The current price action makes it increasingly clear that crypto breaks cyclical patterns of the past. In bitcoin’s short three-cycle history, each cycle saw the token price drop to the 200-week moving average (wma) at the depth of the bear market. However, the price did not fall below the prior cycle high. The current price is below both the 200wma (~$22,200) and prior cycle high of ~ $20K! We have been surprised by the speed and magnitude of the unwind.
What’s clear now is that crypto going mainstream has elevated downside volatility. The Dispatch has touted the benefits of the institutionalization of crypto assets and posited that institutional capital could dampen volatility. That expectation was misplaced as increased connectivity between crypto and traditional finance has amplified volatility. The ~20% price declines this past week were attributed to troubles at traditional financial institutions: Celsius, Three Arrows Capital (3AC) & Babel. Our mantra remains to keep crypto position size small and investment horizon long. We remain confident of the monetary properties (bitcoin) and utility offered by decentralized protocols over the long term. This cycle is proving to be just as volatile as the others.
We continue to see risks to the downside for most risk assets as the Fed withdraws liquidity into a rapidly slowing economy. The liquidity withdrawal will only reach the target levels in September 2022.
Dispatch #14 on June 17th, 2022, focuses on just two topics:
- Taking stock of crypto assets
- Terra-LUNA post-mortem
Crypt breaks cyclical patterns
Celsius news triggered the weakness this week
The sharp selloff that started was precipitated by fears about the health of Celsius, a crypto lending platform, and Three Arrows Capital (3AC), a crypto hedge fund. Celsius, with thousands of clients, has publicly announced a halt to client withdrawals. Think of the withdrawal halt as a bank run without FDIC insurance. Celsius had offered some of the highest yields among crypto yield companies, which came from taking higher risks. There’s no way around the higher return from higher risk, especially in a yield product. Mainstream coverage of Celsius’ troubles have been skimpy, as you can see in this WSJ article. This Blockworks article provides a more in-depth look at what might have caused the troubles, including ETH staking and stETH depeg. As usual, we find the most detailed and clear explanations on Twitter.
Ironically, the Celsius home page still shows “safe forever” and “access your coins whenever” marketing slogans that attracted clients. Do we need any more evidence that some level of regulation is needed to protect consumer?
Source: Celsius home page as of June 17, 2022
3AC added to the sell pressure
3AC, as an institutional money manager, was less forthcoming early in the week. We appear to be getting some information from the fund, which is hiring legal counsel as this WSJ article explains. We also have CEOs of some of the largest crypto exchanges/lenders (think of them as crypto investment banks) make barely disguised statements about the 3AC default.
These tweets from Blockfi and Genesis are highly unusual as they name a client without naming the client!
We should note that both tweets use the word “hedged”. Hedging does not eliminate risk; it merely transfers the risk to someone else. It’s this risk transfer that the broader market feels, as risk is hedged via futures and other market venues.
Furthermore, early in the week, the market was also spooked when Binance, the largest crypto exchange, paused bitcoin withdrawals temporarily. Withdrawals recommenced after a 3-hour outage. Outages at exchanges are not unusual, especially during times of heavy market activity.
Babel withdrawal-halt continued the pressure
The news did not get better over the week as on Friday, Hong Kong-based crypto lender, Babel Finance halted withdrawals. Interestingly, the statement below is NOT visible on the landing page! This Coindesk article provides more details.
Blockchain analysis shows that Celsius and 3AC were wrong footed by the price divergence between ETH and the illiquid staked ETH (stETH). Both entities were also entangled in the Terra-LUNA collapse. There has been less analysis of Babel give the recency of its issues, but that market has widely speculated about “troubles at an Asia -based lender”. These are traditional firms operating in crypto and their risk management didn’t survive the past week’s selloff. With two crypto lenders halting withdrawals in a single week, it’s clear that we need better regulation for consumer-facing centralized companies operating in crypto. Fully decentralized protocols provide transparency, which affords consumers information to make decisions. However, as the NYDIG article towards the end of this Dispatch argues, Defi has excess leverage as well.
Crypto guide posts aren’t robust
One of our guideposts in crypto is this chart below, which shows that bitcoin has hit the 200wma moving average (~ $22.3K) in each of the past three cycles. The flaw is that the series has just three data points. Another three-data-point fact is that bitcoin has not breached the prior cycle high, which is around $20K. Both levels have been breached as we write on Saturday, June 18th. The Crypto ecosystem developed during a period of low inflation and ease money. That macro environment has changed, and we are open to the idea that prior relationships might be broken. However, we remain confident of the monetary properties (bitcoin) and utility offered by decentralized protocols. This confidence will be challenged in the coming months as we all hear increasingly strident naysayers.
Crypto assets have been severely stress tested over the past six week. The tests started with the nearly $50bn implosion of Terra/Luna project. We have forced liquidations (possibly eventual bankruptcy) of Celsius, #AC and Babel Finance all within a single week. Last week, word leaked that another crypto yield service – Blockfi – is trying to raise capital in $1bn down round (vs $3.5bn prior valuation). We are seeing excesses comes out even if it’s earlier than anticipated and the effects much worse.
Economic imbalances remain unsustainable
Our longer-term expectation is that the Fed will not be able to fully unwind the balance sheet. There’s just too much leverage in today’s economy that will prevent sustained high interest rates. Some of this leverage clearly corrupted crypto assets too. This leads to the high probability of the Fed easing liquidity conditions at some point in the future. We do not know when that point might be, but the chart below illustrates the increasing frail underpinning of the US economy.
Finally, bear markets have led to significant innovation as builders continue to tinker without the distraction of rising token prices. Defi and NFTs were developed during that last bear market. We are excited to look for the best future innovations coming out of the current down cycle and to focus on the most resilient existing projects.
We will leave you with a paragraph from this opinion article published this week by historian Niall Ferguson:
Terra-LUNA postmortem
We’d like to highlight two very different yet illuminating research articles on the Terra-LUNA unwind. The first is clinical diagnosis of blockchain data by Chainalysis that lays out the different wallets that triggers the initial UST depeg, the defence of the peg and the ultimate collapse. For anyone unfamiliar with blockchain analysis, it’s worth looking through the report to understand the real time visibility into the activity on-chain. This is the good aspect of blockchains, although that was not enough to deflect the flaws of the UST design.
The second document is a far more in-depth report from NYDIG looking at the fundamental design flaws of the UST stablecoin and the wider Terra ecosystem. This critical analysis has been lacking in crypto assets over the past two years and is needed for the asset class to reach critical mass. The paragraph below provides a glimpse into the thinking.
The authors are bitcoin leaning, you’ll realize if you read all 10 pages. That, for the most part, means they value truly decentralized networks. As they point out, Terra was “decentralized” until the system came under pressure and then key individuals took over important decision like how and when to defend the peg. The report ends in a dreamy narration of a truly decentralized world. That aspirational world is many years away, in our view, because what’s technically possible does not mean in practically possible. Regardless, if you have the time, it’s well worth the read as it’s a deeper reflection into the flaws of the mostly profit driven machinations of the crypto industry in the recent bull market.
Thanks for your attention. Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
Asi
Important Disclosures
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