Q9 Markets | (Un)Clear and Present Danger

23 June 2022

Q9 Capital: www.q9capital.com

(Un)Clear and Present Danger

• BTC recovers to $20k
• SBF extends credit to prop up Voyager and BlockFi
• Does crypto have a transparency issue?

Bitcoin is hovering around the $20k level, suggesting risk appetite has now stabilised after falling as low as $17.7k earlier this week following the fallout from several crypto firms disclosing liquidity issues and blocking redemptions.

Bitcoin Price, 90 Days

Source: CoinGecko

Global macro conditions continue to provide a difficult backdrop for the asset class. Inflation in the UK reached 9.1%, the highest in 40 years, as food and energy prices jumped — and economists are predicting it to hit double digits by the Autumn. The pound has plunged 10% against the dollar this year. A strong dollar is generally bad for crypto and the greenback has been soaring — the US Dollar index (DXY) is now up 8.6% for the year- as the Fed begins to aggressively combat inflation.

UK CPI Inflation (%, year on year)

Source: FT, ONS

The total AuM of crypto products has fallen to its lowest level since Feb ’21. A new report shows investors redeemed $39mn from digital asset funds alone in the seven days through June 17. However, the largest crypto whales are sticking to the strategy of buying the dip and are adding to their holdings in an aggressive fashion, with their relative ownership hitting an all-time record. “Giga-whales” with over 100k BTC have increased their holdings by 16% in the last 30 days.

Crypto miners, the only natural net sellers of Bitcoin, have been offloading their inventories on a large scale this year. In the first four months of 2022, public mining companies sold 30% of their Bitcoin production. Miners have a significant influence on the price of BTC and if they are forced to liquidate a considerable share of their holdings, it could contribute to pushing the price further down.

Source: Arcane Research

Bluechip NFTs are up 40% from a week ago.

Tower of Babel

Babel Finance (who share their name with the infamous Biblical structure) are the latest crypto platform requiring divine intervention, freezing withdrawals and telling clients it is facing “unusual liquidity pressures”. The firm has imposed a $1.5k per month withdrawal limit for each client whilst it undertakes an “emergency assessment” of its operations. At the end of 2021, Babel Finance had an outstanding loan balance of over $3bn.

The firm has now reached preliminary agreements with counterparties on the repayment of some debts — although the details are not yet public. The firm had previously raised $80mn at a $2bn valuation only last month.

Lender of Last Resort

Sam Bankman-Fried has had a busy week propping up other crypto firms. Alameda Research, his quant trading firm, extended a line of credit of $500mn in USDC and BTC to Voyager Digital after it disclosed a $661mn exposure to potentially insolvent firm Three Arrows Capital (3AC). Voyagers shares have fallen over 50% since the crypto broker disclosed its exposure to 3AC. FTX (his crypto exchange) also extended a $250mn loan to BlockFi to bolster its balance sheet. Celsius, meanwhile, has asked users for more time to stabilise liquidity and operations and fix its issues after halting withdraws. “This process will take time” the company said in a blog post.

Bankman-Fried believes his exchange has a “responsibility” to bail out ailing crypto companies in times of crisis. “I do feel like we have a responsibility to seriously consider stepping in, even if it is at a loss to ourselves, to stem contagion… Even if we weren’t the ones who caused it, or weren’t involved in it. I think that’s what’s healthy for the ecosystem, and I want to do what can help it grow and thrive.”

Critics have likened this to acting as a central bank of crypto and a lender of last resort. One of the critical principles of crypto is its independence from authorities such as central banks. But SBF is building a pivotal role akin to the authorities that rescued banks in the 2008 financial crisis or perhaps more closely to JP Morgan in the panic of 1907.

Sam may believe in the crypto ecosystem and help it grow. Of course most entrepreneurs in the space would feel the same. If there is no crypto then there is no business. However, it’s also in his best interest to smooth things where he can. A crypto winter would be bad for growth and even those firms in a position to help now would suffer if the crypto winter lasts for a very long period.

Durable Assets

The CIO of global fixed income at Blackrock, the world’s largest asset manager, says Bitcoin and crypto are durable assets. “I think there’s a healthy recalibration going on,” he said, noting that “if you look two to three years hence, they will be higher than today.”

