FTX collapse prompts outflow of funds to personal wallets

The movement of funds from centralised exchanges to personal wallets has soared, Chainalysis study shows

Bitcoin accounts for 46 per cent of the market value of cryptocurrencies, down from about 70 per cent in January 2022. Reuters

The collapse of cryptocurrency exchange FTX has prompted an increase in outflows from centralised exchanges (CEXes) to personal wallets, a Chainalysis study has shown.

The outflow of funds raises questions on how institutional investors can safeguard their own digital assets and mitigate the risks of decentralised finance.

The percentage of CEX flows to personal wallets attributed to institutional transfers with values of at least $100,000 was at 68 per cent after FTX, once the third-largest cryptocurrency exchange by volume, imploded in November, the New York-based blockchain platform said on Friday.

However, it is still lower compared with the implosions of Celsius Network and TerraUSD in the middle of 2022, when outflows were at 69 per cent and 77 per cent, respectively, the latter by far the highest, Chainalysis said.

Other notable events that caused sharp increases were driven by the collapse of cryptocurrency prices, the highest of which was 62 per cent in 2021 when China announced it was banning cryptocurrency mining.

“Increased flows from CEXes to personal wallets are almost always one consequence of extreme market volatility or price declines, but what separated this latest instance from previous ones was that this time, institutional money led the charge,” Chainalysis analysts said.

“Whether they be individuals with large holdings, crypto native investors or traditional finance players, analysis of transaction sizes suggests these large holders are leading the way now in movements of funds from centralised services to personal wallets.”

FTX filed for bankruptcy on November 11. The downfall of the exchange once valued at $32 billion rocked the entire industry, dealing a blow to arguments making a case for the viability of digital currencies.

Its founder, Sam Bankman-Fried, faces criminal charges in the US.

The FTX crash came at a time when the market was still reeling from the shock of the collapse of the Luna cryptocurrency and its associated Terra stablecoin in May, plus Celsius' own bankruptcy in July.

Job losses across the industry also added to the worries.

“Growing institutional adoption of cryptocurrency means that the common pattern of funds moving out of centralised services and into personal wallets and DeFi in response to market volatility is now being led by deep-pocketed institutional investors,” Chainalysis said.

What is a centralised exchange?

A centralised cryptocurrency exchange is an online platform through which digital assets are bought and sold. It is considered one of the most important trading vehicles in the cryptocurrency industry.

The concept does not necessarily conflict with the concept of cryptocurrencies being a decentralised asset.

The idea of centralisation in this case refers to the third party — or “middleman”, according to Investopedia — that helps to conduct transactions.

This is akin to a traditional bank set-up, where “a customer trusts the bank to hold his or her money”.

What is a personal wallet?

A personal wallet, on the other hand, is a “place” where cryptocurrency can be stored securely, with users in control. The most common type is a hosted wallet, in which a third party keeps it for you, similar to when you keep money in a bank.

Users usually move cryptocurrencies from CEXes to personal wallets when the market is turbulent, and this includes new institutional users, Chainalysis said.

Is there anything to worry about?

While the increased outflows are not a good indicator, Chainalysis had already stressed that many market fundamentals remained stable as the situation at FTX stemmed from “financial fraud rather than a blockchain or crypto-specific failure”.

What are institutional investors?

Institutional investors are those that invest money on behalf of other people, such as mutual funds, pensions and insurance companies. Often, they buy and sell a considerable amount of stocks, bonds or other securities.

They have been attracted to the cryptocurrency industry as they aim to capitalise on its growth potential.

However, not all of them are convinced, for a number of reasons such as the absence of profit guarantees and an uncertain regulatory environment, according to a previous report from Cointelegraph.

“Overall, institutional funds have made up a bigger share of movements from centralised exchanges to personal wallets over time,” the Chainalysis study said.

What does a CEX-wallet movement indicate?

It can mean many things, and many would suggest that it signals users are worried about their CEX's solvency. By moving funds to a personal wallet, users can directly control their assets and ensure they don’t lose access to their funds.

In other cases, moving funds to a personal wallet and then to another CEX, or to a DeFi protocol, would enable them to continue trading or carry out other transactions, such as contributing to a lending pool.

“Regardless of the specific motivations, the behaviour holds true: most spikes in CEX-to-personal-wallet flows are sparked by market volatility,” Chainalysis said.