By Pam Martens and Russ Martens: May 16, 2022 ~
Crypto was in full-blown crash mode last week, wiping out more than $300 billion in market value. TerraUSD, a so-called stablecoin that is supposed to trade at a “stable” $1 value, crashed to a few cents on the dollar. Its sister cryptocurrency, Luna, likewise imploded.
Then there was Bitcoin, which Warren Buffett has called “rat poison squared.” Bitcoin plunged further last week and is now down more than 30 percent year-to-date. So much for the hype that it would be an inflation hedge like gold.
Coinbase, the big crypto exchange, knocked more wind out of the sails of the crypto market on Tuesday of last week when it filed its 10-Q (quarterly report) with the Securities and Exchange Commission and essentially said it had no idea what might happen to $256 billion it held for customers. The filing illuminated its shareholders and customers as follows:
“As of March 31, 2022, we held $256 billion in custodial fiat currencies and cryptocurrencies on behalf of customers. Supported crypto assets are not insured or guaranteed by any government or government agency. We have also entered into partnerships with third parties, such as with the Centre Consortium, as a reseller of USDC, where we or our partners receive and hold funds for the benefit of our customers. Our and our partners’ abilities to manage and accurately safeguard these customer assets requires a high level of internal controls. As our business continues to grow and we expand our product and service offerings, we must continue to strengthen our associated internal controls and ensure that our partners do the same. Our success and the success of our offerings requires significant public confidence in our and our partners’ ability to properly manage customers’ balances and handle large and growing transaction volumes and amounts of customer funds. In addition, we are dependent on our partners’ operations, liquidity, and financial condition for the proper maintenance, use, and safekeeping of these customer assets…Moreover, because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors. This may result in customers finding our custodial services more risky and less attractive and any failure to increase our customer base, discontinuation or reduction in use of our platform and products by existing customers as a result could adversely impact our business, operating results, and financial condition.”
Imagine walking into your federally-insured bank to make a deposit into your savings account and being handed a notice that said it had no idea what might happen to your deposits.
Coinbase went public in April of last year and traded as high as $368.90 intraday last year. It closed the trading week last Friday at a share price of $67.87, a decline of 82 percent from its 52-week intraday high.
If the words “pump and dump” are floating around in your head, you can be forgiven. In 2018, Bill Harris, the former CEO of Intuit and PayPal, wrote a detailed critique of Bitcoin for Vox under the headline: “Bitcoin is the greatest scam in history.” Harris wrote:
“In my opinion, it’s a colossal pump-and-dump scheme, the likes of which the world has never seen. In a pump-and-dump game, promoters ‘pump’ up the price of a security creating a speculative frenzy, then ‘dump’ some of their holdings at artificially high prices. And some cryptocurrencies are pure frauds. Ernst & Young estimates that 10 percent of the money raised for initial coin offerings has been stolen.”
Two Nasdaq stocks which hold large positions in Bitcoin on their balance sheets, MicroStrategy and Tesla, also saw their share prices plunge last week.
Tone deaf Goldman Sachs, however, somehow interpreted last week’s market action as a signal to double down. According to the Financial Times over the weekend, “Goldman Sachs and Barclays have invested in Elwood Technologies, the cryptocurrency trading platform founded by British hedge fund billionaire Alan Howard, in a fresh bet on the mainstream adoption of digital assets.”
The dystopian feel to markets and this socio-political era did not go unnoticed at Saturday Night Live. Weekend Update co-anchor Colin Jost offered this take:
“Is it me or does every story sound like the opening voiceover in a Mad Max movie? The year is 2022. A virus rages across the planet. Digital money has collapsed. Infants have nothing to eat. Women are forced to breed. Men are ready to die for gasoline….”
The situation with crypto was easy to foresee and has been for a long time. (See our 2014 report: Bitcoins, Tulips, and the Madness of Crowds.) On June 30 of last year, the House Financial Services’ Subcommittee on Oversight and Investigations held a hearing on the crypto craze. The hearing was titled: “America on ‘FIRE’: Will the Crypto Frenzy Lead to Financial Independence and Early Retirement or Financial Ruin?”
