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When the timing is right, contagions can quickly spread. A single financial institution can collapse and send the rest tumbling after. This was the case in 2007, when Lehman Brothers executives revealed the bank had overstated the value of subprime mortgage assets worth billions. The news shook investors’ faith in the complex financial deals that had been so lucrative for brokers, and led to a domino effect of falling stock prices, crashing equity, real estate, and derivatives markets.
Now, cryptocurrency markets are at a similarly precarious point.
Notable Collapses of 2022
This year has seen a number of major cryptocurrency-related disasters. In May, the once-trusted stablecoin Terra/Luna, with a market capitalization of $31 billion, was delisted. In April, US-based cryptocurrency lender Celsius, with assets worth $12 billion, went bankrupt. November saw the downfall of FTX, one of the world’s largest crypto exchanges, with assets of $32 billion and 1.2 million clients.
Binance Causes Fear
Cryptocurrency holders are apprehensive and anticipating the next market crisis. Last week, it looked like the world’s largest crypto exchange, Binance, could be the culprit. After investors withdrew $1.9 billion in less than 24 hours, which was just 3.5% of the total $55 billion held by Binance on December 18, panic set in. The reaction was particularly strong among larger depositors, who viewed the disruption of trading as a personal threat.
Centralized Exchanges Pose a Threat
At the core of any market crisis is an underlying issue. In this case, the problem is that centralized crypto exchanges, or CEXs, are riskier than other methods of storing crypto assets. After the events at FTX, another centralized cryptocurrency exchange, there are many reasons why crypto owners should consider withdrawing their assets. The lesson from FTX is that you can’t control your crypto assets if you don’t have custody.
Centralized exchanges act as custodians and hold customer’s crypto or fiat currency, similar to a bank account. However, banks are subject to regulation to prevent potential disasters, such as bank runs. This includes an international regulatory structure known as Basel, which was established in 1988 to ensure banks have the necessary liquidity and capital to meet withdrawal demands, and must provide financial information daily.
Preventing the Next Crisis
Banks are heavily monitored as they have the most money in the economy. It is essential that people can store their money safely and access it quickly for the economy to be successful. The same scrutiny is needed for cryptocurrencies. If customer withdrawals exceed liquid assets, the central crypto exchange could be in danger and forced to freeze accounts. This is what happened to FTX when its founder Sam Bankman-Fried made the most difficult withdrawals.
It may not be possible to avoid a crisis, but it is possible to contain it. Whether governments can move quickly enough to create regulatory buffers to prevent contagion-causing crashes remains to be seen.
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