20 November 2022
Principal Founder, Dalma Capital Management Limited
The Bitcoin Miami conference in April 2022 was a celebration of the triumph of cryptocurrency.
Bitcoin miners were spending over $1 million a table at the high-end nightclubs for which Miami is famed. When the fine Champagne had been drained and the conference ended, the crypto miners, traders, investors and leverage providers were still drunk on liquidity and expecting to ride crypto mania into a long, easy, prosperous future.
Instead, they did not realize that the tide that had raised all boats was already going out. So much of the exuberance and leverage upon which the crypto market depended was unsustainable. The party was ending, in a hurry, and a painful bear market loomed ahead.
It has arrived: Bitcoin trades more than 75 percent off its zenith, with dire news still coming.
How could a market that flew so high, and rewarded so many, fall so precipitously — within a mere seven months?
As digital assets designed to secure transactions cryptographically, Bitcoin (BTC) exists to record transactions of payment between two parties using the Bitcoin blockchain. Launched in 2010, Bitcoin has experienced seemingly endless bouts of speculation, with big price swings.
The large price gains that created so much media hysteria — and investor value — have been accompanied by pronounced levels of volatility: over the past five years, more than five times the S&P 500, seven times the volatility of gold, and 15.5 times that of the U.S. Dollar.
Investing in Bitcoin has never been for the inexperienced or faint of heart.
Fueled by increasingly large amounts of leverage provided by lenders, Bitcoin reached an all-time high of $68,789 on November 10, 2021. This came a few weeks after the first sign of bitcoin’s downfall, when there was blood on the street at a number of global macro funds.
With inflation roaring, a sudden flattening of the yield curve portended that the U.S. Federal Reserve would be forced to hike rates more aggressively, and sooner than the markets expected. Crypto markets continued to appear unphased, but cracks began to emerge. Prices started to correct as the huge leverage in the system peaked out and began to slowly unwind
Rapid deleveraging came a few months later, starting with the riskiest and most unsustainable leverage in the system — the Luna/Anchor/Terra ecosystem. Its sudden failure created a credit death spiral.
Deleveraging further accelerated with the break of the UST peg. The collapses of Celsius Network, BlockFi, Three Arrows Capital and Voyager Digital quickly followed.
Endeavoring to stop the bleeding, FTX Crypto Exchange and its sister firm, Alameda Research, stepped in, offering credit and cash to struggling platforms. These moves succeeded in slowing the deleveraging and allowed Bitcoin prices to stabilize around $18,500 to $21,000 for a few months.
Then came the bad news: Alameda was financing these rescue efforts with undeclared loans from FTX. Public exposure caused a run on FTX that proved ruinous. Under the weight of its multiple failures, FTX now threatens to bring down one of the most solid lenders in the crypto industry, Genesis Global Capital — marking the beginning of the end of the deleveraging cycle.
Among the mixed bag of crypto market participants, Genesis stands out as a highly credible, sophisticated institution. They made some bad loans and had exposure to bad credit — underwriting Three Arrows was particularly poor — but Genesis is a solid business overall. With a high-quality book, they have a good chance of being restructured, recapitalized and surviving.
There will be more shakeouts ahead for the crypto market, but Genesis will likely drive the last major leg down. The last of the unsustainable leverage in the system hopefully soon will be wiped out.
In the short term, more pain can be expected. The aftermath of the downfalls of FTX and Genesis have yet to be felt in full, but this should be the beginning of the end of the deleveraging cycle of what became an unsustainable, debt-infused bubble. Bitcoin will find a bottom, and may already be below its fair value.
Then, on sustainable footing, without the unsustainable leverage, crypto and the ecosystem around it will rebuild — better.
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