Preventing crypto runs

BYTES - Lito Villanueva - The Philippine Star

Cryptocurrency is taking the world by storm.

With more names joining the crypto ecosystem – the popular Bitcoin, Ethereum, Litecoin, and many more – more investors, brokers, traders, and adopters worldwide have been participating profusely, contributing to the meteoric growth and popularity of this alternative form of payment across the globe. Crypto is no longer just a niche trend or hobby for tech enthusiasts – it has become a fast-growing, global force to be reckoned with, thanks to its widespread accessibility, availability, and inherent independence from centralized financial authority and government involvement.

A cryptocurrency is a form of digital currency and a virtual accounting system that uses encryption algorithms for secure transactions and transfers. You can use crypto to exchange certain goods, services, and investments from a growing list of vendors who are slowly adopting virtual currency as a form of payment.

Because crypto is not issued and regulated by private or public entities or central authorities, this decentralized system is typically “immune” to government regulations, taxation, inflation, and economic instability because of its self-governed nature. Border-to-border money transfers are cheaper and quicker, peer-to-peer transactions are secure and private, and you do not need to be formally banked to experience crypto’s transactional freedom.

However, when there are advantages, there are also disadvantages. Crypto and its soaring value in trading and investments may seem very exciting, but it is also inherent in volatility. Too much freedom gives way to the abuse of it. This can leave the unregulated space ripe for criminal activities, investor losses due to scams and bugs, and security risks.

Because it is not regulated and backed by financial institutions, legality is moot. This is risky, especially when it comes to investor losses, fraudulent transactions, and investment scams. Nobody is spared, especially when one of the highest-profile crypto crashes in recent history was because of FTX, one of the world’s top largest crypto exchanges.

FTX was founded by Sam Bankman-Fried in 2019. It quickly boomed in popularity and in fortune due to the marketing of higher yields, low trading fees, and celebrity endorsements from Tom Brady, Steph Curry, Naomi Osaka, and Gisele Bündchen, as well as high-profile sports partnerships.

In 2022, amid rising interest rates, the crypto industry began to decline. FTX seemed to stand strong among other competitive platforms that were shutting down. He even bought some of them. But in November, FTX filed for bankruptcy protection in the US after facing a liquidity crunch. Now coined as one of the biggest crypto fails in history, this resulted in at least $1 billion of customer funds disappearing into thin air, and the $16-billion fortune of his empire gone.

It was revealed that Bankman-Fried moved $10 billion of these funds to his other crypto-investing firm, Alameda Research. This was reported in Alameda Research’s balance sheet, which was published by CoinDesk. It showed unidentified digital assets worth billions of dollars, which was revealed to be FTT, which are FTX’s own digital tokens and stocks that held their own market value and exclusive rewards.

When the prices of FTT tokens sharply dropped, Alameda’s assets became vulnerable to high volatility and grave loss. Native tokens that are unregulated are very susceptible to market losses. Shortly after the balance sheet reveals, FTX rival Binance, who owned an investment in FTT, announced their instant withdrawal from FTX and that they would sell all their FTT tokens. Prices crashed, and the ripple effects were quick, and this is what we call a crypto run. There was a public fear of insolvency, typical to how customers would pull out their assets from traditional banks during a market crash.

FTX customers and retailers attempted to withdraw their stocks and assets from the platform in panic, but many were already locked out. FTX did not have the funds to pay them back. Binance came in to attempt a rescue of the traders, offering to buy FTX. However, after reviewing the internal processes of FTX, the losses were unsolvable to Binance, and they took back the deal.

There was a hole in the balance sheet, and FTX’s liabilities were higher than their assets, causing the filing of bankruptcy. After the CEO resigned and an investigation ensued, it was discovered that the FTX CEO secretly used billions in customer funds to pay for external projects, such as Alameda, an action explicitly barred in FTX’s terms of use.

This isn’t a first in the crypto world – these runs happen because the very operation of crypto exchanges lacks the strict standards and regulations of a financial institution. There are no policies to dictate what is “right” and what is “wrong”, nor any regulatory authority controlling the assets in the market. When there is no regulatory entity overseeing operations, ethical standards and security measures are questionable.

It may be hard to impose regulations (as they will differ per country), but due to the volatility and vulnerability of crypto assets, it must be done. The growth of the market is slowly making its way to mainstream banking, with some governments making digital currency legal.

However, this shouldn’t stop us from growing crypto and producing further innovations. If crypto exchanges can practice transparency through regular auditing and making public the liquidity of exchanges, safety and trust may be built. Registering crypto may also be an option, under major financial institutions in the Philippines or with specific government bodies. Active comprehension of cryptocurrency and financial awareness should also be instilled by market authorities and mainstream banks who want to head this movement of progress.

If we can find a way for both digital and fiat currencies to co-exist without harping on the government’s monetary policy, we may be able to create a safe space and virtual financial ecosystem where more Filipinos can experience the beneficial side of crypto through a solid, safe, and secure regulatory framework. This would be crucial in bringing trust and confidence to consumers and stabilizing the market, which sets the ground for innovations to flourish.

Lito Villanueva is the Philippines’ award-winning thought leader on digital transformation and inclusive digital finance.  He is the executive vice president and chief innovation and inclusion officer of RCBC. Concurrently, he is the chief digital transformation advisor for the Yuchengo Group of Companies. He is also the founding chairman of Fintech Alliance.ph, the Philippines’ largest organization of startups and unicorns that collectively generates over 90 percent of digital transactions volume in the country today. He was recently elected global chairman of the South Africa-based Alliance of Digital Finance Associations. Among his 100 accolades include being named among the Top 100 Fintech Leaders in Asia, and Top 100 Filipinos on LinkedIn, Mr. Fintech of the Philippines by BizNews Asia, and Chief Innovation Officer of the Year by The Banker.

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