The price of bitcoin (BTC), has fallen again following the bankruptcy one of the largest cryptocurrency exchanges in the world, FTX. It now hovers around $16,500, a far cry of the $66,000 record set a year ago.
Why is there such a drastic drop in value? The highly toxic combination of Binance (an online platform for selling and buying) and a stablecoin (a cryptocurrency whose price is tied 1:1 to the US Dollar or another “fiat currency”) called tether and skilled professional traders using high-frequency algorithms are the reasons.
Bitcoin can be traded on multiple exchanges unlike stocks. However, Binance controls more that 50% of the crypto market and sets the bitcoin price and other cryptocurrencies. To buy cryptocurrency, traders need to convert fiat money into stablecoins like tether. The largest number of products on Binance is Bitcoin-tether. Because one dollar equals one Ethereum, bitcoin-tether trading sets the dollar price for bitcoin. The entire crypto ecosystem can be affected if bitcoin crashes.
Binance is not regulated by any traditional market regulators, such as the Securities Exchange Commission (USA) or the Financial Conduct Authority (UK). Professional traders find this attractive because they can use high-frequency price manipulation algorithms on binance. This is contrary to the law in regulated market. These algorithms can lead to rapid price movements, which makes bitcoin volatile.
Binance handles clearing and settlement of trades in the same way as other self-regulated crypto exchanges. This means that losing counterparties, those on the opposite side of profitable trades, often have their positions wiped away without notice.
Self-regulated crypto exchanges don’t have to raise alarms when a trade loses so much that collateral needs to be topped up. Instead, traders are responsible for funding their accounts through monitoring what is called the liquidation rate. The algorithms used by professional traders do this automatically, but it can be exhausting for players like us who must remain vigilant when manipulation is being used in order to create volatility. Professional traders use this to increase their profits.
It is known as toxic flow when professionals trade against one another. The chance of making a profit is greater than 50-50 if the algorithms they use are equally efficient and fast. Professional traders would prefer to have an investor as their counterpart.
Binance is a great place to attract ordinary investors, which is alarming. Its rapid growth has been funded by the fees it receives from these types of investors. Now, it is expanding with its stablecoin and blockchain as well as an NFT marketplace. Binance has established itself as the Amazon of cryptocurrency, using a highly effective business model.
One could compare the current situation in crypto markets with the 2001-2 burst in the dotcom bubble. Many companies became bankrupt as a result of the sudden halt in venture capital that was being invested into internet startups between 1999 and 2000. Three Arrows Capital was one of the biggest crypto hedge funds. Voyager and Celsius, major crypto-lending companies, filed for bankruptcy after the collapse of the price of bitcoin. This happened following unexpected and surprising attacks on Terra, a new stablecoin. Several other exchanges, including Gemini and lending platforms, have prevented customers from withdrawing funds following the bankruptcy of FTX.
This contagion will continue to grow, resulting in widespread bankruptcy among startups now that the cryptocurrency sector has seen its venture capital run dry. There will be more exchanges and lending platforms as well as NFT marketplaces and data aggregators.
This chaos could lead to Binance becoming a monopoly. This non-domiciled, self-regulated company needs revenue from ordinary investors. It also needs market makers (professional traders, akin to unfriendly exchange stall holders) to run its business.
There is a danger that everyone is scared right now. Therefore, the only way to attract ordinary investors to bitcoin is to increase the price. This would encourage people to get back in the crypto game only for their savings to be wiped out by the volatility cycle.