Cryptocurrency enters new territory.
The sector has been hit by a number of damaging developments recently, including the bankruptcy of some key players.
“The crypto market is going through a profound deleveraging process,” said Winston Ma, managing partner of CloudTree Ventures and author of “The Hunt for Unicorns, China’s Mobile Economy and Investing in China.”
Bitcoin is up 1% to $22,318 at last check, according to CoinGecko, with Ether up almost as much to $1,489, while Dogecoin is slightly up to $0.067443.
“A downward spiral”
Ma cited the case of Three Arrows Capital (3AC), a hedge fund that filed for bankruptcy in March, a hedge fund that managed about $10 billion in assets, as “a prominent case study.”
“3AC had lenders from across the sector, it used all that leverage to make extremely risky bets on other crypto projects, and crucially, many of 3AC’s lenders themselves lent money raised by individual investors looking for high DeFi yields wanted to achieve was invested in their platforms of up to 20%,” said Ma.
He added that liquidity and credit issues continue to plague overwhelmed crypto firms, noting that crypto lenders Celsius and Voyager have also filed for bankruptcy.
“The demise of integral crypto players like these has triggered a downward spiral that has dragged other crypto investors and companies down with it,” he said.
“The US bankruptcy courts have never dealt with a bankruptcy case of a multi-billion dollar crypto company,” Ma said. “The complexity of the process means that US crypto regulation may first emerge from the US court system while the US Congress and federal financial regulators are still contemplating a regulatory framework for the cryptocurrency market.”
David Lesperance, managing partner of immigration and tax advisor at Lesperance & Associates, took a similar view.
“regulation is coming”
“The US bankruptcy courts have never dealt with a bankruptcy case for a crypto company on the scale of Voyager Digital or Celsius,” he lamented. “Both lending companies are entering Chapter 11 bankruptcy with billions of dollars in assets and liabilities. The reality for customers is just beginning to be understood.”
Scroll to Next
Unlike broker-dealers or banks, Lesperance said these crypto firms do not have established rules and insurance for customer funds if they file for bankruptcy.
“Bankruptcies take years to complete while working through the big question of creditor priority. In short, who gets repaid how much and in what order,” he said. “Customers are likely to be viewed as unsecured creditors. This means that a bankruptcy court would consolidate client funds as part of the bankruptcy estate, while client accounts must be segregated in the event of a stockbroker bankruptcy.”
Lesperance cited the case of credit platform Cred, which classified its customers as unsecured creditors in its November 2020 bankruptcy filing.
“Regulation is coming,” he said. “But it probably won’t arrive soon enough to remedy the Voyager or Celsius cases.”
The Dollar Index
Frank Corva, Senior Digital Assets Analyst at Finder said, “Many eyes continue to focus on the strength of the US Dollar Currency Index (DXY), which measures the strength of the US Dollar against a basket of six major currencies.”
“DXY is stronger than it has been in almost 20 years, which is a key reason not only crypto but other risky assets are still feeling the pain,” he said. “These assets have declined in part because the US dollar has strengthened. Additionally, the relative strength of the US dollar is wreaking havoc on emerging markets at this time.”
Corva said most emerging market countries have debt denominated in US dollars, and when the dollar strengthens, these countries struggle to repay their loans.
“If these markets have more money to service debt, market participants in these countries will have less disposable income to invest,” he said. “And so emerging market stocks have also taken a big hit recently. If the US dollar gets as strong as it is now, some will call it a ‘dollar wrecking ball’.”
“The Wrecking Ball”
What’s particularly troubling about the dollar currently in a “wrecking ball” state is that the dollar is still losing purchasing power in the United States as CPI inflation came in at 9.1% this week, he said he.
“This puts the Fed in an extremely tight position,” he said. “Are they ending quantitative tightening to stem the pain they’re causing across many different markets? Or will they continue to tighten and do everything in their power to break the backbone of consumer inflation in the United States?”
If they continue to tighten, Corva said, we could see BTC drop into the $10,000-$14,000 range.
“If they stop tightening or maybe start easing again, the crypto market, as well as other markets, could go towards the moon again,” he said. “It seems early for the Fed to stop tightening but as we are in unprecedented times no one is quite sure what will happen next.