FAfter one of the world’s largest cryptocurrency exchanges, FTX, went bankrupt, 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 sharp drop in value? It’s because of the highly toxic combination of an exchange (an electronic buying and selling platform) called Binance, a stablecoin (a crypto whose price is pegged 1:1 to the US dollar or another “fiat” currency) called tether, and the skilled professional traders running high frequency algorithms.
Unlike stocks, bitcoin can be traded on many different exchanges, but Binance owns over 50% of the entire crypto market and therefore sets the price for bitcoin and other cryptocurrencies. In order to buy cryptocurrencies, traders need to convert fiat money into a stablecoin like tether. Bitcoin-tether has by far the largest volume of any product on Binance, and since one dollar generally equals one tether, trading on bitcoin-tether sets the dollar price of bitcoin. But when bitcoin goes down, so does the entire crypto ecosystem.
The problem is that Binance is only self-regulated, which means that it is completely unregulated by traditional market regulators such as the Securities Exchange Commission in the United States or the Financial Conduct Authority in the United Kingdom. This is a big attraction for professional traders as they can deploy high-frequency price manipulation algorithms on Binance, which are against regulated market law. These algorithms can cause rapid upward and downward price movements, making bitcoin extremely volatile.
Binance does its own clearing and settlement of transactions, 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 notice.
Unlike normal exchanges, self-regulated crypto exchanges are not required to sound the alarm when a transaction has lost so much money that the account collateral needs to be recharged. Instead, traders are solely responsible for funding their accounts by constantly monitoring what is known as the liquidation price. This is done automatically by the algorithms run by professional traders, but it’s exhausting for ordinary players like you and me, who have to stay very vigilant every time manipulation is used to create the volatility that professional traders use to increase. their profits.
When professionals trade against each other, it is called a toxic flow because the chances of profit are closer to 50-50 if their algorithms are this fast and efficient. Professional traders much prefer their counterparty to be an ordinary investor.
This is worrying because Binance has been tremendously successful in attracting mainstream investors. The commissions he receives from this type of investor have financed his very rapid expansion; it is now branching out with its own stablecoin, blockchain, and NFT marketplace. Binance consolidates its role as the Amazon of crypto, following a highly efficient business model.
In some ways, the current circumstances in crypto markets can be compared to the bursting of the dot-com bubble in 2001-2. The venture capital that had flowed 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 lenders Celsius and Voyager filed for bankruptcy as the price of bitcoin crashed, at the series of unexpected and shocking attacks on a new type of stablecoin called Terra. Following the bankruptcy of FTX, several other exchanges such as Gemini and lending platforms (ghost banks) including Genesis prevent customers from withdrawing their funds.
We will see much more of this contagion, precipitating widespread bankruptcies among startups now that venture capital has dried up in the crypto sector. More exchanges and lending platforms, along with blockchains, NFT marketplaces, data aggregators and analytics firms, will all bite the dust.
Binance could emerge from this chaos with a monopoly. But right now, this non-domiciled, self-regulating company still needs revenue from ordinary investors, and it needs market makers (professional traders akin to hostile dealers on the stock exchange) to conduct its business.
The danger is that everyone is very scared now, so the only way to attract ordinary investors is to push the price of bitcoin up again. This would tempt people back into the crypto game, only to see their savings wiped out as the volatility cycle continues.
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