The birth of crypto contagion: Grayscale
The crypto credit crisis originates from the massive buoyancy and prolonged premiums of the trusts of DCG’s subsidiary Grayscale. As the contagion still ravages, the credit loop is about to close full circle, with DCG subsidiary Genesis currently facing massive pressure following FTX’s fall.Preview
Grayscale’s funds will not be dissolved. DCG will either resolve the current crisis, or a big traditional finance conglomerate will acquire the massive cash cow that is Grayscale’s close-ended funds.
The catalyst of crypto contagion: Terra
The contagion erupted from Luna’s collapse closely after Luna introduced its BTC reserves strategy.Preview
Contagion has not fully settled.
A wave of selling ensued: The virus is spreading
One fund was particularly involved in Luna - Three Arrows Capital. The fund also had a very sizeable exposure to GBTC and suffered from a lack of liquid assets. Regardless, 3AC had a strong reputation in the space and had vast access to credit from more or less all crypto credit providers. Keep in mind that during the zero interest rate policy regime, the name of the game for growth companies was to focus on growth at all costs. Crypto lenders battled for venture funding by propping themselves up as the biggest loan facilitators in the crypto space, expanding their loan books. Forgetting principles such as caution, due diligence, risk management, and sound growth along the way.Preview
Contagion will settle in early 2023.
The final blow: FTX
Sam was a scam. A period of calmness ensued after the summer contagion havoc. BTC traded at low volatility, Ethereum finally merged, and promising inflation figures prompted investors to grow slightly more optimistic. Then, in early November, Coindesk published the most important crypto news article of 2022, illustrating a huge concentration of FTT in Alameda’s balance sheet. A bank run on FTX ensued, and suddenly withdrawals were halted. It came to light that FTX was indeed insolvent, defrauding customers by co-mingling customer deposits while attending Capital Hill meetings contributing to laying the groundwork for crypto regulation and attracting institutional capital en masse. FTX’s balance sheet whole is estimated to $8-10bn. Genesis, Galois, Galaxy Digital, GSR, FalconX, Wintermute, CoinShares, Coinbase, Crypto.com, and several other crypto institutions were impacted. Genesis Lending quickly suspended withdrawals and sought an emergency loan due to illiquid assets in Genesis’ balance sheet. Gemini’s Earn program was halted, and the market geared towards more Chapter 11s to follow. BlockFi filed for a Chapter 11 bankruptcy after FTX’s collapse and became the third crypto lender to be guided by Kirkland & Ellis in the Chapter 11 proceedings this year, alongside Celsius and Voyager. Per now, Kirkland & Ellis have netted more than $15m on the chapter 11 frenzy in crypto. Legal proceedings directed towards the FTX fraudsters have begun and are likely to end with well-deserved jail time for those involved. Nevertheless, no amount of jail time will reimburse the real losers in this chaotic and sad year for crypto – the 8 million honest market participants at FTX who trusted the company or the 300 million crypto owners who have suffered extended losses due to a complete negligence of risk-management by trusted crypto institutions. The industry can do better, and hopefully, we have learned.2023 predictions: FTX fallout implications- Negative regulatory implications on the market, exchange tokens to be labelled as securities.
- A further dampening of institutional presence in the market.
- Contagion to last longer.
- A new un-eventful low volatility trading range will ensue, and it will define most of 2023.
- Correlations between crypto and other risk assets will subdue as general interest in crypto dwindles.
- The SEC to reassess its stance towards BTC ETFs, leading towards spot ETFs being approved to safeguard investors from dabbling in offshore markets and maintain investments onshore.
The FTX bankruptcy case will not be anywhere near settled by the year end, and will be a long-lasting scar, similar to the still on-going Mt. Gox bankruptcy proceedings.
Crypto Credit Market Outlook
While 2022 has seen a multitude of crypto lender bankruptcies, some entities maintain their operations. At face value, the main task of a bank is to provide maturity and liquidity transformation services – to provide users with a homogenous and liquid IOU (money) in exchange for claims on diverse and non-liquid assets. The liquidity contributes to narrowing spreads, increasing market efficiencies, and financing growth. Such needs are also present in the crypto market, and centralized crypto lenders will serve a role, also in the future, despite all incidents of horrifying risk management witnessed this year.Preview
Some crypto lenders will weather the storm and service the market, but yields will be slim, and times will be dire throughout the year. Retail investors should shy yield-bearing crypto products.