Crypto companies have apparently not learned their lesson: Liquidity is single-handedly the most important project component. The bankruptcy of three different crypto-investing entities as a result of the Terra (LUNA-USD) crash proves as much. Sam Bankman-Fried should have taken notes.
And just like with Terra, FTX’s bankruptcy is radiating into other semi-related entities. Solana (SOL-USD) seems to be suffering the brunt of the trouble, seeing as its SOL coin was among the most held by Sam Bankman-Fried’s crypto conglomerate. And unfortunately for SOL fans, more closely connected to FTX than previously thought.
The FTX collapse is shining a light on Serum (SRM-USD), a DeFi project on Solana that more closely links the company and the layer-1 network. Should investors be concerned about a greater FTX contagion hitting Solana?
FTX’s downfall came swiftly. After an insider catalyzed a massive investor exit from the FTX Token (FTT-USD) things just went downhill from there. FTX’s flagship exchange token is manufactured, distributed and controlled by FTX itself. This isn’t uncommon; Binance (BNB-USD), Crypto.com (CRO-USD) and KuCoin (KCS-USD), and plenty of others have native exchange tokens with perks.
This does become a problem, however, when an exchange starts to entangle its own token in other companies.
FTX had been closely connected to Alameda Research from its very onset, seeing as the two were both founded by Sam Bankman-Fried. However, the relationship between the crypto exchange and the private equity firm was much closer behind the scenes than investors knew.
Alameda was borrowing billions of FTT from FTX and staking it while counting these loans on its balance sheet. Of its $14.6 billion in assets, over $6 billion consisted of FTT — an amount larger than the coin’s market capitalization at the time this news broke.
Alameda’s FTT holding made for the biggest story. With that much FTT locked up, FTX had no liquidity in case big holders wanted to cash out. And cash out they did; led by Binance CEO Changpeng Zhao, investors rushed to pull their money out of FTT, causing a liquidity crisis that ultimately bankrupted FTX and destroyed Alameda.
FTX’s demise is prompting conversation among all corners of the investing and policymaking world. Financial experts are offering up their takes, lawmakers are reiterating calls for regulations on crypto, and investors are crafting up plenty of FTX memes. But, there’s one part of this tale that has been a more silent killer.
Sam Bankman-Fried’s Downfall Causes Ripple Effect Across Solana
Solana, a popular Ethereum rival, was revealed to be one of Alameda’s largest holdings next to FTT. The company held over $1 billion worth of the layer-1 network’s coin. This is a fairly significant amount of SOL, seeing as the project had an $11 billion market capitalization at the time. This caused a crash in SOL prices, as investors feared Alameda and FTX would sell off the stake to retain some money.
However, as was the case with Alameda and FTX, the relationship with Solana and FTX runs deeper. The two entities were deeply intertwined, with one of Solana’s biggest DeFi projects, Serum, built by FTX.
What might that mean for the future of Solana, and how are developers trying to mitigate the FTX contagion?
We know that Solana and Sam Bankman-Fried are well-acquainted. The entrepreneur was an early and large investor in the Solana network, injecting $314 million into Solana via Alameda in 2021. As it turns out, the Solana Foundation was also fairly heavily invested in FTX. The organization held almost $200 million worth of FTT and SRM on FTX.
This stake has plummeted significantly since FTX’s liquidity crunch. Though, the Foundation claims the holdings account for less than 1% of its total portfolio. But beyond simple investment, FTX has had a much larger part in building the Solana network than many previously knew, and the company’s collapse could still mean plenty of headaches for the layer-1 network.
FTX-Founded Serum Crypto Platform Faced Great Danger
The Serum crypto trading platform is one of the Solana network’s largest DeFi tools. It was founded by Sam Bankman-Fried, and in the years since it was launched, it has gained quite a following. Prior to the FTX meltdown, Serum saw over $32 billion in trades throughout 2022. But now that FTX has fallen apart, the project is on a downward trajectory. Volume has dipped 80% in the days since FTX’s bankruptcy. A sizable portion of this downturn can be attributed to Alameda Research winding down operations. The company used Serum as a primary floor for its trades.
While it claims to be a fully decentralized, trustless exchange, Serum must now reckon with reality.
