What's Wrong With Coins? Explaining the Crypto Crisis

What's Wrong With Coins? Explaining the Crypto Crisis ...

Since November's astonishing rise, the cryptocurrency market has dropped $2 trillion in worth.

According to CoinGecko, bitcoin reached a new high of $69,044.77 during cryptocurrency mania, while ether, the second digital currency by market value, reached a new high of $4,878.26.

Bitcoin has lost 71 percent of its value in only eight months, while ether has dropped 77 percent. Other alt-coins have dropped 60% to 90%.

Investors avoid cryptocurrency because they avoid danger. That's because they fear a recession as interest rates have risen in the fight against inflation.

Despite its internal difficulties, the crypto industry also suffers from internal difficulties. For the first time, the sector is experiencing a liquidity crisis, both affecting small businesses and established companies.

What's Going on Right Now?

Imagine that you want to buy a house. You go to a bank and apply for a loan. The bank asks you to provide collateral for the loan. You buy an apartment you own in a city with high real estate prices.

The second bank has no way to verify whether you have already got a second mortgage on the property.

After going to a third bank, you repeat the same thing -- then a fourth, and possibly a sixth. You end up with five different mortgages, based on the same collateral.

The price of your property in the city where your house is located has dropped dramatically a few months later, indicating that the value of your collateral has decreased. However, the balances on your various loans remain the same. So you can't make your monthly payments until they come due, and you default.

In the meantime, worries of recession are causing customers of banks that have loaned you money to claim their deposits from the banks.

The banks liquidate your property, which has since been defaulted. Five banks are battling over the collateral, and your house has lost a lot of value as real estate prices have declined. And the banks are finding themselves without funds to fulfill customers' withdrawal requests.

Now, let's translate this to the cryptocurrency industry. Change the borrower to three-tier hedge fund Three Arrows Capital or 3AC. Change the banks to Voyager Digital, Babel Finance, BlockFi, and Celsius Network, which are top-tier crypto lenders.

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The crypto sector is unregulated, and does not have a federal liquidity backstop, unlike the traditional banking industry.

So is the present situation.

More pain is on the way.

3AC is a Singapore-based hedge fund that made more than $200 million in exposure to the Luna coin in May, valuing at least $55 billion. As a result, 3AC missed margin calls, meaning it couldn't come up with what it owed to its lenders.

"Three Arrows Capital: you can think of it as an alternative to Archegos Capital moment because you have a huge entity that borrowed from a lot of people who were unaware that everybody else was lending to it," says Stan Miroshnik, partner and co-founder of 10T Fund, a private equity firm that invests in digital assets.

"That has resulted in a bit of illiquidity because a lot of people had their collateral or tokens hypothecated to 3AC or effectively stuck there."

"And that's what's causing a cascade through the industry: one group is unable to retrieve their cryptocurrency assets, whether it's bitcoin, ethereum, or other, resulting in being unable to repay, its own liabilities," according to a research conducted by the other.

Miroshnik adds:

"So you have these as a sort of a daisy chain of rehypothecation, where one institution led to another and that institution led to 3AC." "And those coins are not coming back down the chain until they come out of whatever restructuring process you're dealing with, and so you have illiquidity among all these people."

Voyager Digital has just filed under the bankruptcy laws, Celsius is considering its options, and BlockFi has just been bailed out by cryptocurrency exchange FTX.com. Many other lenders have suspended withdrawals.

"There's a good possibility that more cockroaches will be out," says Mike Boroughs, the head portfolio manager for the Fortis Digital Asset Fund.

"It's difficult to know exactly which ones will potentially explode." But often, it's the ones that aren't doing a great job of risk management or that don't have a great system for managing the assets they do have.

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