The shock waves from the cryptocurrency downturn in latest weeks have but to influence the wider monetary markets. But the contagion that has gripped crypto and its numerous decentralised finance (DeFI) platforms is of main concern to traders in Asia.
A mainland Chinese household investor, talking anonymously, informed AsianInvestor: “There’s a high correlation with the fears in the public markets; particularly US, European, and Asian equities. I didn’t expect this correction to happen so quickly. I knew crypto was going to come down a bit, but this is pretty shocking.”
Since the collapse of the Terra/Luna platform in May, the contagion has already taken down the worth of the high 20 cryptocurrencies by 70% from their highs. Investor withdrawal strain is placing a liquidity squeeze on crypto exchanges and there may be rising variety of class-action lawsuits from livid traders in the US.
Contagion in the crypto area wouldn’t, at this level, have a lot impact on the wider monetary markets, in accordance to Standard & Poor’s. At the time of the Terra/Luna collapse, S&P Global Ratings stated the occasion wouldn’t have a fabric influence on conventional monetary markets or the macroeconomy: “These belongings usually are not but systemically vital. This is primarily due to the comparatively small dimension of this rising ecosystem, and its restricted interconnectedness with conventional finance.”
The complete worth of crypto belongings, together with the devices often known as stablecoins, reached a peak of shut to $2.8 trillion in November 2021 — or about 5% of the US fairness market capitalisation.
CONTAGION ESCALATION
Last week’s shutdown of the Celsius Network, following so quickly after the Terra collapse, was one other main contributor to the contagion in crypto asset values.
The Celsius Network, which had $9 billion in staked belongings in April 2022, seems to be shut to working out of liquid funds to pay again large traders. These embrace its largest backer, Alameda Research.
Singapore-based financier Edward Foo noticed that Alameda was “a known concentration risk. When it comes to lending, there are usually models used for VAR (value at risk) and to prevent a collapse due to a bank run or massive redemption events.”
The larger concern, he stated, is that Celsius seems unable to handle dangers internally. “I do wonder why they didn’t gate redemptions earlier. Being unregulated means they can do whatever they deem necessary, right?”
The gating of withdrawals by Celsius is simply the tip of an iceberg. “[This is] section two of the crypto winter,” said Foo. “But it’s on no account a Lehman Brothers/Bear Stearns second — but.”
The unregulated nature of the crypto area is now being laid naked. It has emerged from statements by South Korean prosecutors, that the pockets producing the transaction that brought on the Terra collapse was maintained by founder Do Kwon’s Terraform Labs. The Seoul Police are actually investigating allegations of embezzlement of Terra’s $3.5 billion in Bitcoin holdings.
“If this turns out to be true, the big question is why?” stated Foo. “Did someone already know Luna was not working? Or was this an engineered collapse and if so, to what end?”
NO END IN SIGHT
The full extent of the contagion is but to play out. Cuts are being made at main crypto finance companies. The crypto lender BlockFi, backed by Peter Thiel, introduced final week it’s chopping 20% of its 850-strong workforce. Crypto.com has minimize 260 staff and Gemini lately minimize 10% of its workers.
Meanwhile, Binance.US, the sister firm of cryptocurrency trade Binance, is going through a class-action lawsuit from traders in California for allegedly fraudulent promoting of Terra merchandise.
Observers say it’s too early to say how extreme the crypto contagion will probably be. But the opaque nature of possession and subsequently credit-worthiness, means there’s a very excessive likelihood that it’ll escalate.
Central to this play-out is the enterprise of DeFi lending and the pro-cyclicality that happens when the quantity of lending offered (by the likes of Celsius) is weighed in opposition to the nameless wallets of debtors, pushed largely by the mark-to-market worth of crypto collateral posted, as an alternative of the precise credit score worthiness of the borrower.
In a bull market, as the worth of the underlying crypto collateral rises, collaterisation ratios fall, borrowing limits naturally ease up, and lending quantity expands. In a bear market, as the value of crypto belongings fall, collaterisation ratios rise and margin calls and compelled liquidations happen. The downward spiral continues.
But, in DeFi lending there may be additionally an prevalence often known as the collateral chain, which entails a borrower pledging crypto belongings to a lending platform, which applies a margin to the collateral base and extends a lending facility, normally in the type of stablecoins, to the borrower.
The borrower in flip takes the stablecoins and pledges them as collateral to one other platform, to borrow one other crypto asset. And this will likely go on for a number of layers.
Because of this collateral chain, numerous elements of the DeFi market are inevitably linked. A shock to one a part of the system will ship shockwaves via the whole system.
“So, to answer the question ‘are we at serious contagion risk levels in crypto’, my answer is no, not just yet,” Foo said. “But I can say that all things considered, it is not a good situation and caution and prudence must be the order of the day. Regulations can help.”
¬ Haymarket Media Limited. All rights reserved.
