Cryptocrisis brings back ghosts from Lehman Brothers
For Gen Z, the crisis in the crypto industry, where many of them have made and lost their first investments, is a very painful situation.
For millennials and older investors, the battles of the crypto galaxy bring to mind the financial crisis of 2008.
The crypto-liquidity crisis began in May, when the sister symbols Luna and UST collapsed, wiping out at least $ 55 billion in value and threatening the future of several prominent companies. This has been facilitated by a lack of strict risk management in this young and so far poorly regulated industry.
Strict risk management would have shown that one hedge fund, Three Arrows Capital, or 3AC, had borrowed money from different companies – BlockFi, Voyager Digital, Babel Finance and others – at the same time as the same bitcoin as security.
This feels like deja vu, say industry experts. There are similarities with the Archegos Capital Management scandal in 2021, but the analogy with the financial crisis in 2008 also emerges.
TheStreet interviewed industry players about the current situation. Here’s what they said.
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‘Parallels’ with the financial crisis ’08
“There are some parallels to the 2008 financial crisis,” said Mark Fidelman, founder of SmartBlocks, Miami’s crypto marketing strategist.
“They both had a crisis derived from bad investment packages – derivatives versus extreme influence – but in the 2008 crisis we got Wall Street to commit fraud by labeling mortgages as AAA instead of rubbish.
“Where the 2022 cryptocurrency crisis started with someone exploring Luna’s algorithm. It created a domino effect on all crypto funds that depend on UST and on unrealistic gains.”
Mike Boroughs, lead portfolio manager for Fortis Digital Asset Fund, says: “There’s a lot of influence or loans in the system, a lot of debt in the system that might not have been there.”
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And Shane Molidor, CEO of the financial platform for cryptocurrency AscendEX (formerly BitMax), says that “in 2007 it was the large investment banks that created complex derivatives such as synthetic [collateralized debt obligations]which no one, especially the government, really understood.
“When things started to work out and mortgage owners started defaulting, the market was in the dark regarding the risk of systemic infection.
“Unfortunately, we are in a similar situation right now when it comes to crypto. Many of the major lenders released little information about lending activity, leaving the market in the dark while participants try to ‘price in’ the risk of further contagion.”
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Retail crypto-investors vs. CDO investors
Molidor says that private investors, who have often invested their savings in cryptocurrencies, risk experiencing the same fate as CDO investors.
“Just as many CDO investors were unaware of their exposure to subprime loan delays, many private clients who deposited funds to large crypto borrowers never understood where the returns came from and were completely unaware that 3AC’s real dough trading activity was partly to fund their juicy APYs. “
Michael Wilson, president and CEO of green global exchange 1GCX., Sums up: “The problems we now see in crypto have similarities in that the underlying sense of failure is panic on the outside from greed on the inside.”
Fidelman adds: “The actors in 2008 deliberately defrauded institutions and people. While in 2022, malicious users exploited a faulty system. Very different in my opinion. Although the major institutions in both scenarios did not do their homework.”
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Problems with transparency and risk management
Kenneth Goodwin, Director of Regulatory and Institutional Affairs at the Blockchain Intelligence Group, states: “In both scenarios, audiences (including consumers, retailers and institutional investors) were led by targeted marketing and communications to believe that these products (the stable coins and housing algorithm) loan/[asset-backed securities]/[mortgage-backed securities]) offered higher returns. ”
Goodwin, who worked for the Federal Reserve Bank of New York during the 2008 financial crisis, adds that in both cases there is an “inability” to disclose market-driven risks. The crypto lenders Celsius and Babel Finance and the hedge fund Three Arrows Capital are similar to Lehman Brothers, Bear Stearns and many of “Too Big to Fail Banks” as they all experienced a higher loan-to-value ratio than they reported, he claims.
“A common similarity in both scenarios is the inability to be transparent with their treasury management operations, trading positions and ongoing monitoring of their portfolios,” he says.
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Differences between 2008 and the cryptocurrency crisis
“One difference, however, is that the crypto-society is unregulated and as such does not have a liquidity backlog,” says Goodwin.
“The infection is much less prevalent in the crypto market and is mostly caused by poorly managed risk by individual lenders / custodians,” Wilson adds.
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Can the cryptocurrency crisis infect the real economy?
“Exposure to failed crypto investors is farther removed from Main Street than in 2008,” said Dan Hoover, director of Castle Funds, a company that invests in bitcoin and other digital currencies.
“The crisis of 2008 affected large financial institutions such as Wells Fargo (WFC) – Get Wells Fargo & Company reportBank of America (BAC) – Get Bank of America Corporation reportand Citibank (C) – Get Citigroup Inc. report. These institutions were key providers of liquidity to the “everyday” economy, and their mortgage losses reduced their ability to perform the critical function.
“Finally, regulators in the United States and elsewhere have increased capital requirements and reduced the overall influence of major market players and systemically important institutions.
“This should reduce the risk for another undercapitalized entity, such as AIG Financial Products (AIG) – Get American International Group Inc. Reporttake on an oversized role as a counterpart for market participants and then fail. “
