In the spring of 1720 a wealthy Frenchman by the name of Vermalet put on a peasant’s smock and drove a farming cart full of hay and cow manure from his home in Paris over the border into Belgium. It was a heist: beneath the steaming load were sacks of gold and silver coins, money that Vermalet had made in the speculative bubble of the Mississippi Scheme, in which large numbers of ordinary investors piled into the promise of ever-increasing returns from France’s colonies in America (as recorded in Charles Mackay’s Extraordinary Popular Delusions). Vermalet was a “stock-jobber”, or broker, who was among the first to realise that the market would collapse. He turned his gains into more conventional wealth and spirited them out of France under the cover of a heap of cowpats.
Last week, investors in cryptocurrency were given a look at the finances of two related cryptocurrency companies, the trading company Alameda Capital and the crypto exchange FTX, both run by Sam Bankman-Fried. At the beginning of this year, FTX was valued at $32bn by one investor. But what the accounts showed was that Alameda’s assets, unlike Monsieur Vermalet’s wagon, amounted to a big pile of bullshit and almost no gold.
This was the tipping point behind the current crypto crash: the assets supposedly underpinning a $14bn trading fund were largely in FTT, a “token” that FTX had itself made up, as well as other cryptocurrencies in which Bankman-Fried was either an early investor or a founder. The FTX balance sheet, which appears to have been composed of “rough values” added by Bankman-Fried himself, also contained an entry entitled “hidden, poorly internally labled [sic] ‘fiat@’ account” with a balance of minus $8bn.
Such informal accounting would have been risky for any small business; FTX was the second-largest cryptocurrency exchange in the world. It’s hard to say how many people in total have invested in crypto (most estimates are produced from within the industry, which clearly has a financial interest in overstating its own size) but it’s safe to say that hundreds of millions of people are now wondering if the collapse of FTX could mean the collapse of other businesses and “digital assets” such as Bitcoin.
This is a reasonable concern to have, not least because FTX is enmeshed with other businesses and investors; the FTX bankruptcy filing is a joint administration filing for 134 different businesses and states that there are more than 100,000 creditors. Big investors such as Sequoia Capital and Softbank have written off hundreds of millions of dollars, which will limit the real money that goes to such businesses in future. Businesses that held their assets on FTX include multiple hedge funds and crypto startups, and for some those assets remain trapped.
But the problem for crypto is broader than a bit of contagion. After the 2008 crisis, central bankers stabilised markets with ultra-low interest rates and quantitative easing (QE). In doing so they created a very safe investing environment in which risky, volatile assets gave the best returns. Crypto caught on because it provided volatility in a frozen market. But now that market is being aggressively thawed, and the general appetite for risk is much lower. According to the analytics company Glassnode, the current rate of net outflows from crypto exchanges is equivalent to more than 106,000 Bitcoin per month, or around £1.5bn.
And yet the price of Bitcoin and other cryptocurrencies not directly dependent on FTX seems to have stabilised relatively quickly. Does this mean people still believe in the currencies themselves, even if they’d rather not use the exchanges?
Perhaps. After all, the original use cases for these currencies – tax evasion, fraud, and the anonymous online purchase of drugs, guns, hacked data and illegal pornography – are still there. But the apparent stability of these currencies may also be cause for concern.
The problem is this: if millions of people exited the exchanges used to trade a handful of stocks, especially stocks that change quickly in price and are hard to sell, you’d expect their prices to change dramatically. Even government bonds, as we’ve seen, can be shifted by a single speech. What some people suspect is that prices in crypto markets are manipulated, by printing one currency to buy another, or by “wash trading” between exchanges, and indeed this has been shown to have happened with the price of Bitcoin on more than one occasion, as well as in related markets for NFTs, or non-fungible tokens.
While millions of retail investors and thousands of companies existed to enjoy the gains of this activity, it was obscured by the activity of the real market. The fewer players there are, the more obvious it will become if anyone’s cheating – and in crypto, that has always been the only safe bet.