Even if you’re not part of #HODLgang, chances are you’ve seen headlines about the fallout of one of the biggest crypto exchanges, FTX.
So how exactly does a company lose US$32 billion in a matter of days? Enter the liquidity crisis.
A liquidity crisis happens when a company, industry or government ties its money up in hard-to-convert-to-cash assets or fails to plan ahead for required cash flow, leaving them “illiquid” and unable to cover its liabilities, a.k.a pay its debts.
- This Kevin Hart bit is a great example—he’s got the money, but it’s not available to him at the moment since he has to transfer it between accounts. He’s dealing with a liquidity crunch until that transfer goes through.
An economic shock can spur liquidity crises—an unpredictable and disruptive event like a pandemic, or war (or in the case of FTX, some news about its shoddy business practices is published).
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A report by Coindesk led one of FTX’s biggest and earliest investors to pull almost US$600 million from the exchange, triggering a domino effect of withdrawals that left FTX bleeding cash.
- There was also some other pretty shady stuff going on with FTX that made things even worse (like sketchy balance sheets and mysteriously missing funds).
The FTX failure demonstrates how quickly mismanaged assets and poor cash flow planning can cause an economy to collapse—but this isn’t unique to crypto.
- The bank runs during the Great Depression saw numerous financial institutions forced to shutter their doors when they could not meet customer demand for withdrawals.