Decrypt: Lehmann moment back again?

FTX exchange, one of the biggest and most recognised players in the market for digital assets, and investors are taking cover. Numerous questions remain unresolved.

But two important questions loom: How extensive will the harm be? And can the battered cryptocurrency sector recover? FTX plunges the cryptoverse in turmoil as it declared bankruptcy on Friday. Investors are seeing this as “Lehman moment,”; in reference to the 2008 collapse of the bank that rocked the entire world. Many believe it to be a good comparison. To make things worse, the fear right now, that seems to be materialising, is a contagion effect.

Repercussions of the FTX crisis significantly increase volatility in the crypto ecosystem. The incident has undermined public confidence and emboldened regulators, who are currently on high alert especially since FTX was one of the most trusted entities in the crypto space. And regarded as the gold standard by many.

The circumstance is still rapidly changing. However, one worry is how it would affect the entire cryptocurrency industry, which was worth more than $1 trillion in August.

Over the summer (and through the crypto winter), as digital assets tumbled in value, Sam Bankman-Fried put up about $1 billion to bail out firms and shore up assets to try to keep the entire industry afloat. Now, few white knights are left to rescue FTX and others in distress. The number of entities with stronger balance sheets able to rescue those with low capital and high leverage is shrinking within the crypto ecosystem and the demise of FTX will produce other casualties. It’s hard to know at this point who is exposed, though there are clear ripple effects. Painfully, the least sophisticated of FTX’s constituencies retail investors , who put money on the exchange to trade or even just to save have ended up bearing the deepest wounds.

FTX Ventures, the exchange’s investment division, has invested in close to 50 projects. What the consequences will be for these businesses, which include Helium Inc., Aptos Labs, NEAR Protocol, and Mysten Labs, is unknown but seems ominous now.

Prices of bitcoin and ether, the two most-held cryptocurrencies, are more than 20% lower and Solana has also been battered thanks to reports that Bankman-Fried’s trading firm, Alameda Research, had sizeable holdings. Solana, considered to be a safe place to park cash, recently broke its one-to-one peg to the US dollar. Even crypto lending platform BlockFi is pausing customer withdrawals.

A lot of risky activity has already been flushed out of the system after a tumultuous few months. But as investors pull funds from crypto, more pain could arrive. Bitcoin could fall to its lowest in years and the crypto winter is poised to get even worse, especially as fears about the broader economic backdrop continue to erode the appetite for risky assets. Frankly, in the short term, this is going to be really, really bad for the crypto industry.

It could take years to restore faith in the sector’s promise and it will only embolden regulators to tighten the screws, raising costs for crypto firms that survive the unfolding purge. In fact, the timing is just right to reinforce the view that any sort of financial enterprise needs extensive regulation and while the crypto space is regulated, investors now need better protection.

(The writer is Founder, India Blockchain Alliance)