Assetless Risk: Bitcoin’s Friday Night Flash Crash Only A Glimpse
Originally posted on my Power and Markets Substack, please feel free to share and subscribe to my newsletter to get these articles in your inbox!
Crypto experienced another flash crash late Friday night. Hundreds of billions in paper wealth evaporated nearly instantly. A sea of red down ticks across the board spared few digital currencies. It’s a sobering reminder that Bitcoin and the greater crypto market aren’t simply risk assets, but I would argue they are assetless risks.
We are exiting the final stages of speculative mania. Inflation is ravaging the economy. The Federal Reserve’s ridiculously easy monetary policy is long in the tooth. Fed Chairman Powell and FOMC voting members have indicated an accelerated tapering process. Such actions will not tame inflation. The only prices that will deteriorate are asset prices. For the Fed to get ahead of inflation, they will need to drastically raise interest rates. That will not happen. Instead, we may be in the worst of all worlds: stubbornly high inflation with stagnating real asset values.
The Fed’s easy money has been pumping copious amounts of liquidity into financial markets since 2008. These are the only conditions Bitcoin has known. It is the only reason for its outstanding decade-plus performance. Due to its success, peers are sprouting up like invasive weeds. We are now over 15,000 cryptocurrencies; an increase of more than 2,000 from just a couple months ago.
Bitcoin loyalists refer to imitators as “sh*tcoins.” The truth is, they’re all ridiculous. In fact, Shiba Inu now has the mantle as the greatest performing “asset” in human history. It minted a 5,000,000% gain in only 14 months from initial trading. The problem is Shiba Inu is literally a parody of a parody (Dogecoin) crypto. The more absurd the story, the greater the gains.
These digital tokens are referred to as digital assets. I would argue there’s not much asset you’re actually acquiring. If we can loosely emit thousands of new cryptos in a couple months, it undermines the integrity of the market. At some point it becomes unsustainable.
And therein lies the risk. The market saturation with new cryptos will weigh on the industry. In addition, there’s tremendous leverage in the system. The sharp sell offs lead to forced liquidations from these positions. Some exchanges offer 100-to-1 leverage, allowing traders to control far more crypto for their money. Given the inherent violent swings in the industry to begin with, leverage can quickly wipe out account holders. With Friday’s crash, many were flushed out.
This leverage is precisely how and why crypto prices were on a tear the past 18 months. MicroStrategies CEO Michael Saylor is perhaps the biggest Bitcoin proponent out there. His firm’s most recent 8-K filing just last week indicated a purchase of over 7,000 additional Bitcoin during its fiscal Q4. The average price per token was $59,187. 1
The debt used on exchanges is the factor swinging crypto markets. The off-exchange leverage, however, introduces a much different risk. Equity sales and debt borrowing in other markets buoys the overall industry. Firms like MicroStrategy act as a synthetic permanent bid under the market. It lasts until it doesn’t. They’re averaging their holdings higher, throwing good money after bad. As liquidity is pulled back by central banks, these types of firms will be washed out.
Friday night was a byproduct of crypto exchange leverage being yanked away. The real event will be when ancillary supports are removed. There are dark pools of money daisy chained to the crypto industry. This all evaporates into thin air as the Federal Reserve pulls back. Monthly stimulus checks are likely getting yanked after December as Senator Manchin punts the Build Back Better agenda into January. The income thresholds to qualify are likely going to be much lower. There goes retail demand for crypto. Get ready.
Originally published at https://powerandmarkets.substack.com on December 4, 2021.