Rieder described: “It’s not terribly dissimilar from the internet bubble … if you go back to the ’99 and 2000, was the internet a bad idea? No, it wasn’t a bad idea. But you created so much excess around it and you just have to de-gear that dynamic, and I think we are seeing that today.” He noted: “Markets go down five times faster than they go up … That’s why you were seeing this incredible unwind.”

He also said BTC is “so much more functional than passing a bar of gold around… I like assets that are volatile, that have upside convexity. I could see Bitcoin go up significantly.”

Questions and Answers

For a technology that is designed from its very core to bring openness and transparency to the world, crypto seems to now have a problem with… openness and transparency.

The events of the last few weeks have shown that 1) seemingly “identical” investment products offered by different institutions are sometimes apples and oranges, 2) the way firms manage risk is not created equal and 3) the inner workings of some client firms can be opaque.

Now with the failings or troubles of firms such as Celsius and Babel in the news, a focus on disclosures, suitability and openness to clients is being called for. So is a solid framework for risk management and for exposures to counterparty risk. However, these issues are not unique to crypto. We certainly don’t know what’s going on inside the largest brand name tradfi institutions. The story of Bill Hwang is barely a year old. And clearly regulation alone did not protect everyone. All these firms are regulated, though the brokers did survive, but perhaps that was simply a matter of size.

When crypto folks hear the word regulation they automatically think of burdensome KYC and AML procedures, but regulation in traditional finance also mandates capital requirements, customer segregation and disclosures. So perhaps regulation can help here. But can the on-chain transparency and DeFi help as well?

An interesting hypothesis is “Would this have happened if it was all on DeFi?”… The answer is “we don’t know”. If everything was happening on a transparent on-chain protocol then all the information is publicly available and everybody could see the exposures of every counterparty they are facing. Who is borrowing from who? What are they doing with my assets? Is this something I want to get involved with? Etcetera, etcetera… This obviously could be really good!! However, the current trade off is that when on-chain in smart contracts, the industry hasn’t quite figured out the smart contracts that always work as intended, or more accurately, as their designers hoped. Terra and Anchor were only last month! And to that point the current winners aren’t really the defi protocols. We don’t know how FTX is managing risk, except to the point we know they still have money.

Which leads us to another essential point. It’s important for the industry to disclose this information. But it’s equally important for YOU to ask questions. Questioning is a uniquely powerful tool. It spurs learning and the exchange of ideas, it fuels innovation and improvement, it builds rapport and trust. And it can mitigate risk by uncovering unforeseen pitfalls and hazards. The bar for investors putting their money in both centralized lending platforms like today’s news and defi like Terra and Anchor seems very low. Especially when it was money they couldn’t afford to lose.

We constantly see DYOR written on Twitter and wherever the TikTok generation gets their financial advice. It’s much too much an a** exercise for the author followed by advice. But it’s actually really important! Everyday investors, crypto degens in particular, demand the right to make their own decisions on how they spend their money. And rightfully so! But if we cry wolf when things go wrong then we will never move on from regulation that protects us from somethings by preventing us from most things.

On-chain transparency can help give us the information we need to make better decisions. And over time, we will create better and better on-chain solutions that hold up in the real world. In the meantime, asking questions and kicking the tires on crypto projects and holding people accountable for flaws within them is how the industry will improve and grow.

In the News…

• First short Bitcoin ETF to list on NYSE
• Tether to launch stablecoin tied to pound as UK aims to become crypto hub
• Cardano delays Vasil Hardfork due to pending bug fixes
• Uniswap Labs pushes further into NFTs with Genie acquisition
• UK Gov’ backtracks on unhosted wallet data collection proposal
• South Korea puts Terraform Labs’ staff on no-fly list
• WeChat bans crypto and NFT-related accounts
• Russian Finance Ministry rules out sale of oil for Bitcoin
• NFT marketplace Magic Eden raises $130mn at $1.6bn valuation
• FalconX more than doubles its valuation to $8bn in $150mn round
• Iran cuts electricity to licensed crypto miners
• Cardano founder Charles Hoskinson to feature in Snoop Dogg’s new album
• Cristiano Ronaldo becomes official NFT partner for Binance