it can look like it's an extremely safe place,' Kate Troup, a financial services regulatory lawyer at Fladgate tells Spear's.

'These exchanges give you comfort that there is a proper entity, but they’re not regulated, so it’s all an illusion.'

And many UHNWs ignored red flags in the crypto space. October analysis released by Campden Wealth found that not only were a quarter of family offices planning to increase crypto allocation in 2023, only one in 20 planned to decrease it.

Julius Baer’s annual survey of UHNW families found that a quarter were already strategically invested in digital assets. Of those who weren’t, half planned to do so in the coming years.

FTX Arena in Miami
The FTX Arena in Miami will be renamed after the world's third-largest cryptocurrency filed for bankruptcy

But the fall of FTX, and the resulting shockwaves across the sector, Menke says, have changed all that.

As more companies continue to fold due to FTX exposure, he says, the less likely it is that confidence in crypto will recover in the short-to-medium term.

However, Menke says, the crisis has shown which parts of the digital assets space are strong, and hopefully this crisis will prompt the regulatory action that's needed to make crypto viable in the long term.

'Many blockchains, and in particular the primary ones such as Bitcoin and Ethereum, did not have any technical issues and worked as designed during the current crisis, while the number of active network addresses remained much more resilient than the sell-off would suggest,' he says.

'Regulation is always reactive, never proactive. This year’s crypto crisis will thus serve as the trigger to enact more regulation in the crypto space.'

Carsten Menke is Head of Next Generation Research at Julius Baer

Although evangelicals may still argue that crypto should be totally decentralised, says Troup, it’s likely that crypto firms will be forced to conform to regulations in order to create the stability investors are looking for.

'Like with Northern Rock, this shows that there needs to be similar regulations on crypto as there are on banks,' she says. 'They have to have the financial capital to back it up.'

Ultimately, Troup says, there are some clients who will always be attracted to the high risk-reward nature of digital asset investment. however, this crisis is likely to see more traditional financial institutions shy away from it

While adoption of crypto as a mainstream asset class has likely been delayed by the FTX crisis, wealth managers say the disruptive capabilities at the heart of blockchain still have the potential to provide service to society and the economy.

Now, it’s up to them to prove it.

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