FAfter the bankruptcy of one of the world’s largest cryptocurrency exchanges, FTX, the price of bitcoin (BTC) fell again. It is now around $16,500, a far cry from the all-time high of $66,000 just a year ago.
Why such a big drop in value? This is due to a very toxic combination of an exchange (an electronic platform for buying and selling) called Binance, a stablecoin (cryptocurrency whose price is pegged 1:1 to the US dollar or other “fiat” currency) called Tether, and experienced professional traders. using high frequency algorithms.
Unlike stocks, bitcoin can be traded on many different exchanges, but Binance owns over 50% of the entire crypto market and sets the price of bitcoin and other cryptocurrencies as a result. To buy cryptocurrencies, traders must convert fiat money to a stablecoin like Tether. Bitcoin pegging has the largest volume of all products on Binance, and since one dollar is usually equal to one pegging, trading on Bitcoin pegging sets the dollar price of Bitcoin. But when bitcoin crashes, the whole crypto ecosystem collapses.
The problem is that Binance is self-regulatory, meaning it is completely unregulated by traditional market regulators such as the Securities and Exchange Commission in the US or the Financial Conduct Authority in the UK. This is very attractive to professional traders as they can use high-frequency price manipulation algorithms on Binance, which are against the law in regulated markets. These algorithms can cause rapid up and down price movements, which makes Bitcoin extremely volatile.
Binance performs its own clearing and settlement of trades, just like all other self-regulated crypto exchanges. This means that losing counterparties – those on the other side of profitable trades – often have their positions automatically wiped out without prior notice.
Unlike conventional exchanges, self-regulating crypto exchanges are not required to raise an alarm when a trade has lost so much money that it is necessary to replenish the deposit on the account. Instead, traders are solely responsible for funding their accounts by constantly monitoring what is called the liquidation price. This is done automatically by algorithms run by professional traders, but is tedious for casual bettors like you and me who need to remain highly vigilant whenever manipulation is used to create volatility that professional traders use to increase their profits.
When professionals trade against each other, it is called toxic flow because the chances of profits are more like 50/50 if their algorithms are equally fast and efficient. Professional traders prefer their counterparty to be an ordinary investor.
This is a concern because Binance has been very successful in attracting regular investors. The fees he receives from these kinds of investors have financed his very rapid expansion; now it is expanding with its own marketplace for stablecoins, blockchains and NFTs. Binance is solidifying its role as the Amazon Cryptocurrency with a very efficient business model.
In some ways, the current circumstances in the crypto markets can be compared to the bursting of the dot-com bubble in 2001-2002. The venture capital that poured into Internet startups in 1999-2000 suddenly dried up as many companies went bankrupt. This year, Three Arrows Capital, one of the largest crypto hedge funds, defaulted on its loans, and major crypto lending firms Celsius and Voyager filed for bankruptcy as the price of bitcoin crashed following some unexpected and shocking attacks on the new type of cryptocurrency. stablecoin called Terra. Since the bankruptcy of FTX, several other exchanges such as Gemini and lending platforms (shadow banks) including Genesis have prevented customers from withdrawing their funds.
We will see much more of this contagion that will trigger massive startup bankruptcies now that venture capital has dried up in the crypto sector. More and more exchanges and lending platforms, as well as blockchains, NFT marketplaces, data aggregators and analytics companies, will be a thing of the past.
Binance can emerge from this chaos with a monopoly. But right now, this unregistered and self-regulated company still needs commission income from ordinary investors, and it needs market makers (professional traders that look like hostile stock market stall holders) to run its business.
The danger is that now everyone is very scared, so the only way to attract ordinary investors is to pump up the price of bitcoin again. This will tempt people back into the crypto game only to have their savings wiped out as the cycle of volatility continues.