Guest Post From Kevin Dougherty - BR Capital
Current State of Crypto-Crisis and How to Potentially Play it
The FTX fraud/bankruptcy has hit the crypto ecosystem hard, and there is still more fallout to come. Contagion to other crypto companies who have assets frozen in FTX (or exposure to companies that have assets frozen in FTX) is still rippling outwards. My rule of thumb is that when a systemically important entity announces an asset freeze, bankruptcy, etc, then that starts a two week window when counterparties of that entity are in danger of themselves tipping into insolvency. In crypto, this happens fast and furious as there are no government or central bank backstops to slow things down. For example, FTX froze withdrawals 11 days ago, and yesterday another very systemically important entity (Genesis) announced it was freezing withdrawals as it had a significant amount of liquidity/assets tied up in FTX/Alameda. The Genesis announcement yesterday starts a new two week stopwatch, and I expect many other entities to announce that Genesis' freeze has also negatively impacted them. It is important to note, however, that not EVERY asset freeze/impairment/bankruptcy is systemically important. For example, lots of investment funds have announced that they have assets frozen in FTX, or investments that they likely have to mark down to zero. While painful for the investors in those funds, those actions are not systemically important. It is when Centralized and systemically important entities run into trouble and have to freeze withdrawals that contagion continues to spread. And credit and leverage across the entire crypto ecosystem are being rapidly unwound right now, so if there are more bombs to go off, they should blow up soon.
And it is important to note what TYPE of entities and assets are in trouble. So far, every troubled entity is a centralized entity engaged in lending and/or borrowing. Pure brokerage, exchange or custodian based centralized entities that do not engage in lending/borrowing should be fine, and so far NO decentralized entities have failed. For example, Coinbase is extremely unlikely to have to freeze withdrawals, because they did not engage in activity where their assets (or your coins held on Coinbase) may be tied up with another entity. Of course, there is some tiny possibility that Coinbase engaged in fraudulent activity (just as many banks were revealed to have done in the 2008 crisis), but they have a proper management team and board of directors that would almost certainly prevent that, and are regulated in ways that FTX was not. For what it is worth, I have cash and tokens that I keep on Coinbase and am still keeping them there, but I have taken all of my other tokens into private custody.
Buy, Sell or Hold?
What does this mean for crypto and crypto prices? As painful as this looks and as scammy/criminal/brazen as FTX has been revealed to be, it is not the end of crypto. While FTX was a crypto exchange, its criminal activities were based on it being an old fashioned, centralized entity engaging in hidden, over leveraged, fraudulent activity. It is the very antithesis of the decentralized, fully transparent ethos of cryptocurrency. Here is a good read on this: https://www.ar.ca/blog/the-animals-are-being-blamed-for-the-zookeepers-felony
There will likely be more bad headlines, but it looks likely that the market is in a capitulation period right now. I think it is likely that we are at or very near a bottom, similar to the post-dot com bust, or post 2008. BUT, I am not doing anything yet. As I said above, Genesis' freeze yesterday starts a new 2-week time period where I want to wait and see what further fallout and capitulation there might be. To put things in traditional finance terms - using the 2008 precedent, Terra/Luna and Three Arrows Capital busts in the spring that kicked all of this off were Bear Sterns, FTX is Lehman Brothers, and Genesis is potentially AIG. So I am not buying yet, but am planning to soon.
What to buy? GBTC and ETHE. These are Bitcoin and Ethereum ETF's that trade like normal equities, so you can buy them in your normal brokerage account. They are closed end funds, which means that they can trade at a premium or discount to NAV. Right now they are each trading at record high 40% discounts to NAV. Explaining the mechanics and the why's of that would be another email, but bottom line is that over the long term (2yrs+), I think that discount will very likely be completely eliminated, and over the near term (next 6 months), it should decrease quite a bit, perhaps to 20% or less. It is much better risk/reward to buy these, instead of buying Bitcoin and Ethereum tokens.
If you can buy corporate bonds, there is a Coinbase bond with a 2031 expiry trading at an extremely attractive 14% yield right now. That is deep in junk territory and approaching distressed levels. Coinbase is likely to have a few rough quarters and post steep losses, but this is pricing bankruptcy risk that is not realistic...yet, so this is excellent risk/reward.
Kevin Dougherty
Managing Partner, BR Capital