crypto strategy

Bitcoin’s most fundamental principle has become crypto’s biggest problem

In Ernest Hemingway’s 1926 novel The sun also rises one of the disillusioned young adults of the interwar period is asked how he went bankrupt. “Gradually then suddenly,” he replies. This quote, so apt it has become a cliché, describes in a nutshell the exponential curve that defines so many events. Things happen to us little by little, then all of a sudden.

Less well known is the paragraph that follows, in which the young man is asked what “caused” his financial ruin. “Friends,” he replies. “I had a lot of friends… Then I also had creditors. He probably had more creditors than anyone in England.

Sam Bankman-Fried, the 30-year-old founder of FTX, now bankrupt cryptocurrency exchange, had many friends, with whom he did fun things like building a convoluted mass of Bahamian businesses or making large political donations. He would now have fewer friends and more creditors. Much more: according to his company’s latest bankruptcy filings, FTX and its associated companies may owe money to “more than a million creditors.” Many of them are retail investors who have staked their life savings on FTX; others are institutions that are owed hundreds of millions of dollars.

Perhaps the biggest of these might be Genesis Trading, which provides the kind of “prime brokerage” lending and trading services to professional cryptocurrency investors that City of London and Wall Street banks provide to investors. fund managers investing regular money. Genesis is particularly important, not only because it is a large commercial company in its own right, but also because it is a subsidiary of the Digital Currency Group, a major pillar of the economy of cryptocurrency.

On Nov. 9, Genesis said it had “no material exposure” to FTX or its plummeting FTT token, and estimated that the fallout from FTX’s collapse could cost it around $7 million. The next day, Genesis remembered that he had $175 million locked up in FTX, which most people would consider at least one. little unimportant, but that it “would not have an impact on our market making activities”. By the middle of the following week, however, Genesis had suspended withdrawals from its loan arm, and the next day the the wall street journal reported that Genesis was seeking a $1 billion capital injection to help it negotiate a “cash shortage.” In a statement, Genesis said it “has no plans to file for bankruptcy imminently.”

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For readers for whom a “cash crunch” is the result of trying to eat a Cadbury’s Creme Egg in one bite (is there another way?), that means Genesis has the money, but it’s in the form of something else that might take a while to sell. Unfortunately, the same phrase was used to describe FTX’s predicament in the days leading up to the evidence that the illiquid assets on its balance sheet consisted largely of FTT and Solana – tokens that Bankman-Fried and his friends had. , to be blunt, invented, and not the store of value that some once believed.

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There’s no suggestion that Genesis did anything wrong, but Genesis has a lot of friends too. Its central position as a lender gives it exposure to the broader downsides of the cryptocurrency market: Its two largest borrowers are, a source told Reuters, Bankman-Fried’s bankrupt hedge fund Alameda Research, and Three Arrows Capital (also a hedge fund, also now in bankruptcy proceedings). It also means that Genesis’ problems are problems for other financial institutions that rely on it as a lender.

In fact, Genesis has not just friends, but siblings: Grayscale Investments, also owned by Digital Currency Group, is the largest active holder of Bitcoin via the original and the largest Bitcoin investment fund, the Grayscale Bitcoin Trust. It also seems a bit sharp right now, with its shares trading at a over 40% off on the market value of the underlying assets.

Genesis, Grayscale and others are now challenged by the very problem Bitcoin was designed to solve: trust.

Crypto evangelists have spent a decade cornering people at parties (I’m never invited to these things but I hear reports) and explaining that in their world the mess of trusting fallible humans is being swept away by the immutable and unhackable blockchain. But this immutable, unhackablah blahchain is also surprisingly useless – a single Bitcoin transaction can use as much energy as 1.8 million credit card transactions – and in the beginning it made trading expensive and inefficient. To create a liquid market, they had to bring in all the other elements that make modern financial markets fast and efficient: market makers, trading firms, lenders, exchanges and, of course, people.

Trust in people and institutions had not gone away: it had simply shifted from trust in established banks and regulators to trust in new companies like FTX and people like Bankman-Fried.

The reason many people hastily withdraw their money (or try to) from crypto exchanges and test the liquidity of this market is that they realized there might be more Sam Bankman- Fried into a system that does, let’s face it, it looks more like it was designed by and for exactly that kind of person.

It shouldn’t be difficult for crypto markets to overcome this lack of confidence. Each exchange, currency provider and asset manager could publish a detailed and independent audit of its assets by a renowned auditor. But few are ready to do so. It should be easy for Grayscale to demonstrate to investors exactly what and where its assets are (they are, after all, stored on the famed immutable, tamper-proof blockchain), but on Monday Grayscale refused to do so, citing “security concerns.” security” (the company has since released a letter from crypto exchange Coinbase stating that it owns Grayscale’s digital assets, but did not share any of the “addresses” used to identify those assets). The largest “stablecoin” – a cryptocurrency individually backed by real dollars, to facilitate trading – is Tether, which has also never released a full and detailed audit of its $65 billion reserves. The largest crypto exchange, Binance, won’t even say where its headquarters are.

The cryptocurrency market is clearly aware of this problem, and companies are belatedly adding “proof of reserves” to their websites in an attempt to reassure investors of their creditworthiness, but simple trust in crypto technology has been eroded. . The crypto community is realizing that you can be a friend or a creditor, but you can’t be both.

[See also: How politicians failed to protect the public from crypto]

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