Bitcoin & Co.: Can the crypto market recover?

The bankruptcy of the trading platform FTX has shaken the crypto scene. Whether she can recover from it, what is necessary for it and why one should separate between the technology and the gambling.

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 crashed. At the start of the week – ten days after FTX filed for bankruptcy protection and CEO Sam Bankman-Fried resigned – major currencies continue to suffer from the aftermath.

Bitcoin, the largest cryptocurrency, has fallen in price by more than three percent since Sunday and the second-largest ether by almost five percent. “The fear that more crypto companies could collapse in the coming days and weeks still dominates,” wrote analyst Timo Emden of Emden Research. But is FTX alone responsible for the crisis? Or are the problems deeper?

“Bad year” for the crypto industry

Both bitcoin and ether hit their record 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 the currencies on their way into the mainstream.

But even before the FTX bankruptcy, Bitcoin had fallen below the psychologically important $20,000 mark. The oldest and most important cryptocurrency is now worth less than $16,000 – a whopping 75 percent down from the record level. 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. There was one negative surprise after another: rate hikes by the central banks, the failed projects Terra (Luna) and Celsius and mass job cuts at companies in the industry.

Crypto investors withdraw money

The camel’s back was now heavyweight FTX with the biggest fraud scandal in crypto history. Investor uncertainty is within reach. In the past week alone, according to the analysis house Crypto-Quant, they withdrew Bitcoins worth 3.7 billion dollars from the major trading platforms. With Ether it was therefore 2.5 billion dollars. The market cap of the entire sector has fallen since the collapse from $1.05 trillion to about $830 billion – as of December 2020. Other brokers and exchanges have also faltered as a result.

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

“As more and more new buyers move up, money flows into the coffers, which is distributed to the previous buyers. We commonly call the whole thing a snowball system,” says Krahnen. A crypto exchange like FTX is not a neutral trading place where buyers and sellers simply meet, but has its own interests and passes on customer deposits.

Trading platforms without a business model

“The main problem of the crypto economy is the search for the task. There is no business model that generates serious income with crypto currencies,” emphasizes financial expert Krahnen. As long as that does not exist, there will be no stability in value 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 trust and skepticism about further increases in value.

According to the expert Sandner, however, there are significant differences within the crypto industry: “The most important thing now is that we separate the technology on the one hand and gambling apparatuses in the form of some companies on the other.” An example of the well-functioning infrastructure is the Berlin start-up BaseNote, which pays Nigerian engineers in 20 seconds with no significant transaction costs via the Ethereum blockchain. “This has absolutely nothing to do with FTX, but here you can actually make cross-border payments so that people have a benefit.”

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

FTX bankruptcy a ‘wake-up call’

In addition to paying with cryptocurrencies, the blockchain, with which data can be transmitted securely, up-to-date and transparently, also offers opportunities for companies from industry, for example: They can do without inefficient intermediate instances, control and monitor supply chains more quickly or track production conditions. In the broad masses, however, it is mainly known for Bitcoin & Co.

“It’s no wonder that currency is the first use case. It’s the simplest way to take money out of people’s pockets without giving anything in return – an organized thief spree,” emphasizes Krahnen. In the meantime, fortunately, enough regulators have noticed that “many small investors are being stolen from here”. The FTX case makes it clear that supervisors must quickly ensure stricter controls, said Jon Cunliffe, deputy head of the Bank of England (BoE), yesterday at an event at the Warwick Business School.

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

Regulation could prevent fraud

Sandner from the Frankfurt School of Finance & Management welcomes the planned regulation, but also refers to the global situation: “You have to see that the regulation is also getting better in other countries – the USA in particular has pushed it too far ahead of itself”, says the expert. There is not even a Bitcoin ETF there, which attracts small investors to sites like FTX.

At the same time, Sandner also appeals to 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 pay close attention to who they actually entrust their money to and, for example, look at the imprint on the website.”

According to Krahnen, regulation will ensure that the crypto exchange model no longer works in the future. According to the finance professor, if things were to run like in conventional finance, credit rules would have to be followed, cash flows disclosed and equity deposited. “So either the crypto economy perishes on its own because it’s just becoming too obvious that it’s an organized retail investor scam, or it’s going to be regulated.”