Has the FTX collapse impacted Cryptocurrency’s future?

The cryptocurrency world was thrown into disarray when the cryptocurrency exchange FTX collapsed.

Sam Bankman-Fried is the 30-year-old founder and former CEO of the company. In the span of a few days, he went from one of the 50 richest people in America to the leading figure of the biggest crypto collapse to date.

FTX collapsed into a $32 billion pile of risky bets and worthless tokens.

In a matter of days, Bankman-Fried’s estimated fortune went from $17 billion to less than $1 billion.

A report about the finances of FTX’s sister company, Alameda Research, kicked off the decline.

Speculative investments were allegedly made by using FTX customer deposits, taking billions without users’ knowledge.

It was Alamada that reportedly covered up the scheme because the hedge fund ensured the assets it was trading on FTX steered clear of its own balance sheet.

In a bankruptcy filing, the company estimates it will have more than one million creditors seeking damages.

They were reportedly convinced to invest their life savings into the platform.

The filings also show that Alameda Research handed out three personal loans to FTX executives, with Bankman-Fried borrowing $1 billion.

According to FTX’s bankruptcy filings, Bankman-Fried used the money for his personal use.

FTX put in its bankruptcy filings today & shared that the founder took $1B for his own use + corporate funds were used to buy homes & other person items. Yikes. pic.twitter.com/K8HecblBl3

— Girls That Invest (@girlthatinvest) November 17, 2022

And while FTX CEO Sam Bankman-Fried owned 90% of the trading firm, it was Caroline Ellison at Alameda’s helm when both companies collapsed.

The fallout from FTX’s implosion has raised questions as to whether it has impacted the future of cryptocurrency.

The collapse saw the share price of the $10.5 billion Grayscale Bitcoin Trust (GBTC) plummet to a 39% discount to the value of its underlying assets.

GBTC owns 3.5% of the world’s bitcoin.

Investors in the trust suffered an 83% loss since bitcoin peaked in November 2021, outstripping the 74% decline in the value of bitcoin itself.

Fears hit closer to home for Grayscale on November 16, 2022, when crypto broker Genesis Trading suspended redemptions and originations of loans at its lending arm after suffering financial contagion from the failure of Three Arrows Capital, the Singapore crypto hedge fund that filed for bankruptcy in July 2022.

Genesis acted as an authorised participant to GBTC, responsible for issuing new shares, until in October 2022 when Grayscale launched an in-house broker-dealer, Grayscale Securities.

Digital Currency Group is also the largest shareholder in GBTC, with a 4.1% stake.

GBTC’s main problem is that it has been superseded by the advent of better vehicles for holding bitcoin.

Net assets peaked at $39.8 billion in October 2021 and GBTC traded at a premium to net asset value.

But it was undermined by the emergence of the first bitcoin exchange-traded funds in Canada that year. These vehicles’ fees were typically less than half the 2 per cent a year charged by GBTC. They also offered greater liquidity and new investors did not need to pay a premium.

As flows moved away from GBTC, supply and demand for its shares were tipped out of kilter, pushing its share price to a sharp discount to NAV.

The underlying problem is that there is no arbitrage mechanism to bring supply and demand back into balance.

GBTC shares cannot be redeemed for bitcoin or cash and can only be sold to another buyer via the over-the-counter market.

Grayscale would need regulatory approval to institute a share buyback programme. Grayscale instead hopes to convert GBTC into a “spot” bitcoin ETF, holding the “physical” currency.

So far, these plans have been blocked by the US Securities and Exchange Commission, which has refused to follow the lead of regulators in Canada and elsewhere by approving spot bitcoin ETFs, citing concerns over potential fraud and manipulation on the unregulated exchanges where trading occurs.

Grayscale is currently suing the SEC for the right to convert GBTC.

The continuously-increasing discount indicates that few market participants believe it is likely to succeed.

Todd Rosenbluth, head of research at VettaFi, said:

“If they were successful in winning the court case then any investors would be made whole.

“The discount would sharply erode because the [share] creation and redemption process can freely occur.”

Nate Geraci, president of The ETF Store, said:

“GBTC’s structure is clearly suboptimal since shares cannot be redeemed.

“It’s highly disappointing that the SEC continues allowing any retail investor to access this fund, yet they won’t approve a spot bitcoin ETF which would solve the discount problem.

“This is yet another example of the absurd regulatory dysfunction around the entire crypto ecosystem right now.”

BlockFi is the second-largest shareholder with 2.9%. It has halted withdrawals of customer deposits due to its “significant exposure” to FTX.

Peter Tchir, head of macro strategy at Academy Securities, raised the prospect of Grayscale seeking permission to buy back a large number of shares, then liquidating the fund, potentially making more than enough profit to compensate for its loss of fee income and making external investors whole in the process.

But Geraci believed the discount could widen even more “especially if there is further FTX contagion which weighs on the crypto space as a whole”.

Nevertheless, he suggested GBTC “is clearly a better option than holding bitcoin on an exchange like FTX, as investors can operate with confidence that the underlying bitcoin is actually there”.

Moreover, Geraci believed the FTX collapse has bolstered the case for regulatory oversight of crypto exchanges, “theoretically accelerating the timeline for spot bitcoin ETF approval”.

However, Rosenbluth thought the SEC would see the fiasco as a vindication of its position.

He said: “The SEC has viewed spot bitcoin as risky and is concerned about fraud and manipulation.

“I’m not sure they are going to be surprised by these developments.”