What The Heck is That FTX Meltdown All About?

It’s been a stressful week for coin traders, as digital exchange FTX almost went pop.

Why did it happen, what does it mean for insurers? IE takes a look.

Your IE editor has been following the crypto bubble for some time, so here’s a recap and thoughts on the FTX debacle.

FROM GEEK CODER HOBBY TO INTERNATIONAL MONEY LAUNDERING 

Until recently, crypto currency has been seen as a bit of a South Sea Bubble lark, a way for dubious individuals to make money by writing limited edition strings of code, then selling these bits of code as Ponzi scheme. The rapid increase in valuation of these “coins” allows others to hide their assets online in the Cloud, sometimes known as a “wallet.” But then newly minted people wanted to spend their crypto thousands – what’s next?

But more luxury brands like TAG watches or Balenciaga have started accepting crypto like Bitcoin or Ethereum, at least as partial payment. Earlier this year a property developer in Brazil began accepting Bitcoin as payment and IE expects more of this in the property sector, as governments seek to trace asset ownership.

Digital currency linked to government backed “real” currencies are usually called Stablecoins, although as the recent fluctuations in the Turkish Lira or UK Sterling prove, they are not stable if a significant portion of international currency traders feels they are under/over valued. We can expect the same thing to happen to Stablecoins, especially in the early learning years after an official roll-out.

DEVELOPING COVER THAT WORKS

Blockchain tech underpins cryptocurrecies and it allows a time-stamped money trail to be examined, so you can see every transaction stage. Even hacking events where a virus has been introduced could be pinpointed to a split-second – in theory anyway.

This is good news for insurance brands actively offering coin or digital asset coverage. In some ways crypto is easier to manage as regards fraud or theft than say conventional Commercial cover, since you have all the data that matters; who logged on, when, how much was transferred, where it went, via which exchange or digital entity and so on.

In theory, insuring crypto should be the same as insuring a modern fleet and all its vessels and cargo – if you have the correct data then you know the risks, journey, regulatory bodies and third parties unloading/loading in every port etc. Digital coins are the cargo and the exchanges are the ports.

REPUTATION WILL BE EVERYTHING

Evertas and Superscript are two brands already in this space and Lloyd’s syndicate Atrium has been in the crypto insurance game since 2020. It is important that Lloyd’s and other London insurance brands get into crypto cover and establish a reputation for accuracy and undertsanding true risk, because IE sees rapid growth ahead, as Globalists demand action on abolishing old school cash. But the launch and management of a central bank Stablecoin currency is a separate issue from the private crypto insurance market. Insurers would do well to steer clear of EU or Fed working groups looking to pick their brains on how this thing can work at BACS level scale, with millions of transactions per hour being underwritten.

That stuff is for politicians and big banks to sort out. Insurers have enough to focus on as regards the existing coin exchanges, who regulates them and how risky in terms of liquidity the entire crypto eco-system is, as it grows exponentially.

By that, I mean exchanges can only act as a digital coin crossroads, or marketplace, if they have “real” assets and cash behnd them. In the same way that people trust banks because they see xxx billions on the balance sheet, plus governments baling them out, the crypto exchanges need to project the same confidence and stability to win customers. So, just as insurers offer capcity to MGAs and brokers, so too must insurers back their horses in the emerging crypto market.

With great care, for reputations are hard won and easily lost in one meltdown.

THE FTX LESSONS

Here’s some insights from Ganesh Viswanath Natraj Assistant Professor of Finance and researches cryptocurrencies at Warwock University;

Dr Viswanath Natraj said: “Binance and FTX are two of the three largest centralised exchanges, the other one being Coinbase. One implication of the near-collapse of FTX is that as Binance increases its market share of crypto trading, additional liquidity on Binance means centralised exchanges continue to dominate decentralised exchanges like Uniswap. These exchanges rely on different models, with Binance having a limit order book, and Uniswap having algorithms to execute transactions.

“Which exchange dominates depends a lot on investor preferences, but as liquidity increases on Binance from absorbing FTX, Binance will offer more favorable liquidity and pricing for traders. FTX made a lot of loans to failing crypto companies and have agreed to be absorbed by Binance as part of a bail-out.”

A succinct explanation indeed and the lesson for insurance brands is that marketplace failure is not an option, especially one which makes the mainstream media front pages. Once crypto is seen as something inherently risky, where you have effectively lost all your assets because the trading site has gone bust, the game is up. The only reason people will buy insurance is because they believe that some payout can be made in the event of a vessel sinking and the cargo being lost.

If the digital coins vanish into the ether then insurers need to have the liquidity to bear that catastrophic loss, because history teaches us that that day will come. The worst case scenario is that another Covid19 style legal case over policy wording happens after an exchange goes down. That could ruin a reputation and hand the crypto insurance baton to another country, or trading bloc.