Special Market Summary - June 2022

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CRYPTO MARKET PLUNGE: Who, How And What May Be Yet To Come

The month of June has been an eventful one thus far where markets are concerned, in light of global inflation and monetary policy decisions. Bitcoin is no stranger to this volatility, with its price falling by -30.7% since the start of June (as at 21/06/22).

Some major players have also felt the effects of recent market downturns including the Terra-LUNA situation that occurred in May; Three Arrows Capital (3AC), one of the industry’s largest hedge funds is rumoured to be in financial distress, and Celsius, a large crypto lender has frozen withdrawals.

Since the beginning of 2022, markets have experienced marked volatility as they react to the reality of high inflation globally and the majority of central banks raising interest rates in response. In order to control inflation, the Fed has continued raising rates since January with current interest rates sitting at 1.75% in June.

Similarly, the RBA has also begun increasing interest rates from 0.1% with a 0.25% rate hike in May and a 0.5% hike in June. These higher interest rates are translating to higher costs of borrowing and reduced demand, and a greater aversion to risky asset classes like stocks and cryptocurrency.

The market cap of the entire cryptocurrency ecosystem is notably down to under less than USD $1T from USD $2.2T at the beginning of this year. Bitcoin, with the largest market share, is down 57% YTD as of 20 June 2022.

Celsius freezes transfers & withdrawals

Part of this major market action stemmed from developments surrounding crypto lender / project / pseudo-bank Celsius.

The company gained notoriety earlier this month as it paused all transfers and withdrawals without warning on June 12 due to “extreme market conditions” resulting from the price of Bitcoin and other cryptocurrencies plummeting. This is despite CEO Alex Mashinsky rebuffing criticism just days prior, stating “Mike [Dudas] do you know even one person who has a problem withdrawing from Celsius?”

Celsius began in 2017, and is a platform that gives its users the ability to deposit cryptocurrency, which it then loans to retail and institutional investors, promising to pay its users up to 10% yield each year.

Celsius is not a bank, and as such it is not regulated like one. However, much of what Celsius does is comparable to a bank. To make profit, Celsius was investing users’ lent funds into investments - decentralised finance (DeFi) protocols - in order to generate returns greater than the return given to their users. Celsius took on a tremendous amount of risk in order to provide these yields to investors, however, Celsius does not have an insurance policy and they cannot insure deployed assets which are out of their control.

As markets tumbled, the company was unable to meet the strong volume of redemptions, consequently blocking users from doing so. The company’s assets have been declining for some time now however, with Celsius’ assets under management of just under USD $12 billion as of May down from October where Mashinsky said that the company had more than $25 billion in assets.

What does this have to do with ‘stETH’?

One major development in the market linked to Celsius’ liquidity is the de-pegging of Lido staked ether (‘stETH’) to ether.

‘stETH’ is a staked version of ether whereby every ether you deposit into Lido’s smart contract, you receive one ‘stETH’. The underlying ETH is effectively put into a locked vault until Ethereum undergoes ‘The Merge’ - a shift in protocol from a ‘proof-of-work’ to a ‘proof-of-stake’ blockchain, predicted to occur in late 2022 or early 2023. Investors are unable to withdraw any ETH until this event occurs.

While intended to be 1:1 in value with ETH (effectively a claim to redeem 1 ETH for 1 ‘stETH), ‘stETH’ has been trading below parity over the past few weeks due to heavy continued sell-offs of the token, feeding further into a “DeFi contagion” due to the interwoven nature of many major industry players and projects.

This caused major problems for Celsius, as Celsius’ users looked to withdraw ETH they had given to the lender. Celsius had reportedly taken a large amount of its users’ ETH deposits and staked them on Lido to gain yield on their holdings.

These deposits amount to liabilities of approximately 1million ETH, but only 26% of the company’s deposits of ETH are estimated to be liquid.

Celsius began to sell their large investment in ‘stETH’ to meet its obligations, with the sell off leading to ‘stETH’ falling in value against ETH. Delays in the transition from Ethereum to Ethereum 2.0 are expected to further threaten liquidity, particularly for Celsius who has much of its ETH staked and inaccessible until then.

