Two of the main executives of the FTX group, owned by Sam Bankman-Fried, have just pleaded guilty to fraud in American justice. This is not the first cryptocurrency exchange scandal, nor will it be the last. But it matters for what it reveals about regulatory choices and the impact of interest rates on this ecosystem: as long as the price of money is high, the chances of other companies collapsing are high.
FTX was not a Ponzi scheme in your classic style. In such schemes, money from new depositors is used to repay pledges to previous investors. The scheme only works as long as the flow of new money is high and collapse is inevitable. The FTX case looks like a classic case of fraud, in which resources are simply diverted.
FTX was, roughly speaking, a stock exchange. Exchanges are normally safe businesses, as they are mere intermediaries between buyers and sellers. They require collateral to execute transactions, especially those that allow leverage.
To give you an idea, an investor who places shares as collateral to execute a transaction, instead of cash, on a traditional stock exchange, has his assets valued at 50% of their market value; that is, the investor cannot leave something uncovered, unless the shares he left as collateral fall by more than 50% in value.
What FTX did irregularly was “lend” customers’ money to Alameda Research, the group’s investment fund. As Alameda lost money making bets with the money of FTX customers, this opened a hole in the group’s accounts, of around US$ 8 billion (R$ 41.4 billion). When Binance CEO Changpeng Zhao announced that he was going to liquidate his FTX positions, it triggered a flood of withdrawals; as FTX had no cash due to the gigantic gap in resources diverted to Alameda, the group collapsed.
Two things are surprising in this case: how much of the ecosystem was built on cheap money with zero interest rates in the US and negative interest rates in Europe and Japan, and how the idea of a financial system without centralized regulation was an innocent dream. We have known since the 1930s that financial systems are fragile due to the interconnections of financial institutions and their role in transforming maturity, creating medium and long-term credit on top of a base of deposits that can be withdrawn at any time.
The market is experiencing another “winter” of cryptocurrencies, a recurring phenomenon, but which never came with the force of today. It is even surprising the resilience of the price of a bitcoin, still above US$ 16 thousand (R$ 82.9 billion). Still, it’s going to get a lot worse before it gets better. World interest rates have not stopped rising, and the higher the interest rates, the lower the incentive to carry a digital product that does not offer periodic returns. In a reasonably new market, infrastructure matters. And no company offers proper and secure escrow services. If you invest in this sector, be careful.
This Christmas, if you are wrapped up in a divorce or are having issues with your ex, remember that you should never, ever use your children to hurt the other parent of a child. I keep seeing how common this is, and I can tell you that the only thing you’re going to get is having children who are maladjusted and resentful of your actions.
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