Crypto’s Lehman Brothers moment
- November 15, 2022
- Posted by: OptimizeIAS Team
- Category: DPN Topics
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Crypto’s Lehman Brothers moment
Subject: Economy
Context:
FTX, the world’s second biggest crypto exchange, went bankrupt, affecting an estimated 10 lakh-plus people who were barred from withdrawing funds.
Details:
- The FTX collapse shook investors’ confidence and prompted further selloff in cryptocurrencies.
- It can be called the crypto industry’s Lehman Brothers moment – referring to the bankruptcy of the investment bank that precipitated the 2008 global financial crisis.
Cause of the crisis?
- FTX had extended loans to Alameda (another trading firm of the FTX’s founder) using money that customers had deposited on the exchange and a significant part of Alameda’s assets were in the form of a cryptocurrency called FTT – a token that FTX issued indefinitely according to a report.
- Binance – the world’s largest crypto exchange firm’s announcement of selling FTT tokens and consequent investors sell off due the above revelation led to the token crashing 78% in value in a single day.
- FTX lacked the money to handle so many withdrawals and paused the ability for customers to pull their own money out.
Concept:
A cryptocurrency exchange, or a digital currency exchange (DCE)
- Like stock exchanges, crypto traders can buy, sell, and convert cryptocurrencies on crypto exchanges.
- A cryptocurrency exchange, or a digital currency exchange (DCE), is a business that allows customers to trade cryptocurrencies or digital currencies for other assets, such as conventional fiat money or other digital currencies.
- Working:
- Customers buy or sell digital currency from digital currency exchanges, who transfer the digital currency into or out of the customer’s digital currency providers (DCP) account.
- Some exchanges are subsidiaries of DCP, but many are legally independent businesses
- The exchanges can send cryptocurrency to a user’s personal cryptocurrency wallet. Some can convert digital currency balances into anonymous prepaid cards which can be used to withdraw funds from ATMs worldwide while other digital currencies are backed by real-world commodities such as gold.
- There are currently three types of cryptocurrency exchanges—centralised exchanges (CEXs), decentralised exchanges (DEX) and hybrid exchanges (HEX).
- Example- CEXs such as WazirX, Binance, Coinbase, among others. Some popular DEXs– Uniswap, Pancakeswap, Compound etc..
- Centralised exchanges are the most common types of cryptocurrency exchanges.
- A central entity governs them, typically the owner of the exchange.
- In CEX, every order is recorded and validated by the company to ensure security and correctness.
- These exchanges usually offer both crypto-to-crypto trading and use of funds via your bank account or credit card to trade cryptos.
- Customer support is one of the important features that most CEXs offer.
- Funds remain in a wallet managed by the CEX and the signup process might involve a know-your-customer (KYC) process .
- Decentralised exchanges –A decentralised exchange as the name suggests is truly decentralised.
- This means there is no central oversight or no company or institution governing these exchanges.
- The trades on DEXs are automated and executed via smart contracts and decentralised applications based on certain predefined metrics. Most DEXs currently operate on Ethereum blockchain.
- No KYC is required and with no customer support to fall back on for help, DEXs might prove more useful for experienced traders than novices.
- Hybrid exchanges-In DEX, users have complete control over funds–they can either choose to keep a wallet or trade via smart contracts.
- A hybrid crypto exchange is a platform that provides users with access to their private keys and aims to solve the scalability issues of decentralised exchanges.
- One of the primary goals of HEXs was also to address the DEXs high trading fees. In HEX trading, there are no taker fees and gas fees.
CEX vs DEX vs HEX at a glance
- Ease of use: CEXs and HEXs score over DEXs in terms of ease of access and operations.
- Custody of funds: one has absolute control over your funds in DEX and HEX.
- Transaction speed: CEXs offer the fastest processing speeds followed by HEXs.
- Security: DEXs are hosted on decentralised servers which makes them less vulnerable to hacks. HEXs also provide benefits of decentralisation that CEXs lack.
- Legal safeguards: CEXs need to abide by the regulations of the country they are located in.
- Privacy: KYC that includes providing your identity proof is mandatory for most CEXs without which deposit/withdrawal of funds is not allowed.
Liquidity: CEXs currently have the highest liquidity.