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Crypto Weekly: Swimming naked in an ocean of speculation

Mads Eberhardt

Cryptocurrency Analyst

Summary:  Warren Buffett once said: “Only when the tide goes out do you discover who's been swimming naked.” It now seems that many are swimming naked in the crypto market following the tide, as a large lender has halted withdrawals, citing liquidity concerns, while a substantial crypto hedge fund is likely underwater, due to leveraged longs.


The crypto market tumbles

Fear of contagion has spread throughout the crypto market the past week upon concerns that several crypto lenders and a hedge fund are insolvent. The fear culminated this weekend, as Bitcoin tumbled to as low as 17,500 (BTCUSD) and Ethereum to 880 (ETHUSD). These levels were last touched in December 2020. At present, Bitcoin trades at 20,400 and Ethereum at 1,120.

Centralized crypto-lender Celsius halts withdrawals

The centralized crypto-lender Celsius halted withdrawals 8 days ago, citing liquidity concerns due to clients withdrawing funds amid concerns over insolvency. Celsius has been popular among retail investors since launching 4 years ago for paying lucrative interest rates on crypto of often over 10% yearly. At one point, Celsius had over $10bn in assets under management. The interest rate is earned by allegedly lending the crypto to institutional investors and through decentralized finance protocols. However, to offer such interest rates in a low-interest rate environment, Celsius has to take on severe risk. For instance, Celsius is publicly known to have lost well over $100mn in exploits of decentralized protocols in the past year. Not to mention that Celsius can also have lost a great amount in loans issued to its institutional clients without the public’s knowledge.

Observed due to on-chain analysis, Celsius still owns a substantial amount of crypto, but whether these holdings are sufficient to at least cover its liabilities is not certain yet. If Celsius is insolvent, it will be a harsh hit to the industry, particularly in terms of the trust of retail investors in the industry alongside a potential contagion across the industry. BlockFi, a similar company, is rumored to soon halt withdrawals as well. Speaking of BlockFi, the company is reportedly desperately trying to raise money to a valuation shy of $1bn after raising money to a valuation of $5bn last year, emphasizing the troublesome conditions of crypto. The cases of Celsius and potentially BlockFi stress the urgency for a proper regulatory framework to mitigate the risk of not fully transparent services that operate in the shadows between traditional finance and crypto.

Crypto hedge fund Three Arrows Capital is likely underwater

The large crypto hedge fund Three Arrows Capital is seemingly underwater, due to hefty losses on leveraged long positions. As late as April, Three Arrows Capital had over $3bn in assets under management and has for years been one of the most influential trading firms. The company has seemingly bet heavily on what one of the founders Zhu Su has called a crypto supercycle, in which prices would continue to surge. In late May, Zhu Su went to Twitter to write: “Supercycle price thesis was regrettably wrong, but crypto will still thrive and change the world every day.” It seems that the company has been so confident in this thesis that they have leveraged their long positions for instance by borrowing through BlockFi. The latter reportedly liquidated Three Arrows Capital as they failed to deposit more collateral. It seems reasonable to consider that Three Arrows Capital is insolvent. According to the founders, they are looking at different options to save the firm.

Alongside the cases of Celsius and BlockFi, this highlights the speculative nature of the crypto market. When one of the largest crypto hedge funds can be underwater due to leverage, participants in the market must be aware of the total leverage in the market and how it is affected during times when this credit suddenly vanishes upon a potential contagion. The latter has the power to take many crypto lenders to their knees, effectively fueling the contagion further.

Bitcoin/USD - Source: Saxo Group
Ethereum/USD - Source: Saxo Group
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