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 offered some perspective on upheaval that began in the spring and has lasted into the fall.
In September, a variety of cryptocurrencies were down about 60% year to date, with even Bitcoin down 65% at that time compared with its highs in November 2021.
Estimates are still being kicked around about how long this crypto winter might last, whether or not the thaw has begun, and what long-term repercussions there might be.
At the conference, Lily Francus, chief investment officer with Novi Loren, joined Colleen Sullivan, co-head of private investments with Brevan Howard Digital, on stage. Mary-Catherine Lader, chief operating officer for Uniswap Labs, connected virtually for the “Pricing Risk and Opportunity in Crypto Winter” panel. Chris Brummer, founder of DC Fintech Week, moderated.
“This crypto winter to me is pretty different than the last one,” Sullivan said. “On the trading side in January of 2018, it was pretty clear that we had a problem.” During that prior crypto winter, big crypto arbitrages from the back half of 2017 had vanished, 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 proper bear market until about that time.”
This year’s crypto winter, however, 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 was happening with tech stocks,” Sullivan said. “You hit May 9, Terra depegs and it’s like you’ve gone from one realm to an entirely different realm.”
Over the course of a week in May, the Terra stablecoin and Luna cryptocurrency associated with the Terra blockchain collapsed, in an implosion that saw some $45 billion in market capitalization erased.
“It was just a violent repricing across all stages, all the way down to pre-seed,” Sullivan said. There were other cascading events, she said, including bankruptcies for crypto brokerage firm Voyager Digital, crypto lender Celsius Network, and crypto hedge fund Three Arrows Capital. “It’s kind of 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 with the prior crypto winter.
Though she did not worry that crypto would vanish wholesale, the abruptness of this year’s declines shook up some expectations. “You have institutions that you thought had better risk management than what it turned out they had,” Sullivan said. “These were not crypto problems, per se. They were bad risk management problems 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 sort of decentralized governance or may operate in a decentralized technical architecture. That can include self-executing smart contracts on a blockchain that do not require human operation, she said.
“What we saw for the past 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 were not engaging in the practices that are well-known in traditional financial services to be critical in stewarding people’s assets.” In the DeFi world, she said, there is full transparency of what is happening to assets, whether an individual, retail investor or a large-scale institution.
“Now in crypto winter, the challenge is to focus on building and using this time of less frenzy in the market, and less enthusiasm around specific crypto assets, to instead make those services available to more people,” Lader said. There are difficulties with attempting to use DeFi that still persist, she said, such as too many points of friction in the user experience, as well as being too complicated to explain how they work. “We in the industry haven’t done a great job of explaining why the ability to hold your own assets or the ability to swap in transparent and reliable infrastructure is any different or better,” Lader said.
She sees opportunities in this crypto winter for companies in DeFi to make it easier to use those services and better explain why they have advantages in reducing systemic and other kinds of market risks, which may be replicated in the centralized financial infrastructure that suffered in the past six to nine months.
Quantifying Risk
Francus spoke on metrics for quantifying risk and opportunity 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 issues we’ve seen this year in the crypto markets are pretty well paralleled by what has occurred in the traditional markets previously,” Francus said. “The long running joke is it’s almost like the ants discovered space travel -- that they just speed-ran the history of the traditional financial markets in like 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 were badly damaged by the blowup of Terra and Luna. “On the institutional level, a lot of these larger players -- the genesis is that they have 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 poured into the crypto space that is similar to some old, frothy, bad habits of the startup scene. “You see not only on the venture side, funding of teams without proper due diligence, but even on the institutional or on the lending side, that a lot of these players that were considered the blue chips or the centralized players in the crypto markets were not managing their loan books properly,” Francus said. “They were generating fantastic yields because the markets were full of dumb money.”
There was not enough understanding of the damage that could be done, she said, some of which could be attributed to the relatively short history of the crypto markets. Still, the crypto collapse also exposed some bad actors. “Part of that also came from pure greed,” Francus said.
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