Q9 Markets | Below Zero Celsius

16 June 2022

Q9 Capital: www.q9capital.com

• BTC price nears $20k after sell-off
• Staked Ether (stETH) becomes focus of market stress
• Celsius Network pauses withdrawals

Bitcoin’s price neared $20k (-32%) and ETH threatened $1000 as crypto markets retreated to levels not seen since the beginning of 2020 after crypto lender Celsius told users that it was pausing all withdrawals, swaps and transfers between accounts because of “extreme market volatility”. The total market cap of crypto fell below $1tn for the first time in 18 months (down from its peak of $3.2tn in November) and most coins fell over 20% against the dollar over the last 7 days.

Bitcoin’s price neared $20k (-32%) and ETH threatened $1000 as crypto markets retreated to levels not seen since the beginning of 2020 after crypto lender Celsius told users that it was pausing all withdrawals, swaps and transfers between accounts because of “extreme market volatility”. The total market cap of crypto fell below $1tn for the first time in 18 months (down from its peak of $3.2tn in November) and most coins fell over 20% against the dollar over the last 7 days.

Over $1bn of crypto was liquidated in 24 hours between Monday and Tuesday.

Total Liquidations, 3 Months

This latest downturn is related to a market-wide liquidity crunch which caused Lido’s stETH to trade at a discount against spot ETH.

The sell-off was compounded by the Fed making its biggest interest rate rise in 30 years on Wednesday. The central bank raised its benchmark policy rate by 0.75 points and said another adjustment of that size was possible at its next meeting, part of an aggressive plan to tighten monetary policy to confront the highest US inflation in 40 years. The Bank of England followed with a 0.25% rate rise. The Swiss National Bank (SNB) made a surprise 0.50% rate hike for the first time since 2007. Concerns around a sharp tightening of monetary policy are weighing on financial markets and are trickling down into cryptocurrencies through their influence on large institutional investors.

The declines mean that Bitcoin has shed 70% of its value since last autumn’s peak and is now trading below a metric known as its “realised price” — the average price paid by buyers for coins in circulation.

Frozen Out

Crypto unicorn, Celsius, is in hot water. The firm, which claims 1.7mn clients, $24bn AuM (as of December) and raised $400mn from investors in October, blocked redemptions this week and has hired a restructuring law firm to advise on possible solutions for its mounting financial problems. Nexo, a rival crypto lending platform, has proposed a buyout of Celsius.

Celsius is one of the largest users of stETH and uses it (and some other DeFi investments) to offer higher headline ETH yields and attract more investors. According to blockchain data, Celsius has nearly $500mn of stETH locked up as collateral in stablecoin loans. It’s possible they have more elsewhere in their treasury. The market is now worried that Celsius’ DeFi investments may have declined in value so much that the platform no longer has enough money to pay back its depositors.

Three Arrows Capital is another major firm surrounded by speculation. 3AC drew attention on social media after it began dumping its staked ether (stETH). Although the firm does not take outside investors there are concerns that at its size it could contribute to cascading liquidations and insolvency. The firm has not commented directly except to say it is working with its counterparties.

Celsius Network (CEL) Price, 90 Days

Source: CoinGecko

A Game of High Stakes

“Staked ether” (stETH) is a bond-like product from Ethereum staking service Lido Finance, The asset is an Ethereum-based token representing ETH “staked” on Ethereum’s proof-of-stake Beacon Chain and is supposed to keep a 1:1 peg with ETH. However, it was trading at a record 8% discount on Monday as lenders who had been using it to enhance yields began to cut their positions at a loss in order to meet redemptions.

This is significant, stETH represents around 33% of all staked ether — or around $5bn.

The revenue-generating asset was a key component in many large or institutional crypto traders’ portfolios — including lending platform Celsius Network’s and venture firm Three Arrows Capital and is causing fears of a liquidity crisis and cascading defaults.

The attention on stETH this month stems from the fact that it is no longer trading around 1:1 for ETH. Traditionally, ETH and stETH have traded around parity because each stETH represents a direct claim on ETH that Lido, a decentralized protocol, has staked on the Beacon Chain on behalf of its users.

The catch is that while Lido will happily hand out 1 stETH in exchange for 1 ETH, it does not yet allow users to pull their ETH back out of the protocol. This comes down to a limitation with Ethereum itself: ETH staked on the Beacon Chain will be impossible to withdraw until an update following Ethereum’s “Merge” into a proof-of-stake network.

The main point of a “liquid staking” solution like Lido was to provide users a way to stake, secure the network and earn interest for doing so without losing the ability to use and trade staked assets. It also allows users to participate in staking without the need to put up 32 ETH — which is what’s required if you are setting up a node by yourself.

