The recent crash of Solana can tell us a lot about how different cryptocurrencies are intertwined. As one company faced insolvency issues, the effects were felt by a handful of other cryptocurrencies. One of the cryptocurrencies caught in this ordeal was Solana (SOL). The token fell by over 20% in one day. Here is an in-depth breakdown of why Solana is crashing.
What is Solana?
Solana is a blockchain that looks to use decentralized applications (dApps) and smart contracts with improved scalability of blockchain networks. Its uses range from DeFi to music streaming to non-fungible tokens (NFTs.)
The blockchain combines micropayments with a proof-of-history (PoH) and proof-of-stake (PoS) consensus model to verify its millions of microtransactions. SOL is the native utility token and allows users to process transactions and stake for rewards.
Solana’s supply is currently around 300 million tokens in circulation. It still has a relatively high inflation rate of 7.2% meaning that its supply will continue to increase significantly in the coming years. The inflation rate is lowered every year until it reaches a flat 1.5% in 2031, but for now it’s still relatively high.
Solana currently uses a combination of a PoS and a PoH consensus model to verify transactions. PoS works by employing validators who own SOL to lock their investment on the blockchain. They can then verify the legitimacy of transactions and earn rewards for doing so. The chain holds the token as collateral so they punish those who do not validate correctly.
PoH is a relatively new concept that Solana is employing in coordination with its PoS system. Solana is one of the only blockchains to use it, and it is working quite well. The Solana chain keeps a time record of all transactions and then divides up the validation process using a verifiable delay function (VDF.) PoS does not have a clear sequence of transactions in terms of time. By combining the two consensus models, Solana is able to process transactions much faster and more efficiently.
How is Solana Connected With FTX?
The link between Solana and FTX is not entirely direct, so much so that many did not know about the connection until it was too late. However, the connection was the main cause of why Solana is crashing
FTX CEO Sam Bankman-Fried has a hedge fund called Alameda Research (which also collapsed in this crisis). This fund was heavily invested in Solana (SOL) and FTX Token (FTT). Before the crash, Alameda Research had over $1.2 billion invested in SOL, which was roughly 10% of the market cap before the crash. Bankman-Fried, Alameda and FTX also pushed Solana forward by dramatically increasing its visibility, helping make SOL one of the most popular Ethereum competitors.
What’s Happening with FTX?
FTX is a prominent crypto trading platform that rose to popularity in 2019. More recently, a balance sheet was leaked showing that most of Alameda Research’s capital was invested in FTT. Additionally, a report came out stating that Bankman-Fried had transferred $4 billion from FTX to Alameda, some of which were customer deposits. Finally, reports have been circulating for some time that speculated that Binance might buy FTX. When all three of these factors were combined, many became worried about losing their money and decided to withdraw. FTX typically receives less than $100 million in withdrawal requests every day. However, they received over $6 billion of requests in less than 72 hours. Bankman-Fried thought that FTX had enough liquidity to support such an amount of withdrawals, but mislabeled bank statements meant that they only had enough liquidity to support 80% of the withdrawals.
Because of these insolvency issues, FTX contacted Binance to try and work out a deal to sell FTX to Binance. While a non-binding agreement was signed, a deal ultimately did not go through. In the words of Bankman-Fried, FTX will “live to fight another day.”
Why is Solana Crashing?
With FTX’s recent downturn, some believe that it could use the investments of Alameda Research to cover the debts. This process could be the logical option, allowing it to pay off debts without having to sell the company (which likely no one will want to buy anyway with its enormous debts). However, to do so, it would have to sell some if not all of its assets. The FTT token, which was its largest holding, has fallen so much that selling it would not be very helpful. Solana, on the other hand, is still relatively valuable despite the crash. If it were to dump its SOL position, it would cause a catastrophic fall in the price and could potentially destroy the token’s future. Because of this, many tried to sell their SOL positions to limit losses in the event of a mass sell-off from Alameda.
This was a main driver in why Solana is crashing, but the token came back a bit and seems to be holding steady after an announcement regarding a partnership with Google.
Can Crypto Exchanges Be Trusted Anymore?
It would be somewhat irrational to say that this situation has not eroded the trust between investors and crypto exchanges. However, there are two potential takeaways that you could get from this situation. You could say that the situation was isolated and that different exchanges would likely not face similar issues. Conversely, you could apply FTX’s shortcomings to the other crypto exchanges and say that they are also likely to face insolvency issues.
Regardless of how you feel about crypto exchanges, personal wallets are the safer option.
How Can Investors Keep Their Crypto Safe?
While it is perhaps easiest to store your crypto on a trading platform, it can be vulnerable to cyber-attacks and insolvency issues. It also does not allow users much discretion over their tokens. Wallets give users full control over their tokens and can be safer than holding them on an exchange.
Is Solana a Good Buy Right now?
In terms of Solana’s future, a couple of potential scenarios are worth highlighting. First, FTX’s insolvency issues could worsen and its SOL position could be liquidated. In this case, the price could be dragged down further. Conversely, the partnership with Google could spur growth and leave the issues with FTX in the past. It’s possible the mass sell-off was an overreaction. There is no guarantee either way, but your outlook on these two potential scenarios can give some insight into your decision to invest in SOL.