This week’s biggest story in crypto is easily Binance’s (BNB-USD) almost-acquisition of FTX. The deal, which has since fallen through, is one of highest-profile potential mergers in the history of blockchain. It also comes after what might be one of the most controversial and consequential company meltdowns ever. Yet this deal didn’t stand to improve the crypto world. Sure, it may have saved some FTX users caught up in the drama. Ultimately, though, the news should be sending red flags across the crypto space.
The stars certainly aligned for Binance in the last week. Indeed, much of the FTX implosion was FTX’s own doing. Binance CEO Changpeng Zhao needed only knock over the first domino to send the competitor reeling.
Last week, CoinDesk published a report showing a high concentration of FTX Token (FTT-USD) holdings by FTX sister company Alameda Research. In fact, over one-third of the company’s entire holdings were comprised of FTT. By primarily holding an illiquid token created by its sister company, Alameda could not actually move this mass of assets without essentially destroying FTT prices.
This also meant FTX couldn’t risk other FTT whales selling their wallets. Which, of course, is exactly what Zhao set out to do with Binance’s deep FTT holdings. The company soon began selling its entire FTT portfolio and investors saw prices tank shortly thereafter. Today, the token is trading for over 80% less than it did at the start of the week.
A social media spat between Zhao and FTX CEO Sam Bankman-Fried briefly preceded the announcement of a non-binding agreement for Binance to fully acquire FTX. The deal would allow the world’s largest exchange to absorb one of its biggest competitors. But would this merger be a healthy thing?
Binance-FTX Deal Would Have Further Concentrated Assets Among Top Players
By trading volume, Binance is easily the largest in the world. Just on Nov. 10, it processed around $40 billion in transactions. FTX is not very close in this metric, processing only about $3 billion, but it’s still the fourth-largest exchange by volume. Coinbase (NASDAQ:COIN) and Kraken, the second- and third-largest exchanges, processed $5 billion and $2 billion, respectively.
Obviously, Binance owns a lot of the global crypto market. And by buying another one of the world’s top exchanges, Binance inches ever-closer to a full-on monopoly of all things crypto. If the company were to purchase FTX, it would own 80% of the world’s crypto market.
Regardless of whether or not the deal was finalized, though, this news should be sounding an alarm for the entire industry. Indeed, if the acquisition news proves any one thing, it’s that crypto monopolization is a very real threat. Changpeng Zhao and Binance is to crypto what J.D. Rockefeller and Standard Oil was to the oil market. And seeing as crypto has arguably far less regulation than even the oil market, this will wind up being a big problem.
There’s no surprise, then, that analysts and Zhao alike expected the deal to provoke anti-trust regulators. And already, anti-trust law experts have called out the potential deal between the two exchanges as an illegal agreement.
Binance: Competitive or Monopolistic?
Make no mistake, FTX is just as aggressive with its expansion across the market as Binance or any other crypto company. It spent this past summer swallowing up just about every deal it could get its hands on, signing a deal to buy BlockFi. Earlier this fall, it also outbid Binance on the purchase of Voyager Digital’s remaining assets.
However, given the monolithic difference in size between the two, it’s easy to understand these moves are simply to compete with a company which has most of the market under its thumb.
The entire circumstance by which FTX fell apart is evidence of Binance’s power. Binance was able to send the FTX project tumbling — a $32 billion enterprise — by selling off its whale-sized stake in FTT. By selling off this stake, it put FTX in a spot where it couldn’t create liquidity quickly enough. The whole project suffered as a result.
This phenomenon is not unlike a major shareholder exit, which oftentimes causes the value of a stock to fall. Crypto whale exits can often be far more dramatic, however, due to a number of factors. For example, exchanges can’t institute widespread trading halts like the New York Stock Exchange. Whales can also lurk in the dark without investors knowing of their existence until a sale occurs.
As Binance continues to swallow up other companies’ assets, it has more power to send competitors into a downward spiral at will. Without regulation, the bigger fish in an ocean of free-roaming companies wields substantial influence over investors’ funds.
