FTX fallout stains the crypto sector: Moody’s

The FTX debacle is casting a pall over the entire crypto sector, which faces contagion risks from the exchange’s downfall, says Moody’s Investors Service.

In a new report, the rating agency said the collapse of the cryptocurrency exchange, which declared bankruptcy last week amid solvency concerns, is a “negative for the entire crypto market because FTX and its customers are exposed to losses.”

The firm’s downfall after a run by its customers followed the failure of other major crypto platforms such as Celsius Network LLC and Voyager Digital Holdings earlier this year, Moody’s said.

The report noted that these episodes highlight the fact that the crypto sector faces risks similar to the risks of the traditional financial sector, but that the lack of transparency in the crypto space “makes them harder to measure.”

“Another important distinction is that the crypto finance system lacks official sector backstops such as a lender of last resort and deposit insurance. The lack of regulatory oversight and the sector’s overall opacity facilitate risky financial strategies, exposing firms to an environment in which rumours of illiquidity can become self-fulfilling prophecies,” Moody’s said.

The report’s conclusions were echoed by DBRS.

“Unlike traditional exchanges, where client monies are segregated and strictly audited, cryptocurrency exchanges are largely unregulated and provide little or no client protection,” a report from the rating agency said.

“This high-profile collapse in the fast-growing crypto market could potentially dampen future cryptoasset activity and at the very least provide a clear warning to smaller retail investors of the high risks from investing in cryptocurrency,” DBRS said.

At the same time, the damage from the collapse of FTX appears largely contained to the crypto sector.

In its report, DBRS noted that “the impact on the financial system appears limited,” although there are traditional market players, including the Ontario Teachers’ Pension Plan, which have direct exposures to the firm’s failure.

The Teachers’ investment is “still relatively small and represents less than 0.05% of their total assets,” DBRS said.

Apart from these individual exposures, these events actually represent a positive for the traditional financial sector, which has so far taken a relatively cautious approach to crypto, Moody’s noted.

“Crypto losses so far by retail and digital asset institutional participants have largely been contained within the crypto sphere,” Moody’s said.

“However, should leverage again build substantially in the crypto finance system, it could unsettle the banking system even if banks continue distancing themselves from direct interaction with the crypto economy.”

DBRS said that one possible consequence of the failure of FTX is that it “leads regulators to take more steps towards regulating the cryptocurrency markets to protect consumers and avoid systemic financial contagion.”

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.