Bitcoin & Co.: Can the crypto market recover?

The bankruptcy of the FTX trading platform has shaken the crypto scene. If she can get over it, what she needs and why we need to separate technology and play.

It was a bankruptcy that dragged an entire industry into the abyss: after the bankruptcy of the second largest crypto exchange FTX, all digital currencies collapsed. At the start of the week – ten days after FTX filed for bankruptcy and CEO Sam Bankman-Fried stepped down – major currencies continue to suffer the consequences.

The price of bitcoin, the largest cryptocurrency, has fallen more than three percent since Sunday and the second-largest ether by almost five percent. “Fear that more crypto firms will crash in the days and weeks ahead still dominates,” wrote analyst Timo Emden of Emden Research. But is FTX solely responsible for the crisis? Or are the problems deeper?

“Bad Year” for the Crypto Industry

Both bitcoin and ether hit their all-time highs of nearly $69,000 and over $4,800, respectively, about a year ago. At that time, high global liquidity, low interest rates, inflation and the corona pandemic caused digital currencies to rally. Not only fans, but also some financial experts had already seen currencies entering the mainstream.

But even before FTX went bankrupt, Bitcoin had fallen below the psychologically important $20,000 mark. The oldest and largest cryptocurrency is now worth less than $16,000, down 75% from the all-time high. Ether also currently costs just over $1,000.

“The year couldn’t have been worse for everyone in the crypto scene,” says Philipp Sandner, head of the Blockchain Center at the Frankfurt School of Finance & Management, in an interview with tagesschau.de. Negative surprises followed one another: rate hikes by central banks, failures of the Terra (Luna) and Celsius projects and massive job cuts in companies in the sector.

Crypto investors withdraw money

Camelback was now an FTX heavyweight with the biggest fraud scandal in crypto history. Investor uncertainty is at hand. In the last week alone, according to analytics firm Crypto-Quant, they withdrew $3.7 billion worth of Bitcoin from major trading platforms. With Ether it was therefore 2.5 billion dollars. The market capitalization of the entire industry has fallen since collapsing from $1.05 trillion to around $830 billion – in December 2020. Other brokers and exchanges have also faltered as a result.

Because: “The key word for understanding the rise and fall of the crypto industry as a whole is trust,” says Jan Pieter Krahnen, director of the Leibniz Institute for Financial Markets Research ( SAFE) in Frankfurt. tagesschau.de. Unlike banks, which earn money through deposits and loans, platforms generate profits from a so-called Ponzi game – a model in which income is not generated by economic added value, but by integrating new customers.

“As more and more new buyers move forward, money flows into the coffers, which is distributed to previous buyers. We usually call this all a snowball system,” says Krahnen. A crypto exchange like FTX is not a neutral place of exchange where buyers and sellers simply meet, but has its own interests and forwards customer deposits.

Trading platforms without a business model

“The main problem in the crypto economy is the search for the task. There is no business model that generates serious income with cryptocurrencies,” stresses financial expert Krahnen. Until that exists, there will be no value stability and ultimately no future for the scene. Because like any Ponzi scheme, at some point you will reach a limit where no new customers will come. The reason: loss of confidence and skepticism about further increases in value.

According to expert Sandner, however, there are significant differences within the crypto industry: “The most important thing now is that we separate out technology on the one hand and gaming devices in the form of certain gaming companies. ‘somewhere else.” An example of a well-functioning infrastructure is Berlin-based startup BaseNote, which pays Nigerian engineers in 20 seconds with no hefty transaction fees via the Ethereum blockchain. “It has absolutely nothing to do with FTX, but here you can actually make cross-border payments for people to benefit from.”

“The heart of these cryptocurrencies is the blockchain. The promise of being able to credibly document transactions without external oversight is a great and fascinating technological achievement,” says SAFE Director Krahnen. In his opinion, however, there is still no economically sensible and widespread application. Blockchain does not yet work for real payment transactions because it is too expensive, slow and complex and can only transfer small values.

FTX’s bankruptcy is a ‘red flag’

In addition to paying with cryptocurrencies, the blockchain, with which data can be transmitted in a secure, up-to-date and transparent manner, also offers opportunities for companies in the industry, for example: they can do without instances inefficient intermediaries, control and monitor supply chains more quickly or track production conditions. In the broad masses, however, he is mainly known for Bitcoin & Co.

“It’s no wonder that currency is the number one use case. It’s the easiest way to take money out of people’s pockets without giving anything back – an organized theft spree,” points out Krahnen. In the meantime, fortunately, enough regulators have noticed that “many small investors are being robbed here”. The FTX case makes it clear that supervisors must quickly ensure tighter controls, Bank of England (BoE) Deputy Director Jon Cunliffe told an event at Warwick Business School yesterday.

The goal is to ensure that innovation in crypto can happen, but within a framework where risks are appropriately managed. FTX’s bankruptcy is a “wake-up call”, EU Finance Commissioner Mairead McGuinness told “Handelsblatt”. “We can’t let things like this continue.” At the end of June, the representatives of the European Parliament and the Member States had already agreed on the set of rules “Markets in Crypto Assets” (Mica). Although the directive has not yet been officially adopted, it will probably come from 2024.

Regulation could prevent fraud

Sandner of the Frankfurt School of Finance & Management welcomes the planned regulation, but also refers to the global situation: “You have to see that regulation is also improving in other countries – the United States in particular the have pushed too far ahead of itself,” says the expert. There aren’t even Bitcoin ETFs there, which attracts small investors to sites like FTX.

At the same time, Sandner also calls for the responsibility of individual investors who do not go to BaFin-licensed trading platforms such as Coinbase or the Stuttgart Stock Exchange, but instead use platforms such as FTX. “Investors will have to be more careful and skeptical in the future. They should always be very careful who they actually entrust with their money and, for example, look at the imprint on the website.”

According to Krahnen, the regulations will ensure that the crypto exchange model does not work in the future. According to the finance professor, if things were to work like in conventional finance, credit rules would have to be followed, cash flow disclosed and equity deposited. “So either the crypto economy perishes on its own because it’s becoming too obvious that this is an organized scam of retail investors, or it’s going to be regulated.”