Tales From the Crypt
The Credit Strategist Blob
The crypto sector is crashing on the back of the meltdown of crypto lending company Celsius. This follows the collapse of the Terra/Luna token which placed serious pressure on Bitcoin. Celsius seems to be taking an especially high toll on Ethereum (which seems very cheap to me but that is not a “buy” recommendation just an observation). The total “market cap” of the crypto sector reportedly dropped below $1 trillion and may fall further a because the asset class is highly leveraged and filled with speculators a lot of technologists who lack market nous.
Nobody knows what Bitcoin or Ethereum is worth. Their value is based on adoption rather than the full faith and credit of a sovereign with taxing credit like traditional currencies. These two tokens have institutional sponsorship and capital behind them but are still in their early days of adoption. Tokens like Terra/Luna and Celsius have no institutional backing and are designed to lure unsophisticated investors, many of whom bought them and suffered total or near-total losses while regulators stood by and did nothing.
Andy Kessler wrote an interesting article in The Wall Street Journal today (“Who Pays for Crypto’s Collapse?”) in which he discusses the legal status of cryptocurrencies. A 1946 Supreme Court case, Securities and Exchange Commission v. W.J.Howey Co. established the test that determines whether a financial instrument is a security (and therefore subject to regulatory oversight). The Court established a four-part test that a security requires an investment in a common enterprise with expectations of profit via efforts by others. Decentralized tokens such as Bitcoin seem to flunk the “common enterprise” part of this test but it may be time for Congress to revisit this issue since there are strong public policy reasons to regulate certain tokens. As with all things on Wall Street, cryptocurrencies are a new idea that exploited regulatory loopholes and an insanely loose monetary environment to trigger wild speculation at the expense of unsophisticated investors.
I believe there are legitimate uses for cryptocurrencies as well as for the blockchain but outside of a handful of top tokens (there are reportedly as many as 8,000 tokens which would be laughable if so many people weren’t going to lose so much money) most of the industry is a case study in speculative psychology. In many ways, cryptocurrencies are the most extreme symptom of the bubble created by the Federal Reserve’s decade-long adventure in excessive money printing. As with tech stocks, the entire crypto sector will re-price with many tokens (like many tech stocks and SPACs) vaporizing completely (with their promoters walking away with lots of money).
This meltdown is an opportunity for leading crypto trading firms to step in and support viable tokens like Bitcoin and Ethereum with capital. If they fail to do so, it probably indicates that they are themselves in financial trouble which in turn means they were using too much leverage and were not building their businesses in the right way. As someone who lived through the early days of the high yield bond market, which saw similar collapses (1990-92, 1998 and 2001-2 for example), I can attest to the importance of market makers standing up at times like these. Unfortunately they rarely do so which is why today’s high yield bond market suffers from extremely poor liquidity. But supporting the market is not only the right thing to do but also a very profitable thing to do if they are serious about building a new asset class for the long-term. Of course, they say that if you want a friend on Wall Street, you should buy a dog.