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Crypto Keeps Falling on FTX Fallout -- Will It Recover?

By Dan Caplinger – Nov 21, 2022 at 2:29PM

Key Points

  • Cryptocurrency prices have fallen sharply following the bankruptcy of digital-asset exchange FTX.
  • The impact of FTX's failure continues to ripple across the industry and beyond.
  • Tighter regulation might be necessary to give would-be crypto investors the confidence to come back to digital assets.

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Even the highest-profile digital assets are under pressure.

Throughout much of 2022, cryptocurrency investors bemoaned the fact that prices of digital assets were highly correlated with the stock market. As major stock indexes fell into extended bear markets, crypto investors seemed to hope that prices of Bitcoin (BTC -0.57%), Ethereum (ETH -0.84%), and other cryptocurrencies would break away from downturns in the stock market and assert their independence.

Unfortunately, crypto prices have now diverged from behavior in the stock market for a reason that's unfavorable for digital assets: the bankruptcy of crypto-exchange FTX. As more fallout from the FTX bankruptcy becomes evident, some investors worry that digital assets might not bounce back this time around as they have after past downturns.

Why FTX's impact isn't going away

Major crypto assets continue to see their prices decline. As of early  Monday afternoon, Bitcoin prices had fallen 3% in the past 24 hours, briefly moving below the $16,000 mark. Ethereum had fallen an even steeper 6% from the same time on Sunday, flirting with $1,100. Many smaller digital assets were also down single-digit percentages for the 24-hour period.

Those moves extended broader declines over the past few weeks. As recently as the first week of November, Bitcoin traded above $21,000, and Ethereum had moved over the $1,600 mark. That works out to losses of between a quarter and a third of their respective values.

FTX continues to generate high-profile headlines that document the damage that the exchange's failure has done. According to filings, it owes its biggest creditor more than $225 million. Aggregating its top 50 creditors, FTX owes more than $3 billion.

Meanwhile, investors are licking their wounds and taking their losses. Late last week, the Ontario Teachers' Pension Fund said that it would write down its entire $95 million investment in FTX and the U.S. entity FTX.US. That marks just a tiny portion of the $250 billion in assets that the pension fund has under management but nevertheless, it's not a good result for an investment that the fund made just one year ago.

Some are still seeking to profit from FTX's misfortune. Numerous reports have  documented the ongoing movement of $600 million in assets stolen from the cryptocurrency exchange earlier this month, apparently due to hackers exploiting a weakness that allowed them to tap FTX's wallets.

What's next for crypto?

At this point, companies that have relied on the strength of cryptocurrencies appear to be the next potential dominos to fall. Bond-market investors are losing confidence in the long-term viability of some of the most fervent advocates for digital assets.

Long-term bonds issued by Coinbase Global (COIN 0.17%) have fallen sharply this month, sending yields well into double-digit percentages. Even Coinbase bonds maturing in the next three years are yielding 17%, suggesting that investors perceive a substantial risk of default and are demanding higher potential returns to retain that risk.

Similarly, MicroStrategy (MSTR -1.08%) has been a proponent of Bitcoin, choosing to hold large positions in the digital asset on its balance sheet. The debt that MicroStrategy issued to purchase more Bitcoin has seen its price drop sharply, sending yields higher.

At this point, investors who got into digital assets because of their stellar price gains are learning the hard way about their potential pitfalls. Unlike the nearly universal availability of FDIC insurance for banks and SIPC insurance for stockbrokers, customers of cryptocurrency exchanges are finding that any protection they have from losses is extremely limited. Despite many crypto advocates having long urged investors to hold their digital assets in their own cold wallets, the ease of using exchange-provided custody lured many into leaving their cryptocurrency exposed to losses.

The crypto industry might well have to agree to tighter regulation in order to regain the confidence of mainstream investors. That could run counter to the founding principles of many digital assets, but for those who want the industry to survive, it could be tough to find alternatives. Crypto has emerged phoenix-like from ashes in the past, though, so counting it out for good is premature.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin, Coinbase Global, Inc., and Ethereum. The Motley Fool has a disclosure policy.

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