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Weekly Update: The Crypto Paradox

Weekly Update: The Crypto Paradox

When there is no hope

US futures fall amid concerns about the health of the broader economy and the possibility that the FED will not pause rate hikes anytime soon as stated by San Francisco FED president, Mary Daly on CNBC. Recent CPI reports have come in lower than expected but still remain above the FED's target. However, markets are still pricing an interest hike of 50bp vs 75bp on the last 4 hikes and see the peak rate within the 4.5%-5% range. On the European markets, expectations are the same as inflation remains above 10% (Les Echos | Forbes).

Black Friday

Grayscale Bitcoin Trust, or GBTC, has been trading at a record high 42% discount to the underlying value of the Bitcoin it holds. But is it a real bargain? GBTC is the largest bitcoin investment vehicle which makes them unable to quickly adapt to changing supply and demand as unlike an ETF, money cannot easily flow in and out. When it started and was the only player in town, market demand was much higher than the supply and the shares were trading at a premium to the underlying Bitcoin it held. However, other Bitcoin ETFs have appeared and supply outweighs demand, driving the price of the shares below the underlying net asset value. Grayscale has been applying to become a spot Bitcoin ETF for a few years already but their application has been denied every single time by the FED, who argued there is manipulation and fraud in the Bitcoin market. Grayscale is suing the FED but the FTX situation is unlikely to play in its favor. Given the discount, is it "free money" as some Reddit messages mentioned? Clearly not according to Bobby Blue, senior research analyst at Morningstar Research as the gap could widen, and if you had directly invested in Bitcoin between Dec 2020 and Oct 2021, you would have picked up a much higher return (+160%) than investing in GBTC (+64%) (Axios).

FTX contagion & update

After BlockFi, Genesis Global Trading's crypto lending unit is the latest to suspend its services following the implosion of FTX. Last week Genesis announced that its derivatives unit had $175m in locked funds in its FTX account which allowed DCG to strengthen Genesis' balance sheet with an equity infusion of $140m. Why does it matter? First, it could lead to another wave of fear since the collateral of existing customers cannot be withdrawn. And second, many companies rely on credit lines from Genesis to meet their obligations. It is worth mentioning that Genesis was already facing some difficulties with third-quarter loan origination heavily down at $8.4bn compared to $35.7bn the previous year. (Axios | Coindesk).

The Australian Securities & Investments Commission (ASIC) announced on Tuesday that it had suspended the financial services license of FTX Australia. The latter was not included in the Chapter 11 filing like FTX Express Pay Ltd, Ledger X LLC, and FTX Digital Markets Ltd. FTX Australia's license will be suspended until May 2023 but it can continue to provide limited financial services related to the termination of existing derivatives with clients until December 19, 2022. (Decrypt).

FTX Digital Markets, the Bahamas arm of the crypto exchange, has filed for chapter 15 bankruptcy proceeding in the Southern District of New York (Coindesk).

The Crypto Paradox

At the heart of cryptocurrencies is the idea that it is possible to reach a stable monetary system without intermediaries like central banks. But the latest developments in the cryptoverse and the liquidity crisis that FTX faced, could push one to argue that a central bank might be needed. However, as pointed out by Matt Levine, there are some major differences in the "standard" bank-run story compared to FTX, mainly surrounding the quality of assets on the balance sheet. In a nutshell, in TradFi, Central Banks will agree to lend to a firm a certain amount of money in exchange for a penalty interest rate provided that the bank holds long-term "good" assets e.g. mortgages, in order to prevent a liquidity crisis. In the case of crypto, the story is a bit different: firms tend to hold "magic beans" which are assets (such as native tokens) that do not have any cash flows, are highly correlated to confidence in cryptos, and are created out of thin air. In such a case, no one will be willing to lend to such a company, not even a central bank. However, Binance decided to form an industry recovery fund that will help projects facing a liquidity crisis but are otherwise strong. In the long run, this fund could act as a pseudo-central bank of sorts. But then, the entire ethos of decentralization on which cryptocurrencies were originally built becomes somewhat jeopardized (Bloomberg).

Bankrupt and robbed

Last Friday, $400m in digital assets were stolen from FTX, including $215m in ETH, $48m in DAI, and $44m in BNB. The fraud seems to have been committed by a high-level insider as they had access to the cold wallet storage. The hacker used various exchanges to convert the tokens. According to Arkham Intelligence, the "FTX exploiter is not very sophisticated [...] and hastily tried to do whatever they can with the funds seemingly without much of a plan". They also made an amateur mistake. They tried to transfer USDT on the Tron blockchain multiple times but failed since there was not enough TRX to cover the transaction fees. So they decided to send 500 TRX to the wallet to cover transaction fees using his Kraken-verified personal account. Kraken's Chief Security Officer, Nick Percoco, said on Twitter that they know the user's identity and that they are in contact with law enforcement. There might still be hope to recover the funds (Coindesk 1 | 2).

What's to come

Inflation data for Japan (today), Michigan consumer sentiment final (Nov) for the US (23-Nov), FOMC Minutes (23-Nov), Durable goods orders Mom Oct for US (23-Nov) and Ifo business climate for Germany (24-Nov).

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