Wall Street veteran, Alexis Goldstein, then the Director of Financial Policy for the nonprofit group, the Open Markets Institute, was a witness at the hearing. Goldstein was asked by Congresswoman Maxine Waters about a survey released earlier in the year by the accounting firm, PwC, which indicated that 1 in 7 hedge funds have 10 to 20 percent of their total assets under management invested in crypto. The survey also found that 86 percent of the hedge funds investing in crypto intended to deploy more capital by the end of 2021.
Goldstein responded that the public had already witnessed the collapse of the family office hedge fund, Archegos, which demonstrated that when banks have prime broker relationships with hedge funds it can create losses at the banks, which hold federally-insured (taxpayer-backstopped) deposits. Large global banks lost more than $10.4 billion when Archegos defaulted on its margin loans to the banks in March of 2021. Goldstein explained:
“If hedge funds get farther into crypto, they don’t care about direction. They’ll go long, they’ll go short. They can use leverage. There are lots of cryptocurrency exchanges like FTX and Binance and many others that allow people to use insane amounts of leverage – 100 times to 1…So what happens if a huge number of hedge funds have prime broker relationships with too-big-to-fail banks [and] all happen to be in similar crypto positions, whether it’s long or short and there’s massive volatility in the market. They may have to sell some of their other assets. It may lead to margin calls in their non-crypto assets which could lead to forced liquidations and sort of redound to the banks themselves in the form of counterparty risk.”
Counterparty risk is what led to the financial contagion that crashed Wall Street in 2008, leading to the worst economic crisis in the U.S. since the Great Depression of the 1930s. (For a look at Goldman Sachs’ role in that leverage and counterparty contagion in the 2008 crash, here’s a chart of Goldman Sachs’ derivative exposure to other banks as of June 2008.)
Waters then asked Goldstein if there was any transparency on which specific hedge funds held the largest positions in crypto and who their counterparties are. Goldstein responded that crypto is not currently reported on the 13F forms that hedge funds are required to file with the SEC so regulators are currently “totally in the dark.” Regulators were also in the dark about Archegos. It also did not make 13F filings with the SEC.
Goldstein also explained how the mega banks on Wall Street, which provide margin lending and securities lending to hedge funds under a program they call “prime broker” services, are themselves taking a “growing presence in the cryptocurrency market.” Goldstein provided the following remarks in her written testimony to the Subcommittee:
“…Too Big To Fail banks are also a growing presence in the cryptocurrency market. Goldman Sachs plans to open a cryptocurrency trading desk, BNY Mellon allows its clients to hold Bitcoin as of February 19, Wells Fargo will offer professionally managed cryptocurrency funds for qualified investors. Morgan Stanley’s Europe Opportunity Fund reported owning 28,298 shares of the Grayscale Bitcoin Trust, according to a June 28 filing. Venture Capital firms have already invested $17 billion into cryptocurrency firms so far in 2021, more than three times what they invested in all of 2020. In addition, the concentration of particular cryptocurrency assets into a small handful of addresses raise concerns about power concentrations. To take one example, there are several very large ‘whales’ in the Dogecoin cryptocurrency, including a single address that holds over 36.7 billion DOGE (or some 28% of total Dogecoin) worth more than $8 billion. As of February , the top 20 largest Dogecoin addresses held half of the cryptocurrency’s entire supply.”
Another loud warning came last December 14 when the Senate Banking Committee held a hearing titled “Stablecoins: How Do They Work, How Are They Used, and What Are Their Risks?” Senator Sherrod Brown (D-OH), the Chair of the Committee, said the following as part of his remarks:
“So let’s be clear about one thing: if you put your money in stablecoins, there’s no guarantee you’re going to get it back. They call it a currency, implying it’s the same as having dollars in the bank, and you can withdraw the money at any time. But many of these companies hide their terms and conditions in the fine print, allowing them to trap customers’ money. And if there’s no guarantee you’ll get your money back, that’s not a currency with a fixed value – it’s gambling.
“And with this much money tied up, it sure looks to me like a potential asset bubble.”