Modern-Day Crypto Bank Run
We’ve all seen the historic photos of bank runs during the Great Depression. Expecting the banking system to fail, crowds of people piled into banks across the US to withdraw their deposits before the banks became insolvent. As more people began withdrawing their money, others followed suit. This feedback loop culminated in the failure of roughly 9,000 banks during the 1930s, erasing $7 billion in depositors’ assets. Looking at the banking system today, measures such as deposit insurance have been implemented to prevent bank runs from occurring. However, even with protective measures in place, this doesn’t mean that bank runs cannot still happen.
Just this past week, the financial industry has witnessed a modern-day bank run caused by FTX, one of the largest crypto exchanges in the world. According to The Verge, the problem started when FTX loaned billions of its customers’ deposits to sister trading firm Alameda Research to make risky bets on cryptocurrencies. Using the loan, Alameda invested in various coins—one of which was FTT, making up a large portion of Alameda’s assets. However, trouble started when rival firm Binance sold billions of FTT, sending the value of FTT plummeting along with the value of Alameda’s assets. As a result, Alameda owed FTX $10 billion, creating fears that FTX would become insolvent. Like the bank runs in the 1930s this news sent depositors rushing to withdraw their money from FTX, leading the FTX’s Ethereum reserves to plummet 90% in 48 hours from 322,000 to less than 32,000.
This is a classic example of an information cascade, where depositors have the decision of whether or not to withdraw their money. Each person has private information, such as how much money they have deposited in FTX and how likely they believe FTX will declare bankruptcy. All depositors can also observe the decisions of others before them. With this setup, a few people withdrawing their deposits develops into mass withdrawals as more and more people see others taking their money out of FTX. Compared to the bank runs of the 1930s, what we’ve seen with FTX is incredibly similar, except that rate of withdrawals is magnitudes faster because of the speed at which information travels through the internet.
How has this crisis affected FTX? As of today, FTX just declared Chapter 11 bankruptcy. It is incredible how quickly FTX met its downfall, going from one of the world’s largest exchanges to insolvency in just days. Just like the banks of the Great Depression, FTX has been written in history as well.
Sources:
https://www.theverge.com/2022/11/10/23451484/ftx-customer-funds-alameda-research-sam-bankman-fried
https://www.nytimes.com/2022/11/11/business/ftx-bankruptcy.html
https://bitcoinist.com/bank-run-leaves-ftx-reserves-in-shambles/