JPM: “A New Wave of Crypto Decommissioning Underway”

Wild times. Even TradFi people are stuck staring on the crypto cluster right now, but JPMorgan’s Nikolaos Panigirtzoglou has followed the “asset class” longer than most sell-side analysts, so we thought we’d share some of his latest report.

He points out that what makes this latest crypto vomit extra poignant is that JPEG Morgan itself has now imploded.

Earlier in the 2022 crypto winter, Sam Bankman-Fried’s FTX and its affiliate market maker Alameda Research came in for several failed projects. Now the list of potential crypto saviors looks pretty thin, Panigirtzoglou points out:

What makes this new phase of deleveraging more problematic is that the number of entities with stronger balance sheets capable of rescuing those with low capital and high leverage is shrinking within the crypto ecosystem. FTX and Alameda Research had emerged last May/June as the main entities with seemingly strong balance sheets to rescue weaker and more leveraged entities such as BlockFi, Voyager Digital and Celsius. Now that the balance sheet strength of Alameda Research and FTX is in question just a few months after being perceived as strong balance sheet entities, it creates a crisis of confidence and reduces the appetite of other crypto companies to come to the rescue.

Regarding “balance sheet strength under question”, we should point out that the latest news is that SBF is currently going around asking for eight billion real dollars of emergency funding.

There is basically no balance left worth talking about.

FTAV is a (reluctant) member of some crypto discussion groups and there is a lot of chatter about locked up money in FTX and class actions. Many hedge funds used FTX because it was perceived as more “legitimate” than many of its rivals.

Inevitably, then, the debacle is going to raise regulatory questions again, forcing much of the crypto trading infrastructure to be more transparent about their holdings, Panigirtzoglou argues.

What is certain is that the collapse of Alameda Research/FTX will increase investor and regulatory pressure on crypto entities to disclose more information about their balance sheets, to safeguard client assets, to limit asset concentration and will induce more careful risk management including counterparty management . risk among crypto market players. FTX in particular has been favored over Binance by institutional clients such as hedge funds, so the events of the past few days are likely to change the way institutional investors interact with exchanges to ensure their assets are protected. Encouragingly, nine exchanges including Binance, Gate.io, KuCoin, Poloniex, Bitget, Huobi, OKX, Deribit and Bybit have issued statements that they will publish their Merkle tree reserve certificates to increase transparency. Merkle trees allow Exchanges to store each user account’s hash value of assets in the leaf nodes of the Merkle tree. Assets on a leaf node can be audited and verified by a third party.

However, Panigirtzoglou believes that this wave of crypto decommissioning is going to be less acute than the one that followed the collapse of Terra/Luna, 3AC and Celsius earlier this year, simply because the crypto universe has already shrunk so much.

He says JPM’s proxy for bitcoin futures positioning is at its lowest since January 2020, “which points to fairly advanced deleveraging.”

The deleveraging phase that followed the Terra collapse had induced a 50% decline in the crypto market cap from around $1.7tr in early May to a low of $0.86tr in mid-June. With the crypto market cap at just over $1tr before the FTX/Alameda Research collapse, our guess is that the crypto market will find a floor above $500bn in the current drawdown phase. Another way to think about the downside from here is the bitcoin production cost which historically served as a floor for the bitcoin price. Currently this production cost is $15k, but it is likely to return to the low $13k seen over the summer months. A production cost of $13k implies 25% downside from here, which would bring the crypto market cap to a low of $650bn.