Impact of FTX Collapse on Financial Markets Appears Limited

The failure on 11 November of FTX, a “cryptocurrency exchange” that has filed for Chapter 11 bankruptcy protection, is having only a limited impact on the broader financial markets.

Unlike traditional exchanges, where client monies are segregated and strictly audited, cryptocurrency exchanges are largely unregulated and provide little or no client protection. The collapse of FTX has affected confidence in other cryptocurrency exchanges and cryptoassets, however systemic market participants appear to have little or no exposure to the exchange and consequently the impact on the financial system appears limited.

Some of the elements that have contributed to the collapse include an opaque corporate structure (with FTX’s founder holding a wide range of investments including a trading firm, Alameda Research, which in turn invested in the FTX exchange’s FTT token), client deposits being moved from the exchange to the trading firm, as well as excessive leverage provided by non-bank sources and a weak liquidity risk management framework.

Those exposed to FTX through investment capital or client deposits include both hedge funds and retail investors. One of the seed investors includes a traditional asset manager, Ontario Teachers’ Pension Plan (OTPP, rated AAA by DBRS Morningstar), although at USD 95 million, the investment is still relatively small and represents less than 0.05% of their total assets.

This high profile collapse in the fast-growing crypto market could potentially dampen future cryptoasset activity and at the very least provide a clear warning to smaller retail investors of the high risks from investing in cryptocurrency. Global regulators have issued frequent public communications about the risks associated with cryptocurrency and have taken varied approaches regarding their level of intervention in these markets (also see Sovereigns and Cryptocurrencies: Mutual Tolerance and Suspicion (July 12, 2022) https://www.dbrsmorningstar.com/research/399727). More recently, the U.S. Federal Deposit Insurance Corporation issued an order to several cryptocurrency exchanges to cease implying to investors that their money was insured by the federal government. The crypto markets are largely unregulated, although due to concerns that cryptocurrencies could facilitate money laundering operations, a number of countries have put in place powers to supervise how cryptoasset businesses manage the risk of money laundering and counter-terrorist financing. Another possible development from the failure of FTX is that it leads regulators to take more steps towards regulating the cryptocurrency markets to protect consumers and avoid systemic financial contagion.