Note on Liquidity
As you are likely currently aware (or will be aware in the future reading this), it is reported that cryptocurrency exchange FTX has potentially a gap between liabilities and assets of more than
$6 Billion dollars. Yes, that's
BILLIONS. Basically, clients of FTX exchange tried to withdraw that amount (or more!) over the preceding few days, and FTX was not able to pay it out and subsequently halted withdrawals. This is in effect a "run on the bank", and why banks are required to have liquidity buffers and savings accounts are FDIC insured. One rational explanation of what could have happened (and
US regulators are now investigating), is that client funds/deposits were used for other purposes (loans to others), and not available on-hand. What happens to investor psyche when someone is unable to withdraw $$ from their account?
Panic and loss of confidence. There are even rumors floating that several large pension funds, banks, hedge funds, and even
Tom Brady may each individually lose hundreds of millions of dollars in the event of an FTX bankruptcy. More information and specifics to loss metrics will be available as time goes on.
Swimming Without Pants On
Bitcoin has been a market of excess liquidity after years loose interest rate policy and QE programs that kept interest rates artificially low (to stimulate growth). And now that the Federal Reserve has chosen to raise interest rates to fight inflation, there is less investment capital for the cryptocurrency space, as better yields can be found in riskless US Treasury assets. At the time of this writing, several large players in the space over the last 6 months that have gotten caught using too much leverage, and took large losses after adverse market movements. As positions move against them severely and quickly, more collateral is required to be posted (due to the leverage), and when that capital is not readily available, a liquidity crisis emerges:
No one wants to lend to one another, because they do not know if they will have that money returned. The last big liquidity crisis was in 2008 between the banks. This time around, the cryptocurrency / DeFi space could be in spotlight. As Warren Buffet has famously stated ... "Only when the tide goes out do you discover who's been swimming naked."
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