FTX Collapse Clears Way for Crypto’s Future

By Juan Villaverde

It's been roughly a month since the epic collapse of FTX — the most infamous event to stir up crypto markets in many years.

Many wondered if crypto could survive the failure of one of its largest and most trusted exchanges.

Here's my take: Of course, it can. And it will.

To understand why, we need to draw a distinction between the crypto industry and its technology. Though obviously related, they're not the same.

Despite all the recent market tension and turmoil, crypto technology continues to advance at breakneck speed. For example:

•  Powerful new scalability solutions are being rolled out for Ethereum (ETH, Tech/Adoption Grade "B"). ETH is set on becoming so fast and cheap, you'll see a whole new macrocosm of decentralized applications spring up that are impossible today, given the technology's current limitations.

•  Decentralized finance has continued to perform as expected, with no major hacks, breaks or failures in the wake of so many companies filing for bankruptcy.

•  Most important, one of the most pivotal — and potentially dangerous — events to ever take place in crypto-land went so smoothly, it was barely noticed.
I'm referring to Ethereum's September transition from a proof-of-work to a proof-of-stake consensus.

Ultimately, this is what really matters in crypto: Its technology keeps innovating. And use cases continue to grow.

As a result, more users get onboarded in each cycle. Despite all the trials and tribulations of 2022, there have never been more people actively engaged in crypto than right now.

Yes, many of them will eventually decamp for greener pastures, as they were only lured in by rising prices.

But there's still a cohort of steadfast diehards — folks who cut their teeth using this technology — who will never go away. They will continue to build bigger and better things.

And then there's the crypto industry, which has been disappointing in 2022. It's plagued by the same issues we've seen in every financial crisis in the past, both inside and outside of crypto.

I'm talking about too much leverage and not enough transparency. There's been a tangle of counterparty risk, where no one knows who owes how much money to whom.

The Latest Installment of This Sad,
Repetitive Story

As the 2020 bull market began, some trading shops started making a lot of money buying random altcoins.

As months passed, these folks sought to increase their returns by borrowing as much money as they could.

How were they able to borrow such vast sums?

In short, because they were able to pay interest considerably higher than the interest rates set by the Federal Reserve.

With the prospect of earning interest near 20% on the table — when the best you could get for a Treasury note or money market account was far less — lenders came pouring in.

At first, some firms lent out their own money to hedge funds such as Alameda Research and Three Arrows Capital — both now defunct.

Over time, lenders themselves got greedy, and started levering up: They took in customer deposits and paid them high interest — say, 10%. Then, they lent those deposits out to crypto hedge funds, earning the spread.

In other words: This was a whole daisy chain of counterparty risk, predicated on prices going parabolic month after month, year after year.

What could ever go wrong with that? Well, to start, the Fed started raising rates … which made crypto prices fall.

Small, illiquid altcoins took the brunt of the beating. Most are down over 90% and will never recover.

Soon, the hedge fund heroes who rode the raging bull market on the way up were singing a different tune. Taking heavy losses on their long crypto books, many of them crowded into the same, supposedly safe lifeboat: stablecoin lending on centralized platforms.

They parked money in TerraUSD (UST) — the stablecoin of Terra (LUNA, Unrated) — and staked it for 20% yield. As long as they got that 20%, they figured they could still pay back their creditors.

But LUNA collapsed spectacularly in June … which really put them in hot water. And because they sucked up capital from so many eager lenders, their failure brought their lenders down as well.

This is how Three Arrows Capital toppled, which led straightaway to the collapse of Celsius Network (CEL, Tech/Adoption Grade "C-"), BlockFi and a bunch of others.

Another one of these hedge funds was Alameda Research.

Unlike all the rest, however, Alameda had FTX, its sister company, to bail it out. And FTX was sitting on a large pile of money … customer money, on deposit, in their FTX exchange accounts.

Alameda tried to raise more funds in late June, but crypto credit markets had already seized up. There were no willing lenders anywhere.

At this point, the responsible thing for FTX and Alameda CEO Sam Bankman-Fried to do would be to admit defeat and unwind his fund. But instead, he decided to roll the dice on an unthinkable gamble.

He moved billions in customer deposits from FTX to Alameda and replaced them with an IOU, hoping no one would notice.

But people did notice.

In early November, Coindesk broke a story with the leaked balance sheet of Alameda. It showed a company with a monster pile of debt … and no credible means to repay it.

This news ignited a panic, which ultimately led to the demise of both FTX and Alameda Research. The rest, as they say, is history.

While the FTX fiasco sent the crypto market in a tailspin, it's important to remember …

FTX-Related Upheavals Will Not Destroy Crypto's Future

Crypto is an incredible technology with the power to lift people out of poverty by giving them access to stable money, basic financial services and plenty more.

This hasn't changed at all.

And it all but guarantees we're going to see higher prices in the long term … and perhaps sooner than people think.

But in the short run, plenty of distressed companies are fighting to stay solvent.

Many of them have lots of crypto on their balance sheet. And they could easily be forced to unload this crypto as part of a restructuring process.

This is a near-term risk to crypto asset prices, but nothing more.

And this could be the best course of action for the health and growth of the entire crypto industry — to knock out the bad players while they're down and set the stage for the next generation of promising crypto projects to excel in the next bull market.

Where does that leave us now? For me, I know I'm keeping my powder dry until I see confirmation of a market bottom.

Then, I'll be able get exposure to the projects I think will dominate this upcoming cycle.

For more details about which cryptos I'm considering, you'll want to check out my Weiss Crypto Portfolio. In it, I give exact "Buy/Sell" recommendations based on our Crypto Timing Model for near-term trading and long-term investing.

Or, if you're looking for a less active introduction to crypto investing, my Weiss Crypto Investor may be more your speed. It focuses on HODLing those blue-chip cryptos and crypto-leveraged assets that I believe have significant long-term value.

Best,

Juan