Read Part 1, Part 2 and Part 3 if you haven’t already.
The ignominious crash and debacle of Terra/Luna is having a wild cascading effect that is reverberating throughout the crypto markets and I doubt that it is over yet. The ripple impacts of the interconnections are huge and the domino effects won’t be over until the last of the weakest links fall. The pattern and the syntaxes may be different but the foundational principle is the same.
In 2008, the main cause of the crash was over-leverage. The financial innovations that has taken place in the last 30 years or so has given tremendous opportunities for market participants to amplify leverage to various degrees. It is all good as long as the going is good but when there is a breakdown or friction of some significance, everyone is affected.
I can say this from my own institutional trading experience. Back in 1998, on Oct 7 and Oct 8, I was making an insane amount of money by being long dollars on the yen (long USD/JPY) as an institutional trader. There was no real reason for me to close my position or take profits. It also happened that for those two days, (well now, that is a reason, isn’t it?) I was on leave and the whole world came crashing down on me. Dollar/Yen or USD/JPY came down 25% (the price of yen had never moved that many handles before or after in such a short period) in two days because an obscure hedge fund advised by two Nobel Prize Laureates and a nutty and no less egomaniac trader went out of business. Until then I hadn’t even heard the name of LTCM. For years I never recovered from that loss. The scars that it left on me emotionally was staggering but eventually it made me stronger and more resilient. I will share my learnings from those mistakes at a later time.
For example, if you have $100 mln, you can basically do whatever you want. You could use that $100 mln to get $1 bln in loans and use those loans to buy up $10 bln in assets by only putting down a down payment on whatever asset you want to buy. This is all good if and when things are going well and you will make tons of money on your investments, but if matters turn south, it only takes a minor downturn to completely wipe you out. Leverage kills and one should be always cognizant of your individual risk tolerance and the asymmetric opportunity that is ahead of you.
Gary Gensler the SEC Chairman said crypto is the Wild West and in a way it is true. Crypto has not been tamed as yet but it has not been shut down as securities. Different states in the US are taking adhoc decisions to protect retail investors from being too exposed or scammed by bringing regulations for pre-sales, NFTs, investment contracts, interest bearing accounts. This is all part of the evolutionary process but crypto regulations are on the agenda at the G-20 meeting in October this year as a major discussion point. It surely will build on the discussion points from the G7 meetings.
Regulations are a must and without that institutional adoption will not take off. Once that happens and the over-leveraged companies and weak projects are out of the way, it should be a real takeoff for the utility projects with value. Value in crypto cannot be determined in the same way as what you would do in equity markets through dividend discount models or anything else. Value in cryptos is largely determined by the network effects, productivity gains, inflation control, and disruptions the technology will bring to improve existing situations.
Since crypto is generally pseudononymous, hard to track, and unregulated many companies have repeated similar mistakes that led to the collapse during the GFC.
Let me state some turn of events that has happened lately. Three Arrows Capital, a $2 bln hedge fund was centered entirely on cryptos. Of the $2 bln was a loan of $670 mln from Voyager they recently defaulted on. They also had loans from Genesis, Celsius, BlockFi, Babel, and Deribit. We can safely conclude at a minimum 50% of the money that they were trading was a loan. It is likely that it was even a lot more because these firms confirmed that they have been margin called and liquidated 3 Arrows Capital at various stages. But the fall started with the Luna collapse which caused $200 mln in losses for 3AC overnight. This caused Voyager, Celsius, BlockFi, Babel, and many others to collapse in a few weeks. There have been freezes of trading, withdrawals, and other services due to this for many other platforms and several are slowly moving towards, or are in bankruptcy. Can you see where I am going with this? As I stated before, when regulations are in place almost 90% of the existing 20,000 cryptos would disappear - since most of them will not be able to meet the exacting standards.
BlockFi was a $5 bln company last year but was bought up by Sam Bankman-Fried of FTX for $240 mln. Some of the opportunities that exist now in this space are akin to a hyena sensing a wounded deer’s blood in the Serengeti grasslands.
Are we close to a bottom yet? We could be but the market is sensing blood with the way Tether is trading. It is a stablecoin valued at almost $65 bln. While they are bleeding assets, the USDC stablecoin assets are rising. So there is a mass migration taking place. The recent interview given by Tether’s CTO to a TV channel doesn’t inspire any confidence in the Tether holders. A collapse of Tether can happen at any time giving investors a great opportunity to scoop up and buy into some great projects at throwaway prices. For all you know, Tether may survive and come out clean on their collateral whereabouts and status boosting their investor confidence.
Continue to Part 5
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.