This Week in Crypto: June 24 2022

I discus counterparty risk in the context of the breakdown in crypto markets

Read the video transcript

Happy Friday, everyone. It’s Friday, June 24th, and it’s time for another this week in Crypto. I’m your host, Dave Weisberger, the CEO of Coin Routes. And it’s been basically a bit of a relief, kind of take a breather sort of week in the crypto markets as equity markets and other risk assets have rallied a little bit more strongly. We’re in what many people consider the eye of the storm.

We’ll see if that is true. But what we’re witnessing in the crypto markets is a continuation of the trend we talked about last week, which really is deleveraging. When we talk about leverage in crypto this week, we’ve had a few stories that all center upon the notion of counterparty risk. And what I mean by counterparty risk is something that in the crypto community, people say not your coins, not your keys, not your coins. If they belong to someone else’s platform, you don’t own them, you have no access to them, and they may as well be gone. Well, that’s not true. And then there are others who say, hey, it doesn’t really matter. Whoever I trade with, it’s all going to be fine. Kumbaya, let’s not worry. And that’s clearly wrong. So what do I mean by counterparty risk?

I mean by make sure that when you trade with somebody or have your positions with somebody, that there is enough capital or your coins are ring fenced to the extent that no matter what this company does, you won’t lose access to it. And this sounds easy in theory, but it’s not been actually looked at. So there are a couple of examples here that have come out this week. One of them, probably the most excessive extreme, was Voyager, who is a public company listed on the Canadian exchange. And they watched themselves drop, I think, at one point by 70% because they had to admit exposure, significant exposure to 3 arrows capital.

Now, Voyager has since received a revolving line of credit from FTX, as has another lender. Blockfly received a line of credit from FTX. And there were reported stories of them trying to raise capital. And it turns out they got a revolving line of credit that was larger than what they’re looking to raise. So with luck, both of those positions will be resolved by lines of credit, and the situation is resolving themselves as the collateral to whatever degree it’s impaired, either becomes unimpaired or isn’t necessary anymore for running their businesses. But it begs the question of why is it that a company could have so much exposure to other companies risk? It’s one thing to be able to control your own risk in terms of understanding if Bitcoin moves down 15%, how will that impair my assets? It’s another to be able to understand if the market tanks, how much impairment will I take if somebody else, who I don’t have any really good transparency into their risk control, how they would impair my balance sheet now, that’s the business of companies in the financial markets called prime brokers. What they do is they provide leverage to other companies, and they do so by analyzing both the risks that that company is taking and their processes around it.

It looks like crypto is in for a serious reevaluation of how that counterparty risk is taken, and that if that’s the result of what’s happened recently, would be an incredibly strong, positive move for the maturation of the crypto market. But it is very different. It is very clear that this is happening. For example, there was just a podcast where the CEO of wintermute said that their credit lines have been shrunk and they are, by all accounts, creditworthy. I have seen nothing to indicate anything other than that.

But the reality is, if solid citizens who are reasonably capitalized are having issues with having loans called in, it tells you the entire system is compressing. And at some point, we will have the transparency to know whether there’s any more non-performing assets in the crypto ecosystem that could trigger forced sales. Because after all, that’s what we care about bitcoin. When it was dropping both of the last couple of weekends, the issue was people worried about forced sales that firms would have to do in order to either remain solvent or satisfy their obligations. That is the big issue in the market because, as we can see, the fundamentals along bitcoin are actually doing really, really well.

There’s a lot of evidence to indicate the hash rate, for example, is still well above levels than it was before the original China ban. Yet there’s evidence that says electricity use for the bitcoin network is actually down significantly. And we understand that miners, while they’ve been selling, of course, to raise cash to pay for their expenses, it has not cracked the price. The price of bitcoin is still maintaining the 20,000 level as press time, as we do this, it’s a little over 21,000. It’s not causing any serious issues, so arguably there’s no tremendous issue. And the long term bull case for bitcoin as a store of value in the future is still very much intact. Altcoins there’s lots of news and velocity around several, and I won’t get into all of them, but, you know, things like Solana, launching a phone, that sort of thing, that gets some excitement going, and we see a little bit of a rally in Solana. Yet at the end of the day, it’s still well below where it was in any sort of euphoric phase, and I wouldn’t expect euphoria in this market any time soon. In fact, when people ask me, I think that a lot of confidence has been lost, and I think it will take a while to re establish that confidence.

That said, the real question is, are we in the eye of a hurricane? i.e. Will risk markets sell off again like they did in many other years? I remember when the Internet bubble burst. Markets actually re rallied in August and before a final slide down in the fall that was the culmination of that particular fall. That is something that we have to worry about. Is it going to happen? I don’t know. I don’t know. My crystal ball, it’s in the shop. But what I can say is the most important thing in the crypto markets to understand is leverage the impact of it and the opacity thereof.

Do we understand what is going on? Once we have more transparency, we’ll have a much better picture of the situation and that will cut it off and let people go to their weekends. Hopefully we’ll have a relaxing one, but the last two weekends would attest. It’s certainly not a sure thing. Stay safe out there. And bye.

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