Did macro kill crypto or are risk-laden lenders to blame?

Did macro kill crypto or are risk-laden lenders to blame?

Crypto markets are right in the toilet. Bitcoin is trading around $22,000 - nearly 70% below its November all-time high. Ether has somehow fared even worse.

The collapsing lending platform Celsius is an easy scapegoat for the widespread carnage. Rumors of its bankruptcy come ahead of native Celsius token CEL losing 50% this month. The platform has since locked users out of their accounts while it disputes various leveraged DeFi positions.

Just a few weeks ago, markets were reeling from the implosion of the Terra ecosystem, which wiped out the ninth and tenth largest tokens by market capitalization and a representative value of around $40 billion.

But macroeconomic factors such as inflation, interest rate hikes and the war in Ukraine have sent the tech-heavy Nasdaq and the broader S&P 500 down 30% and 20%, respectively, this year as the U.S. flirts with recession. Commodities, meanwhile, are rising, with the benchmark S&P GSCI index up more than 40% since the start of the year.

It is clear that investors are moving away from “risky” assets like crypto and technology stocks towards more recession-resistant names.

This all presents a classic chicken-and-egg problem: Has Celsius caused the cryptocurrency to lose more than 25% of its total value in the past week, or are investors simply reducing risk across the board?

The big risk reduction

Anthony Scaramucci, managing partner of hedge fund SkyBridge Capital, told Blockworks he is not surprised by falling crypto prices. SkyBridge offers an institutional Bitcoin fund as well as other vehicles designed to provide limited partner crypto exposure.

“You have a low-risk market, an oil crisis that has arisen from the current war environment, and you have the scars of the pandemic,” Scaramucci said. “Also, we may not feel it as much in Europe and the United States, but they are going through ‘zero COVID’ lockdown strategies in China and that is having a huge impact on the supply chain.”

The precarious macro landscape – combined with too much money in traders' pockets as a result of US stimulus measures – has led to high inflation numbers, according to Scaramucci, which has caused a correlation across multiple asset classes, such as in technology stocks and Bitcoin.

“Bitcoin is rising faster than the market in a buoyant market,” he said. “In a suppressed, depressed market, things will go even further down.”

The rising inflation postulated by the financier is probably not systemic or secular, but rather arises directly from the ongoing crises mentioned above.

“In a year we could very well be out of the pandemic and inflation numbers could actually be trending downward,” Scaramucci added this week said CNBC SkyBridge had just bought more Bitcoin and Ether. "The future of the Internet will include these decentralized technologies - I'm incredibly long-term bullish. You just have to have the stomach for this level of volatility right now."

Macro factors exposed unsustainable digital assets

Jeff Dorman, chief investment officer at crypto investment firm Arca, said the subdued macro environment has prompted some participants to take on additional risks.

“I think macro is causing Celsius problems, rather than Celsius causing problems for the market,” Dorman said. "If Bob gives me a Bitcoin (BTC) and I pay him 2% interest on it and then loan it to Alice, who pays me 3% - that's easy. I have a one-to-one asset liability match. And I make 1% net interest margin on the spread," Dorman said.

But problems arise when Bob gives five BTC, but Alice only wants to borrow one. The lender still has to pay Bob 2% on his five BTC, but Alice only pays the lender 3% on one.

“Now I have to figure out how to make up for that loss,” Dorman said. "So what am I going to do? I'm going to do risky hedge fund shit to make up for that return and hope no one knows what I'm doing - because no one is paying attention because it's not regulated. This is where these companies get into trouble: they basically operate like unregistered hedge funds."

But Dorman rejected the current zeitgeist that demands investors lump all digital assets together to view them as one giant risk trade, with Bitcoin representing the least risk outside of stablecoins.

Believing that Bitcoin is king and everything else is an altcoin is an "archaic way of thinking about this market," he said, the equivalent of calling the S&P 500 the only ETF and everything else a lesser alternative ETF.

Crypto investors might ask: What will risk mitigation look like in the absence of a complete exit from digital asset markets?

Defensive digital assets

Of course there are stablecoins, some riskier than others. (SkyBridge's Scaramucci told Circles USD Coin and Tether have held up remarkably well during the recent chaos, with both firms processing billions of dollars worth of redemptions with no downtime.)

Scaramucci suggested investors stay away from leverage, saying: "Stay unlevered. Go long-term. What has caused the positive surprises and the negative surprises is the leverage in the system."

For Arca's Dorman, crypto's ongoing price correlation is more the result of an immature investor class than something inherent to digital assets.

“In theory, Bitcoin has nothing to do with Axie Infinity, which has nothing to do with BNB,” Dorman said. “But if a guy owns all three and they use those three as collateral to do something, they will be forced to sell all three at the same time.”

Crypto exchange tokens should be resilient to market downturns in a mature market (there is already some evidence), while native assets for blockchain-powered games should prove resilient even during a recession, Dorman said – as long as the tokens are structured in a sustainable spirit.

"In the world of digital assets, what are the areas where investors don't stop what they're doing just because of a bad market or because of a recession: Gamers don't stop playing because of a recession," he said. "If anything, they're actually starting to play more because they have more time and aren't working. Gaming should, in theory, be a defensive sector."

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The post Did macro kill crypto or are risky lenders to blame? is not financial advice.