Cryptocurrency is heading uncharted territory.
The sector has been hammered recently by a slew of damaging developments, including the bankruptcies of some major players.
"The crypto market is undergoing a profound de-leveraging process right now," said Winston Ma, managing partner of CloudTree Ventures, and author of "The Hunt for Unicorns, China’s Mobile Economy and Investing in China."
Bitcoin was up 1% to $22,318 at last check, according to CoinGecko, with ether up nearly as much to $1,489, while dogecoin was up slightly to $0.067443.
'A Downward Spiral'
Ma cited the case of Three Arrows Capital (3AC), a hedge fund managing about $10 billion in assets a recently as March that filed for bankruptcy, as "a prominent case study."
"3AC had creditors from across the sector, it used all of that leverage to make extremely risky bets on other crypto projects, and crucially, many of 3AC's lenders were themselves lending out cash invested in their platforms by individual investors looking to earn high DeFi returns of up to 20%," Ma said.
He added that the liquidity and credit issues continue to ripple through more overextended crypto firms, noting that crypto lenders Celsius and Voyager have also filed for bankruptcy.
"The fall of integral crypto players like those has triggered a downward spiral that's taken other crypto investors and companies down with it," he said.
"The U.S. bankruptcy courts have never dealt with an insolvency proceeding of a crypto company on the scale of multiple billions," Ma said. "The uncharted nature of the proceedings means some US crypto regulation may emerge from the U.S. court system first, while the US Congress and federal financial regulators are still mulling over a regulatory framework for the cryptocurrency market."
David Lesperance, managing partner of immigration and tax adviser at Lesperance & Associates, had a similar viewpoint.
'Regulation is Coming'
"The U.S. bankruptcy courts have never dealt with an insolvency proceeding of a crypto company on the scale of Voyager Digital or Celsius," he sad. "Both companies, which operate lending businesses, are entering Chapter 11 bankruptcy with billions in both assets and liabilities. The realities for customers is just starting to sink in."
Unlike with broker-dealers or banks, Lesperance said, these crypto firms have no established rules and insurance for customer funds if they declare bankruptcy.
"Bankruptcies take years to be finalized as they work through the major question of the priority of the creditors. In short who gets paid back, how much and in what order," he said. "Customers will probably be considered unsecured creditors. This means that a bankruptcy court would pool customers' funds as part of the bankruptcy estate, whereas customer accounts have to be kept separate in a stockbroker bankruptcy."
Lesperance pointed to the case of the lending platform Cred which classified its customers as unsecured creditors in its November 2020 bankruptcy filing.
"Regulation is coming," he said. "But it likely won’t arrive soon enough to provide relief in the Voyager or Celsius cases."
The Dollar Index
Frank Corva, senior analyst for digital assets at Finder, said "many eyes remain focused on the strength of the U.S. Dollar Currency Index (DXY), which measures the US dollar’s strength against a basket of six major currencies."
"The DXY is stronger than it’s been in almost 20 years, which is a major reason why not only crypto, but other risk-on assets are still feeling the pain," he said. "These assets are down in part because the US dollar is up. Also, the relative strength of the US dollar is currently wreaking havoc on emerging markets."
Corva said most emerging markets have their debt denominated in US dollars, and when the dollar gets stronger, these countries struggle to pay back their loans.
"When more money has to go to servicing debt in these markets, market participants in these jurisdictions have less disposable income to invest," he said. "And so emerging market stocks have also taken a major hit as of late. When the US dollar gets as strong as it currently is, some refer to it as 'the dollar wrecking ball.'”
'The Wrecking Ball'
What’s particularly troubling about the dollar being in a “wrecking ball” state right now is that the dollar is still losing purchasing power in the United States, as CPI inflation came in at 9.1% this week, he said.
"This leaves the Fed in an extremely tight position," he said. "Do they stop quantitative tightening as a means to curb the pain that they are causing across many different markets? Or do they continue to tighten and do everything in their power to break the back of consumer good inflation in the United States?"
If they continue to tighten, Corva said, we may see BTC drop into the $10,000 to $14,000 range.
"If they stop tightening or maybe resume easing, the crypto market, as well as other markets, may be headed back in the direction of the moon," he said. "It still seems early for the Fed to stop tightening, but, as we are in unprecedented times, no one is quite sure what will happen next.