Crypto Hedge Fund Potentially Completes Trifecta of Collapses

Also in the spotlight is hedge fund Three Arrows Capital (3AC) who are rumoured to be in financial distress after a number of major headline-worthy losses including Terra’s LUNA token ‘death spiral’ and a $1.2b position in the Grayscale Bitcoin Fund (GBTC) potentially acquired via leverage and a split purchase between it’s Singaporean and British Virgin Islands branches.

“Three Arrows Capital, one of the largest crypto hedge funds, was reportedly liquidating its positions after witnessing huge losses on its investments.”

An analysis by Messari.io of 27 assets that 3AC had invested in suggests the crypto hedge fund would have lost 60% of its investment for the year to date. The assets included lead cryptos such as Bitcoin (BTC), Ethereum (ETH), and Avalanche (AVAX).

According to the Twitter account for The Defi Edge, 3AC had also spent $559.6m buying locked LUNA before the cryptocurrency’s collapse last month. “It's now worth roughly ~$670,” added The Defi Edge.

Danny Yuan, head of trading at crypto trading firm and liquidity provider 8BlockCapital, suggested Three Arrows Capital was “leveraged long everywhere”.

“What we learned is that they [3AC] were leveraged long everywhere and were getting margin-called,” tweeted Yuan.

“Instead of answering the margin calls, they ghosted everyone. The platforms had no choice, but to liquidate their positions, causing the markets to further dump.”

Another thread tying events together relates to 3AC’s major holdings of ‘stETH’. The firm was one of the largest holders of the staked currency. In weeks leading up to Celsius’ withdrawal freeze and subsequent market plummet 3AC began offloading their stETH, putting pressure on the targeted 1:1 peg, in turn putting pressure on holders such as Celsius.

Fallout of a 3AC liquidation may also extend beyond individual crypto projects and directly backed ventures. As mentioned above, the firm holds a major holding of GBTC, being the largest single holder with over 38 million GBTC on its books.

Where To Now And Potential Long-Tail Contagion

While markets have paused at or near recent price lows caused by recent events, it may be worth considering that the full scope of contagion may not be fully revealed.

Spaces to watch include:

1. BlockFi

Another crypto lending platform, BlockFi, has also come into the spotlight following Celsius’ developments - notably in the form of a $250 million USD revolving credit facility from digital currency exchange FTX. BlockFi recently laid of approximately 20% of it’s staff.

Another company helmed by FTX CEO Sam Bankman-Fried, Alameda Research, recently bailed out crypto broker Voyager Capital to the tune of nearly $500m USD. Alameda Research has been theorised to be a driving seller of stETH, contributing to both stETH falling off peg and Celsius halting withdrawals. Another lending platform to watch that is similar to both BlockFi and Celsius is Nexo.

2. USDD & TRON

The recently launched algorithmic US dollar stablecoin of the TRON crypto project, USDD represents one element to watch in light of the Terra LUNA collapse. Some market watchers have raised concerns regarding true rates of USDD ‘overcollateralisation’. This ‘overcollateralisation’, claimed by USDD to be in excess of 300%, is in effect an extended backing designed to ensure that every USDD token has excess reserves to guarantee a 1:1 conversion rate with the US dollar. On the 13th of June USDD dropped off peg and continues to remain below 1:1 parity.

In addition, it should be noted that the effects of recent weeks may leak across to a whole suite of other entities with indirect exposure.

The above examples show that poor strategies and risk processes typically get found out during bear markets and this is no different for the crypto-asset industry.

Disclaimer: The content, presentations and discussion topics covered in this material are intended for licensed financial advisers and institutional clients only and are not intended for use by retail clients. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented. Except for any liability which cannot be excluded, Monochrome, its directors, officers, employees and agents disclaim all liability for any error or inaccuracy in this material or any loss or damage suffered by any person as a consequence of relying upon it. Monochrome advises that the views expressed in this material are not necessarily those of Monochrome or of any organisation Monochrome is associated with. Monochrome does not purport to provide legal or other expert advice in this material and if any such advice is required, you should obtain the services of a suitably qualified professional.

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