The epic fall of the $32 billion FTX cryptocurrency empire will probably down as one of the great financial collapses of all time. But while it has features similar to a classic banking crisis, what it lacks are actual banks. The bankruptcy filings of platforms like Voyager Digital Holdings Inc., Celsius Network LLC, FTX Trading Ltd, and hedge fund Three Arrows Capital, don’t have any banks listed as creditors, The Wall Street Journal reports.
Although these bankruptcy filings aren’t very clear, they describe the largest creditors as customers or other crypto-related companies. That means cryptocurrency platforms operate in a closed loop, deeply interconnected but with few connections to traditional financial institutions. That explains how a cryptocurrency asset once worth roughly $3 trillion could lose 72% of its value, prompting the collapse of intermediaries, with no discernible spillovers to the financial system.
Speaking about the cryptocurrency collapse, Yale University economist Gary Gorton and University of Michigan law professor Jeffery Zhang described the space as largely circular. “Once crypto banks obtain deposits from investors, these firms borrow, lend, and trade with themselves. They do not interact with firms connected to the real economy,” they said. This is good news for the larger economy as they are not connected to banks.
A few years from now, things might have been different due to the intensifying pressure on regulators and bankers to embrace crypto. The cryptocurrency collapse may have prevented that and a much larger crisis. Although crypto has been marketed as an unregulated, anonymous, frictionless, more accessible alternative to traditional financial institutions, its ecosystem is similar to a banking system, accepting deposits and making loans.
“Crypto lending platforms recreated banking,” Gorton and Zhang explain. “If an entity engages in borrowing and lending, it is economically equivalent to a bank even if it’s not labeled as one.” And much like banks, crypto is leveraged and interconnected which makes it vulnerable to debilitating runs and contagion. To historians, this litany of contagion and collapse is similar to the free banking era of 1837 to 1863, when banks issued their own money and panics occurred regularly.
Yet while those crises routinely halted business activity, cryptocurrency has largely passed the economy by and won’t cause it to collapse, The Wall Street Journal says. While some investors, from individuals to big venture capital and pension funds, have sustained losses, they are different from the sorts of losses that threaten the solvency of major lending institutions and the broader financial system’s stability.
Additionally, crypto currency’s grubby reputation and impending collapse repelled mainstream financiers like Warren Buffett and JPMorgan Chase & Co and made regulators nervous about bank involvement. This was bound to change because crypto was becoming useful as it was generating profit for speculators and their supporting ecosystem.
Still, several banks have made private-equity investments in crypto companies and many are investing in blockchain, the distributed ledger technology underlying the platform. A flood of crypto lobbying money was pushing Congress to create a regulatory framework under which cryptocurrency, having collapsed as an alternative to the dollar, could become a riskier, less regulated alternative to equities.