DC Fintech Week explores risks and opportunities in the crypto winter

This year’s dramatic downturn in the cryptocurrency market was the focus of a panel at the DC Fintech Week conference, offered both in person and virtually this week. The discussion gave a perspective on the upheavals that began in the spring and have lasted through the autumn.

In September, a number of cryptocurrencies were down roughly 60% year-to-date, with even Bitcoin down 65% in that time compared to its November 2021 peaks.

Estimates continue to circulate about how long this crypto winter may last, whether the thaw has begun or not, and what long-term consequences it may have.

At the conference, Lily Francus, chief investment officer at Novi Loren, joined Colleen Sullivan, co-head of private investments with Brevan Howard Digital, on stage. Mary-Catherine Lader, CEO of Uniswap Labs, joined the panel “Pricing Risk and Opportunity in Crypto Winter” virtually. Chris Brummer, founder of DC Fintech Week, moderated.

“This crypto winter for me is quite different than the last,” Sullivan said. “On the trading side in January 2018, it was pretty clear that we had a problem.” During the previous crypto winter, large crypto arbitrages from the back half of 2017 had disappeared, she said, and proprietary trading firms entered the space. It took until the third quarter of 2018 for the bearish trends to reach the venture side, Sullivan said. “We didn’t really know we were in a real bear market until about that time.”

However, this year’s crypto winter is behaving differently, she said. “While we saw some fragility in the growth stages in mid-February and March, we thought that was primarily related to the global macro environment and what happened to technology stocks,” Sullivan said. “You hit the 9th of May, Terra depegs, and it’s like you’ve gone from one realm to another entirely.”

Over the course of a week in May, the Terra stablecoin and Luna cryptocurrency linked to the Terra blockchain collapsed in an implosion that wiped out about $45 billion in market capitalization.

“There was just violent repricing across all stages, right down to pre-seed,” Sullivan said. There were other sweeping events, she said, including the bankruptcies of crypto brokerage firm Voyager Digital, crypto lender Celsius Network and crypto hedge fund Three Arrows Capital. “It’s quite remarkable, I think, that Bitcoin and Ethereum have held up the way they have. It was very different — it was much more abrupt than the last one,” she said, comparing the latest downturn to the previous crypto winter.

Although she did not worry that crypto would disappear in the wholesale sector, the abruptness of this year’s decline shook up some expectations. “You have institutions that you thought had better risk management than they turned out to have,” Sullivan said. “These weren’t crypto issues per se. They were poor risk management issues and some fraud mixed in.”

Validating DeFi

Lader said this crypto winter gave some validation to decentralized finance (DeFi), which are protocols that have some kind of decentralized governance or can operate in a decentralized technical architecture. That could include self-executing smart contracts on a blockchain that don’t require human operation, she said.

“What we saw in the last year … the big challenges were traditional risk management challenges,” Lader said. “They were often organizations that had centralized risk management functions, centralized liquidity management that didn’t engage in practices that are well known in traditional financial services to be critical to managing people’s assets.” In the DeFi world, she said, there is full transparency about what happens to assets, whether it’s an individual, a private investor or a large-scale institution.

“Now in the crypto winter, the challenge is to focus on building and using this time with less frenzy in the market, and less enthusiasm around specific crypto assets, to instead make these services available to more people,” Lader said. There are difficulties in trying to use DeFi that still persist, she said, such as too many friction points in the user experience, as well as being too complicated to explain how they work. “We in the industry haven’t done a good job of explaining why the ability to hold your own assets or the ability to trade in transparent and reliable infrastructure is different or better,” Lader said.

She sees opportunities in this crypto winter for companies in DeFi to make it easier to use these services and better explain why they have benefits in reducing systemic and other types of market risk, which can be replicated in the centralized financial infrastructure that suffered in the previous six to nine months .

Quantifying risk

Francus talked about metrics to quantify risks and opportunities in the crypto markets. Furthermore, she said there is a lack of industry accepted as well as regulatory accepted metrics and frameworks for understanding risk. “A lot of the problems we’ve seen this year in the crypto markets pretty well parallel what’s happened in the traditional markets in the past,” Francus said. “The long-running joke is that it’s almost like the ants discovered space travel — that they just accelerated the history of the traditional financial markets by about 10 years.”

A significant downward pressure seen in May, she said, was that institutional players had hidden exposures to counterparties that were either functionally insolvent or badly damaged by the explosion of Terra and Luna. “At the institutional level, a lot of these larger players — the origin is that they’ve pulled back a lot of their leverage that they’ve lent to these counterparties,” Francus said.

If anything, this crypto winter has exposed some of the overzealous funding and hype pouring into the crypto space to resemble some old, frothy, bad habits of the startup scene. “You see not only on the venture side, funding teams without proper due diligence, but even on the institutional side or on the lending side, that many of these players who were considered blue chips or the centralized players in the crypto markets were not managing their loan books the right way,” Francus said. “They generated amazing returns because the markets were full of dumb money.”

There was not enough understanding of the damage that could be done, she said, which can be attributed to the relatively short history of the crypto markets. Yet the crypto collapse also exposed some bad actors. “Part of it also came from sheer greed,” Francus said.

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