The FTX stack of dominoes continues to tumble along and take out everything in its path. On November 16, the Australian crypto exchange Digital Surge announced that it was “temporarily” suspending withdrawals and deposits. As we all know, a “temporary” halt is about as likely as “transitory” inflation.
It has been a scary few weeks for customers, and some might have hoped things would come right. But then, on December 7, the company entered voluntary administration with KordaMentha.
Australia has a different legal system from the US. Hence, voluntary administration has some differences, but it ultimately leads to the same outcome. A company enters into voluntary administration when they believe they owe more money than they can pay. It means they are underwater. If you’re a shareholder or creditor (i.e., you have funds on the exchange), then at best, you’re looking to get back a fraction of what you put in.
There is a tiny bit of good news. Now that the company is in voluntary administration, the administrator, KordaMentha, can find out what assets the company has. Then try to find a buyer for the assets (and possibly the business). And then pay back the creditors with any funds they retrieve.
If you are a Digital Surge customer, then you are a creditor and can register your interest with the local authorities. This is to ensure you’re in line to get paid back some of the funds you had on their exchange.
Like many smaller exchanges, Digital Surge needed to rely on more significant exchanges to ensure they could source enough crypto for their customers. Co-founder Dan Rutter said in November that Digital Surge “has some limited exposure to FTX.” He also said that they don’t own any of their FTT tokens, which recently plunged to zero.
Despite only having “limited” exposure to FTX, this was enough to leave them in a position where they couldn’t pay their bills. It means either they were running a very low margin of safety or, in fact, their “limited” exposure to FTX was a lot more substantial than they were willing to admit.
According to Dr. Joeri Schasfoort from the Money and Macro Youtube channel, the big issue we’re seeing is called “contagion.” There are two types:
Digital Surge is like most of the companies we’ve seen impacted by the fact that FTX has gone down. They have directly lost funds as a result of this. This direct contagion can be blamed squarely on FTX, but there’s another big piece of the puzzle. It is a bad time to have money on a crypto exchange.
Chances are you’ve seen the massive drop in crypto market cap. From a peak of nearly 3 trillion dollars in 2021, falling down to its current level of 0.8 trillion dollars. This itself is a drop of 70%.
This will naturally scare away customers, which is bad for business. Still, it also means that any individual or company that has funds invested in any cryptocurrency will see a loss in the value of their investments. You can call this a “paper loss.” Say that if you own 1 BTC and the price drops, you still own 1 BTC until you sell it.
The problem is that there is no guarantee that the value of the investment will come back up. And, of course, you still have to pay your debts in traditional currency. So at some point, you will need to sell your cryptocurrencies that have fallen in value. This causes a feedback loop. Companies sell their crypto, which makes the price drop, and more people sell crypto to pay their bills. Eventually, some of them go out of business.
We’ll have to wait for the administrator’s results to know for sure what happened with the said exchange. However, we bet Digital Surge will have taken a direct loss on the funds they had with FTX. It’s likely that they have also made investments in crypto that have gone underwater and taken the whole business with it.
Some may find it ironic that we invented an entirely new suite of currencies designed to be decentralized. The whole idea was avoiding control, or better said, giving it to owners. Centralized exchanges we trusted to take care of them lost these funds, being quite an unpleasant turnaround.
The year 2022 has been an unfortunate but timely reminder that trusting a big company with your crypto has its own problems. If you hold your crypto yourself, you take on the risk that things can go wrong with your local wallet (hacks or losing your private keys, among other things). And many people have been surprised by this increasingly expensive lesson.
You shouldn’t need crypto on an exchange (CeFi or DeFi) unless you are actively trading. Even then, the bulk of your crypto should be kept somewhere safe. Unfortunately, this advice will come a little late to some of you. Fortunately, the bankruptcy/administration procedures allow you to recover at least part of your investment.
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