Investors have now learned that FTX owns Serum’s private keys. Solana developers, too, must reckon with this reality. Serum’s collapse would create a domino effect across many more Solana tools and products. It’s a liquidity provider for over two dozen Solana dapps, which collectively process hundreds of millions of dollars in volume.
And as with many DeFi projects, Serum is only decentralized to a point. Its code, and thus its ability to be upgraded or changed, rests with those who hold its private keys. The private key owner? An unknown individual associated with FTX.
The problem is thus quite obvious. A company plunging into bankruptcy, suffering a liquidity crisis and massive asset freeze, has a mystery employee holding control over one of Solana’s biggest liquidity providers. And, the recent FTX hack lumps more uncertainty and fear atop all of this.
Hack on FTX Makes Serum Ownership Even More High-Stakes
Late last week, a bad actor was able to infiltrate the exchange and siphon over $600 million in assets. FTX executives are not just perturbed by the loss of funds. They fear the hacker could contaminate FTX apps, the FTX website and more. Most unsettling for Serum crypto users is the fear that this hacker may have access to the liquidity provider’s private key.
So, the Serum crypto community had to make a quick decision. Sure, the Solana Foundation has limited its exposure to FTX, and it’s unlikely to be hit by the project’s collapse in the way, say, Voyager Digital was affected by the Terra unraveling. But, there’s no saying what some mystery FTX employee might do with the keys to such a sizable liquidity provider, given FTX’s liquidity crisis and the seemingly erratic behavior presented by Sam Bankman-Fried in recent days, both on Twitter and behind the scenes.
Moreover, the SRM crypto was already rocked by the FTX meltdown. The token dropped 80% after Alameda’s balance sheet revealed its exposure to it. With so many projects integrated to run on Serum, further damage could ravage the DeFi ecosystem. Serum would need to be hard forked to remove this keyholder from the equation.
A group of developers on Solana have led an effort to do just that. Recognizing that the protocol is not as trustless and decentralized as community members intended, these developers copied the original Serum protocol line for line, making an ever-so-slight exception to keep keys out of corporate hands.
Serum Crypto Hard Fork Is “Net-Positive” for Struggling Project
These developers add that the upgrade is a multifaceted net positive for the Serum crypto. Atop removing corporate control from the dapp, the upgrade team says the hard fork is “probably better in the long run.” FTX had gone almost completely silent toward the community, and the team tasked with maintaining the Serum crypto was doing a lackluster job. Moreover, all decentralized autonomous organization (or DAO) decisions in recent months have been decided, ironically, entirely by one wallet which belonged to Alameda Research. This hard fork opens the door for more tangible, community-driven changes to improve the project.
This is all fantastic for Serum, sure. The hard fork will help it escape FTX ownership and distance itself from further possible contamination. However, it’s still not a storybook ending with Serum riding off into the sunset. The news speaks to a bigger issue for the DeFi world, and other dapps should take cues from Serum.
Serum has been calling itself a decentralized blockchain project since it launched over two years ago. It took a nearly disastrous scenario for the community to even challenge this notion. It was not decentralized — FTX and Alameda had overwhelming control over decision-making, and it had full access to funds.
Why Other DeFi Projects Should Take Notice of the Serum News
There is an issue with DeFi projects, layer-1 networks and the like. Oftentimes, these projects play naive when it comes to their lack of decentralization. Throughout the year, it has been shown time and again what happens to DeFi tools that are not actually decentralized, but rather controlled by a small group or even a single individual. When Yearn Finance’s (YFI-USD) two developers stepped down from controlling the ecosystem, YFI and its sibling tokens plummeted by 70%. Terra, too, was described as a decentralized chain governed by LUNA holders. Yet, when it came to deciding where to go after the network’s collapse, Terraform Labs founder Do Kwon manipulated the governance vote in order to make a decision.
Analysts agree that the “decentralized” verbiage is, up to this point, simply a buzzword. Most projects purporting themselves to be decentralized are not.
Solana was lucky that its community was able to douse the fuse on its ticking time bomb and prevent the FTX meltdown from further wreaking havoc on its network.
But now, after the second implosion in a single year, it’s time for projects calling themselves “decentralized” to take a good hard look in the mirror. Many will need to make hard decisions like the Serum crypto community did if they wish to prevent their own bombs from going off.
On the date of publication, Brenden Rearick did not have (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.