Crypto 2022 Roundup

The time has come to shed some light on what the hell is going on. 𝗔 𝗹𝗼𝗼𝗸 𝗯𝗲𝗵𝗶𝗻𝗱 𝘁𝗵𝗲 𝘀𝗰𝗲𝗻𝗲𝘀 𝗼𝗳 𝘄𝗵𝗮𝘁 𝗿𝗲𝗮𝗹𝗹𝘆 𝗵𝗮𝗽𝗽𝗲𝗻𝗲𝗱 𝗶𝗻 𝗖𝗿𝘆𝗽𝘁𝗼 𝗶𝗻 𝟮𝟬𝟮𝟮. A few friends reached out and asked me what’s going on in crypto land so here we are. Grab a coffee, because this is going to be a long post, but in order to understand what’s going on now (and potentially where we are headed), we need to go back a couple of years…

Once upon a time there was an era with 0 interest rates, free money and Quantitative Easing. Basically, the perfect recipe to create hype around “risk on” assets: crypto and tech. Monkey jpegs were trading at hundreds of thousands of dollars and the money machine was broken.

It’s in this environment that the 3AC hedge fund managed to get up to $10b in Assets Under Management. 3AC was founded back in 2012 trading various asset classes. Since 2018, they pivoted their business model and pretty much went 100% into crypto - mainly $BTC and $ETH. They then started investing in crypto projects and new protocols, which did very well in the 2020/2021 bull run and allowed them to grow their capital exponentially.

It was all well and good for a few years until they came across Terra $LUNC… 3AC couldn’t let that one go and bought over 10m Luna coins for approximately $550m, all vested (which means that they can’t liquidate their investment until a certain date).

…and we all know what happened to Luna…

After the Luna collapse, AC3's $550m investment was worth around $650. When the Luna death spiral began, the Luna Foundation Guard (some sort of savior of last resort of the Luna ecosystem) started selling their reserves (in BTC and other crypto) and that only worsened 3AC’s balance sheet as it pushed the whole market down. 3AC were also engaged in GBTC arbitrage (Grayscale BTC trust, which trades at a premium or a discount) and in stETH (staked ETH that generates yield and that will be redeemable when the smart contract to do is finally developed… another topic).

As you can imagine, neither of these trades went in the right direction… Bad macro conditions and other factors caused panic. To be fair, stETH was never supposed to be pegged 1:1 to ETH (because it has more inherent risk and therefore it should trade at a discount), but that wasn’t enough to calm the investors. Institutional investors (amongst which a company called “Alameda”) started dumping their stETH trade via Curve (defi protocol) and that only made things worse because the ETH/stETH pair ran out of liquidity, therefore widening the gap between stETH and ETH.

I am getting a bit technical here, but long story short they lost quite a bit of money on that trade (on top of all of the other investments that went in the other direction). Enough was enough. Rumors started circulating. This stETH depeg is key, because it played a key role in the fall of Celsius too, the first (and largest) centralised finance player to enter Chapter 11 (bankruptcy, restructuring).

UPDATE: it has just come out that BlockFi, another large centralised finance player has also filed for chapter 11, primarily due to the FTX saga, which I will cover in a minute.

2) Rumors started circulating about Celsius being locked up in a bad trade (stETH) and that it was illiquid (potentially insolvent) and a proper “run on the bank” took place on Celsius. Long and behold Celsius announced that they halted withdrawals, eventually declaring bankruptcy. What happened there? They are currently undergoing chapter 11 so please take this with a grain of salt, but there are speculations that they invested their clients’ funds in Bitcoin mining operations, lost some funds on staking protocols due to hacks and did discretionary trading (which didn’t go well).

3AC and Celsius are now gone…. but hey… now we learned more about bad practice and poor risk management in this space, so why don’t we look at other centralised finance players and exchanges?

Bank-runs started happening on ce-fi again, leading Voyager (publicly listed on the Canadian stock exchange, also a lender to 3AC in the tone of $100m) and BlockFi into bankrupcy. Luckily for them, they were both salvaged by the “JPMorgan of crypto”, as defined by CNBC: FTX CEO Sam Bankman-Fried (SBF). The “JPMorgan of crypto” was a massive player in this industry with investments in various projects and a particularly interesting related company called “Alameda research”, which SBF co-founded himself.