Crypto Bailouts Enable Mismanagement of Investor Funds
One obviously can’t hold Binance responsible for all of these woes. Sure, the company’s handling of the situation may seem anti-competitive, but Binance didn’t violate any laws. Profit-taking isn’t a crime. However, the company taking profits doesn’t benefit investors equally.
Binance choosing to back out of the deal is basically the best-case scenario for investors in the long run. It doesn’t just prevent Binance from gaining more ownership over the market. It also breaks a cycle of bailouts and acquisitions which have enabled projects to continue mismanaging investor funds behind the scenes.
As long as companies continue to extend lines of credit to companies with liquidity issues, there’s no real incentive for those companies to free up liquidity. European Central Bank President Christine Lagarde has been on the record saying she doesn’t like bailouts because they simply cover up fraud for an unregulated space. U.S. Securities and Exchange Commission ( ) Commissioner Hester Peirce has said much of the same herself.
Surprisingly enough, Changpeng Zhao agrees with both of them. “Don’t perpetuate bad companies,” Zhao has said through official channels. “Let them fail. Let other better projects take their place, and they will.” By backing out of the deal, Zhao is putting his money where his mouth is.
All of this so far is to say crypto, while very different from the traditional market in many positive ways, is also very different from the traditional market in many detrimental ways. The fast monopolization of assets by big players, the lack of transparency and the relative ease with which these companies can perpetuate the cycle with bailouts ensures these FTX-esque meltdowns are sure to continue. What the market needs is regulation — and fast.
Regulators Lose an Ally as FTX Falls
Sam Bankman-Fried has been playing a role unlike other crypto executives, however, advocating for stringent regulations of the market. Contrary to the ethos of many crypto enthusiasts, he has often suggested that strict regulations of the crypto industry are the best way to ensure expansion of blockchain technology and protection of users.
In an industry predicated on decentralization and libertarian values of financial and personal freedom, Bankman-Fried has found himself at odds with nearly every one of his peers. This is especially true as he has supported the concept of wallet address blacklisting, used in sanctions by the U.S. Department of the Treasury. Coincidentally, the project the Treasury sanctioned in this manner has been accused of aiding North Korea’s Lazarus Group, which laundered stolen funds through the service before selling them for profit on the Binance exchange.
Now that Bankman-Fried’s status as crypto figurehead is coming to an end, policymakers have lost access to one of their biggest allies (and his millions of campaign contribution dollars). Zhao, on the other hand, has largely stayed out of U.S. regulation talks. In the wake of the FTX collapse, he is subverting regulations by setting a new transparency standard called proof-of-reserves. Binance says it will make its balance sheet entirely transparent and implores other exchanges to do the same.
What to Take From the Binance-FTX News
There’s a lot to take in from this whole situation. FTX is likely soon to be no longer. With the Binance acquisition deal falling through, the company will probably fall into bankruptcy. Binance choosing not to pursue the deal is proving good for crypto, though, as it won’t centralize more of the market under one company — and won’t reinforce the behavior of companies who use a lack of regulations to mismanage funds behind the scenes.
Binance’s proof-of-reserves idea is one start toward a solution. When companies can’t hide what they’re doing with funds, they won’t do stupid things like lock up all of their liquidity in staking. When investors can see these activities, they can also rest easier knowing their money is safe.
But this isn’t a permanent solution. Not all companies will adhere to this self-policing and not all investors will even be paying attention to these proofs. Banks don’t get by on policing themselves. They have regulators looming over them to make sure everything is legal.
Regulations are the permanent solution. Laws that ensure companies adhere to government-instituted checks and balances are more effective than self-imposed proofs. Laws that ensure companies don’t have the power to poison and then scoop up competitors are needed in every industry, crypto included. The collapse of FTX is not even the first multi-billion dollar crypto company implosion this year. Until regulation reaches the market, one can expect the implosions to continue.
On the date of publication, Brenden Rearick did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.