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Whales smell blood, start accumulating bitcoin after crypto’s annus horribilis

This year will go down as one of the worst in the short but storied history of cryptos, comparable perhaps with the disastrous Mt. Gox hack of 2014, when thieves made off with 740 000 bitcoin (BTC) from customers and 100 000 from the company itself – worth $460 million at the time.

That may seem like child’s play compared with the $60 billion wipeout of the Terra Luna crypto network earlier this year – or the estimated $8 billion in customer money lost in the collapse of the FTX exchange and its sister company, Alameda Research, later in 2022.

But bear in mind that the Mt. Gox exchange at one time handled 70% of the world’s BTC transactions.

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Crypto crash

The total crypto market cap hovered around $2.4 trillion in January this year. This week, that figure had crashed to $850 billion, with most of the damage done in the immediate aftermath of the Terra Luna collapse.

This blood-letting appears to have excited crypto whales, defined as those owning 100 or more BTC. Crypto analytics firm Santiment notes that whales accumulated $726 million worth of BTC over a nine-day period in December, with new crypto addresses growing at the fastest rate in 10 months.

This week BTC traded at $16 750, clinging to its $16 700 technical support level in the absence of any further bad news.

There is a sense that prices like these may not be around for long.

Meanwhile, one of the big trends of the last six weeks was a massive move by crypto owners towards self-custody, using hardware wallets like Ledger or Trezor, or software wallets such as MetaMask and TrustWallet.

Crypto owners generally assumed that exchange security was rock solid, but the FTX collapse exploded that myth when customers found out their coins were being on-lent without their permission.

FTX – ‘old-fashioned embezzlement’

Mt. Gox and FTX shared a commonality: they were both centralised exchanges, meaning they were run, in these cases, by corrupt or flawed individuals.

When the final tally is done, it appears that FTX appears will have lost $51 billion in collateral.

When FTX filed for bankruptcy and its former CEO Sam Bankman-Fried was arrested in the Bahamas earlier this month, John J Ray III stepped in as the new CEO.

Giving testimony before the US House Financial Services Committee, Ray said FTX’s collapse “appears to stem from absolute concentration of control in the hands of a small group of grossly inexperienced, unsophisticated individuals who failed to implement virtually any of the systems or controls that are necessary for a company entrusted with other people’s money or assets”.

Customer assets in FTX were co-mingled with assets from Alameda Trading. Loans and other payments worth $1.5 billion were made to insiders, with no description of the purpose of the loan. That’s not counting the 500 investments made by Alameda in businesses that may be worth just a fraction of what was paid for them.

In one instance Bankman-Fried signed as the issuer and recipient of a loan.

There was also no independent board.

Management had access to customer assets, customers’ private keys without effective security controls or encryption, and a virtual blank cheque was extended to Alameda so it could gamble it away.

There was an absence of audited or reliable financial statements, no governance worthy of the name, no centralised records on banking, no daily reconciliations of crypt assets, and no adequate insurance.

A year ago, Bankman-Fried testified to the exact opposite before the US Congress. “We store collateral from our users in a way which is not always done in the traditional financial system to back up our positions.” That turned out to be a lie – one of many now pouring out of the rotting carcass of FTX.

“I’ve never seen anything like it in 40 years of doing corporate restructuring work. I don’t trust a single piece of paper in this organisation,” said Ray.

“This is old-fashioned embezzlement … taking money from customers and using it for your own purposes, (it was) not sophisticated at all.”

Terra Luna

As bad as the FTX collapse was, Terra Luna was more severe in terms of financial impact.

It was a novel construct, comprising a US dollar stablecoin (UST) backed not by US dollars, but by a sister token called Luna that relied on speculative flows.

Lured by the ability to earn 20% a year on the stablecoin, Luna soared over the period of a year to $116, before speculators pulled the rug and sent it crashing to a fraction of a penny.

And with that, the stablecoin lost its backing and died, with founder Do Kwon now wanted by authorities in South Korea.

Given their heavy exposure to Terra Luna, crypto leaders Voyager and Celsius filed for bankruptcy, while hedge fund Three Arrows Capital (3AC) was forced into liquidation.

Where does this leave us?

We’re left more than $1.5 trillion poorer in terms of crypto market cap with still no turnaround in sight, and with questions being asked everywhere about the state of governance around a technology that may become the standard bearer of the coming financial revolution.

Total cryptocurrency market cap

Total cryptocurrency market cap

Source: CoinMarketCap

Thousands of projects built on zephyrs of hype and greed will fold, and that will leave the field relatively cleansed of junk.

In a year-end note to clients, Franklin Templeton peers into the future of blockchain finance and suggests regulation is inevitable and welcome.

“Regulation of blockchain finance was always probably going to happen. After all, regulation of financial markets is a fact of life. Quasi-libertarian ideals for a parallel set of unregulated and unsupervised currencies, assets and securities have always been fanciful.

“Financial regulation is burdensome, and one can openly question whether in some cases it may be excessive, but at the heart of all finance – old and new – reside asymmetries of information and misalignments of incentives that, if left unchecked, impair the functioning of financial markets, and stunt their growth.

“Regulation enhances trust between the providers and users of financial services. In that regard, proper regulation enables the financial services industry to reach its potential.”

Blockchain finance, in all its forms, has begun to recognise that regulation is a step toward its broader adoption, and that step is now inevitable as we enter 2023.




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