Cryptocurrency’s liquidity crunch: 5 no-regrets actions to take now

Despite the hype, the recent collapse of crypto exchange company FTX doesn’t signal the end of cryptocurrency – far from it. But nor was it just “a run on the bank”.

The drop in the crypto market in 2022 has been exacerbated by the far-reaching contagion of FTX’s insolvency.  In this blog we look at the potential liquidity impact in Australia, as well as the levers and options available for businesses and investors.

Where are we now?

2022 sent the cryptocurrency market on a rollercoaster ride, with total market capitalisation dropping from around US$3 Trillion in 2021 to just under US$1 Trillion. Exchanges are facing materially lower trading volumes.

As interest rates ratchet higher, availability of capital is tightening. Those unable to sustainably manage costs may discover they can’t rely on new capital, and their cash reserves don’t cut it.

Meanwhile, the ‘FTX effect’ will put growing pressure on exchanges to prove their resilience. Exchanges are looking at lower revenues, higher liquidity requirements, and more regulation. 

What’s next?

Crypto is no stranger to volatility. But given the size and contagion of FTX’s collapse, we expect clear winners and losers. Trends include:

1. Crypto prices at a two-year low
   Crashing crypto prices (down 70+% in 12 months) are causing stress for those business models tied to asset prices (which is pretty much all crypto businesses and investors). Trading volumes and consumer confidence are down… but the FTX fallout could be less contagious than Mt Gox’s catastrophic collapse (2014). 
2. Bridging liquidity is needed for the next bull run
   Global rate rises, and subsequent capital tightening, spells higher financing costs for less-established business models. Specifically, the tech sector is hurting and many businesses will need bridge funding to make it out of the ‘crypto winter’. 
   
3. Improved security and governance is expected
   In an industry that relies on trust and reputation, there is growing pressure for crypto exchanges to prioritise transparency. Some will be forced to improve their approaches to asset custody. Others need stronger balance sheets. All require good internal governance.
4. Insolvency protections are gaining popularity
   Insolvency protections, such as ‘safe harbour’ provisions, are likely to become increasingly relevant. A well-informed set of advisors with international reach is increasingly critical. (Think: control of assets being held in other jurisdictions.)

5 no-regrets actions to consider

While we wait to see the extent of contagion caused by FTX’s liquidity crisis, we’ve developed five no-regrets actions businesses can take: 

1. Plan early to maintain optionality: Crypto moves fast. Plan early so you can act when required, and so you have a wider range of options on the table.
2. Visibility is key: Pumping cash into crypto businesses during a growth phase is tempting, but challenging conditions right now mean managing cash and working capital are critical. The upside? Improved visibility of your cash reduces the risk of overreacting to a crisis and an improved understanding of your options. 
3. Understand all scenarios and options: Scenario planning is paramount. Look at all available solutions, develop short/medium-term roadmaps, and be positive without developing a positive bias. 
4. Seek integrated specialist advice: Maximise your impact by seeking advice from those in the know who can consider all major issues simultaneously – legal, regulatory, commercial, operational and financial advisors.
5. Reputation and communication are critical: Finally, trust is everything in crypto. Develop a holistic plan for communicating with financiers, stakeholders, regulators, and the media, and proactively manage your reputation. Your actions now – and your customers’ perceptions of these actions – may prove the decider for the future of cryptocurrency. 

In short, in the wake of FTX’s failure – amidst the consternation, the accusations, and the recriminations – now’s the time for calm heads and clear thinking.