Here’s how it works.

Source: Messari

Source: Messari

We Are Not Just Reducing Risk

The size of crypto books was not the only thing being reduced this week. Coinbase and BlockFi are laying off hundreds of staff, equivalent to a fifth of their workforces. Coinbase CEO Brian Armstrong tweeted that it was a mistake to hire so fast. This is after some of the fastest hiring we have seen following enormous capital raises in 2021.

We may not see cap raises of that size again anytime soon. They will still happen and there’s money to deploy, A16Z is sitting on a freshly raised $4bn fund. New money will more likely be focused on value than growth and a low burn rate will probably become a feature now instead of a bug. So look for more practical valuations, M&A and some more down rounds like Blockfi recently announced according to a recent report.

KYR

Know Your Risk. All investors want to know that their assets are secure. At a bare minimum, depositors/investors need to understand the risks they are taking. If something is too good to be true, it often is. Look for firms that offer transparency around their products and ensure risk management controls of their platform and products.

While much of what happens in DeFi is innovative, there is no such thing as a free lunch. To repeat, there is no such thing as a free lunch. When you are getting higher than market yields you may be subject to credit risk, or illiquidity or hidden tail risks. This is not necessarily bad, but you need to understand the risks you are taking and plan accordingly. The market is meant to provide a menu of choices across the risk spectrum. If you are high fiving your friends or posting videos of how easy it is to make money you either don’t know what you are doing or you are being insincere. If you are saying this one looks like a good risk reward, I hope it works out, that is what great long term investors sound like. Sure, sometimes we get really lucky and sometimes we don’t. This week reminds us of the don’t. You can lose money, but you must live.

At Q9, we work to provide our clients with innovative products with high standards in an effort to build crypto for everyone. Lido Finance was innovative in creating this liquid staking derivative (stETH). However, in the end we see that the liquidity was conditional. Lido did not meet our risk parameters, even after considering the higher ETH staking rewards that were (previously) considered to be a low risk strategy among many market participants.

We will continue to innovate and be transparent so that our clients can make the right investment decisions. As regards to the current market, at Q9 we:

- Do not have exposure to or support Luna, UST or stETH on the platform

- Do not have exposure to any DeFi protocols

- Do not have exposure to any of the firms reportedly facing solvency issues

We continue to provide liquidity 24/7 via our online portal and through our desk and remain diligent to observe the market, manage risk and protect our clients’ assets.

This market cycle is not likely over and several other firms hit the headlines for the wrong reasons. It happened near the end of the dot.com boom as well. Some firms didn’t survive, but some had not been born yet. The internet grew up and created the fastest technological change the world has ever seen. Today, despite a change in market sentiment (which is much larger than crypto) blockchain tech is going mainstream and blockchain, crypto and digital assets are growing up. Make sure you survive for the new fastest technological change the world has ever seen.

In the News…

• New Bank of America survey reveals 90% of US adults plan to buy crypto this year
• Uncovered: The trades that triggered UST’s collapse
• Majority of crypto hedge funds extremely bullish on BTC despite weak price action: PwC Study
• Consensus 2022 was the crypto bull market’s goodbye party
• El Salvador’s Bitcoin investment suffers amid crypto meltdown
• UK Minister wants nation to be a Crypto Hub, minus the criminals
• What will Ethereum miners do after the merge?
• Bitcoin miners flock to Texas
• Bangladesh starts exploring CBDC
• DOJ announces closure of darknet market selling social security numbers
  and other personally identifiable information
• SEC reportedly launches investigation into insider trading on exchanges

Legacy Markets

• Oil futures dropped -3.6% and US Equities (SPX) fell -8% week on week
• The US Dollar index rose +20 bps week on week
• 10 year US treasury yields rose 15bps and the Gold & Silver index dropped -3% this week

Crypto Markets

• BTC & ETH plummeted by -32.3% & -40.3% respectively (vs previous week). The total market cap of crypto market dropped down to $878bln mark and Bitcoin dominance hovered around +44% during last week.
• Among other majors SOL dropped -25%, defi space nosedived with COMP & CRV dropping -45.7% & -42.5% week on week
• Seven-day Annualized realised volatility in crypto markets rose BTC to 46.5% and ETH to 49.5% vs previous week levels

Our Flows

• Client activity skewed towards selling (6.5x sellers vs buyers) during last week
• Flow dominated by sellers in BTC & ETH
• Buying activity in FTM, EOS and Selling Activity in MATIC, SOL