FTX collapse could have been avoided

Business risk is a difficult thing to weigh but even more so is the risk related to investments, the FTX collapse could and should have been avoided

How the collapse of FTX could have been anticipated
Recently the market was shaken by the FTX / Alameda Research issue that cascaded into a heavy market crash when the overall look did not foreshadow it. 
The contagion collapse over the FTX affairs was predictable if we had looked at the FTT Token and Sam Bankman-Fried (SBF) companies with the same gaze with which we look at publicly traded companies. 
For publicly traded companies for example, there are strict periodic controls with lots of audited financial statements and more or less solid but always sufficient hedges, at least on paper. 
Solvency, EBITDA, profit margin, are just some of the parameters to be taken into account and which do not always find a counterpart in the crypto world, but that is not the point. 
Inadequate risk management in cryptocurrencies can lead to serious problems, and companies should be looked at with a closer eye and should be chosen based on the soundness of their foundations. 
In the case of Terra, or in the tumultuous FTX affair, it occurred that huge companies, at least at first glance, turned out to be opaque and not at all financially sound, making them liable to become insolvent in no time.
Quantifying risk through tools such as VaR and expected shortfall as well as quantifying centralized and decentralized liquidity are a prerogative sine qua non for any company in this industry all the more so after the FTX affair.
Widespread lack of transparency and poor regulation (removed from MiCA and the US one, which in any case are still immature, there is no detailed regulation) facilitates a lax, superficial way of doing things that has little to do with the dictates of classical finance rigor.
Risk management metrics 
Value at Risk (VaR)
VaR, short for Value at Risk, can be used to measure how much and how possible losses might occur in a crypto portfolio and how to then escape market crashes. 
This parameter allows users to give a weight (a value) to what they are analyzing and putting their money on.
VaR can range between 90% and 99%, if a VaR of 95% is $30,000 it means that the entire portfolio will almost certainly lose less than this amount in a stress case.
The loss may average a maximum of $30,000 5 days per 100 (100%-95%= 5%). 
VaR is basically the loss we could accept based on market risk.
If the risk budget is smaller such as in the case of an exchange or leader, the VaR drops to about 99% and should be in conjunction with more stringent rules as demonstrated in SBF’s FTX case.
The expected shortfall (ES)
This indicator as well as the previous one, rises to the role of measuring the highest (weighted) loss in a borderline case. 
In the case of a black swan as FTT might have been, it alters the composition of the distributions of returns.
ES and VaR are able to give investment managers, and thus, risk, a sense of how precipitous the situation could be in the event of a market crash.
With these parameters, companies can determine acceptable risk and ensure sufficient liquidity to cope with sudden surges in value in the market during crashes such as the one of the past 20 days.
Implied volatility
This criterion partly constitutes the price of an option, and depending on the volatility with which the market discounts an option, one can determine how much the market will be shaken as it nears expiration.
Liquidity metrics
Market depth on centralized exchanges
Black swans such as Celsius and FTX depend on the liquidity problems of the related Tokens namely stETH and FTT. 
Those who held these Tokens in their portfolios could and should have even before the collapse, understood what they could be up against if all holders withdrew sums at the same time.
FTT was almost totally held by FTX, and supply-side liquidity was not enough to cope with all the sales as happened during the collapse. 
Polkadot’s token, DOT has a mirror history to FTT’s before the disaster, in this specific case it has only $4 million of supply-side support within 2% of the average price on the exchanges where it is present. 
This situation for DOT is dangerous and could cause it to incur an FTT-style price collapse. 
Data on the DeFi liquidity
The CEX market is not enough to offer full coverage to a cryptocurrency’s liquidity, and cryptocurrency companies should be convinced that liquidity on these exchanges as well as on DEX exchanges could include scenarios such as a collapse leading to bankruptcy and protect themselves. 
Due diligence on exchanges
Due diligence on exchanges is now of paramount importance for protecting oneself and scouting.
FTX was considered trustworthy in the crypto world even by insiders but when Coindesk opened Pandora’s box it was discovered how much dust was under the carpet and FTX went bankrupt within days. 
The account holders were certainly the ones who got mocked with huge capital losses but also the hedge funds and trading desks that had their funds stored on FTX found themselves very hurt, especially as they had to justify their choice of having preferred SBF’s company to their investors.
Due diligence becomes de facto necessary and is always necessary to monitor liquidity and governance.
In conclusion, it is often the case, especially in companies with good reputations and large size, that the controls become more lax, but that is the biggest mistake. 
In a bear market like the one we are experiencing, the flaws of companies come out easily and illiquid tokens are slowly exposed.
STETH and FTT were just the useful examples but there may be others. 
VaR and Expected Shortfall, helping investors get through these crashes and emerge unscathed from the bear market. 

This article has been originally published at: https://en.cryptonomist.ch/2022/11/25/ftx-collapse-could-have-been-avoided/