Turns out that more than “research”, they were a liquidity provider and discretionary trading firm (they evolved into a hedge fund investing in new protocols and the likes). Alameda’s balance sheet was then leaked on Nov 2 by on an article published by CoinDesk and it showed that their assets mainly consisted of low liquidity altcoins and #FTT tokens (Of which some were locked aswell). The same FTT issued by FTX…

A balance sheet has 2 sides though, right…? assets and liabilities…. so what was in the liabilities’ bucket? Loans from various financial institutions, including their very own FTX. Loans backed by…. the FTT token (their assets). Not a red flag at all. It’s basically as if JPM extended a loan to someone who used JPM stock as collateral. If the price of FTT falls, they need to sell or get margin called… This didn’t go unnoticed. Let’s just say that there was a very interested party in all of this… his name is Changpeng Zhao (CZ), the CEO of Binance, the largest crypto exchange in the world.

CZ and SBF weren’t best friends. SBF mocked CZ in various occasions on twitter and he even alluded to the fact that he wasn’t welcome in DC to talk regulations. CZ wasted no time and picked up on the article and tweeted about progressively liquidating their FTT reserves. CZ explained that he would so over a period of various months to minimize market impact and that it wasn’t a move against their competition: “Binance always encourages collaboration between industry players. Regarding any speculation as to whether this is a move against a competitor, it is not. Our industry is in it’s nascency and every time a project publicly fails it hurts every user and every platform”. Oh boy. 😂

Because of the Alameda — FTX relationship, selling orders started piling up on FTT (I mean, why not when you have a massive player publicly announcing they will dump their holdings over the following months). Alameda’s CEO (prodigy 28yo Caroline Ellison) came to rescue and tweeted back to CZ offering to buy up all of their reserves for $22/coin (I am personally not sure what money they were planning on using since their balance sheet was leaked, but I might be missing something). The market smelt blood in the water and sold off FTT. FTX was taken under assault by their customers trying to withdraw their coins. This was the beginning of the end.

3) Faced with what appeared to be a liquidity crunch, SBF reached out to friends and investors for some liquidity to honor their customers’ withdrawals…. including… yes… their rival CZ. CZ knows that a potential collapse of a giant such as FTX would set the crypto world back a few years (as per his tweet above) so he decided to look into the deal and potentially acquire FTX. Now… you have to understand this… crypto is not traditional finance. Things don’t happen over emails and such. It’s all on Twitter. And this time was no different. The day after CZ tweeted that they pulled out of the deal and that they wouldn’t come to the rescue. The rest is history.

FTX International halted withdrawals, SBF tweeted that FTX US wasn’t impacted, but that wasn’t true and on November 11, both FTX International and US filed for bankruptcy. Another one to hit the dust… So… how did this happen? Now, as I said at the start, this is just my view but… It looks like Alameda was caught up on the other side of large trades and when their lenders started to clawback the funding, they didn’t have the liquidity to pay them back. In order to avoid immediate bankruptcy, they apparently reached out to their bff FTX and got the funding required… where was this money coming from?

FTX was already investing aggressively in ventures and marketing… Well, it seems that FTX sent them the very own customers’ funds. This is shocking if true. Probably a breach of T&Cs but I am no lawyer (and no financial advisor). To top it all, a few days ago FTX issued a statement telling all their customers to avoid opening the app or downloading any updates because they were hacked and some of their customers’ funds were drained out of their accounts.

Ok, quite a long one today…. Is this all over? I have to be honest…. In my PERSONAL opinion…. No, it’s not over. We can’t deny that there’s a huge risk of contagion. 2022 was a pretty sad year for crypto which emphasized the need for regulations and risk management. The only silver lining I can think of is that most of the bad actors will need to leave this space and that regulations will come, just like what happened after the 2008 crisis. It will take time to go back to the splendors of 2020. My investment thesis hasn’t changed, I am still bullish over the long time on SELECT cryptocurrencies.

Thank you very much for reading and have a good week :)

Sources used:

CNBC

Coindesk

yahoo finance

the financial times

Coinmarketcap

coin telegraph