Contagion

CFTC’s Johnson urges Congress to expand commission’s crypto oversight powers

Commodity Futures Trading Commission Kristin Johnson wants to protect customers in a way that reduces the risk of future crises.

Commodity Futures Trading Commission (CFTC) Commissioner Kristin Johnson has urged Congress to adopt legislation that “closes the current gap in the oversight of crypto spot markets.”

During a speech at a digital assets conference at Duke University on Jan. 21, Johnson propose d a number of amendments that would enable the CFTC to conduct “effective due diligence” on businesses, including crypto firms, that want to acquire CFTC-regulated entities.

The commissioner also wants expanded powers for the commodities regulator to enhance customer protection, prevent liquidity crises and mitigate conflicts of interest.

*CFTC Commissioner Kristin Johnson. Source: YouTube*

One of these potential changes would be to give the commodities regulator new powers to investigate any business that wants to purchase 10% or more of a CFTC-registered exchange or clearinghouse.

Johnson highlighted the example of derivatives exchange LedgerX, which became a subsidiary of FTX on Aug. 31, 2021, and is now wrapped up in the crypto exchange’s collapse.

The commissioner notes that the regulator currently has no ability to conduct due diligence on whichever firm buys the business and is merely a passenger as the exchange goes through the sales process.

Johnson also addressed co-mingling of customer funds, which was one of the more egregious accusations levied at FTX following its collapse, calling for regulation that formalizes the obligation of crypto firms to segregate customer funds.

Another gap pointed out by Johnson was in risk management procedures, pointing to the contagion that has continued to spread after major crypto company collapses, such as FTX:

“Interconnectedness among crypto-firms amplified by fragile or non-existent risk management, corporate governance failures, and conflicts of interests at individual firms fuels the likelihood of crises.”

The commissioner argued that current “frameworks such as anti-trust law and regulation may prove too limited in scope” in increasingly diverse markets, and instead advocated for “tailored and effective governance, and risk management controls.”

Silvergate denies recent FUD, confirms minimal exposure to BlockFi

Silvergate Capital has been quick to distance itself from the now-bankrupt crypto lender BlockFi.

Institutional crypto services provider Silvergate Capital has confirmed its minimal exposure to the embattled BlockFi crypto lending firm.

On Nov. 28, Silvergate announced that its deposit relationship with BlockFi is “limited to less than $20 million of its total deposits from all digital asset customers.” Those deposits totaled $13.2 billion in Q3 according to the firm’s revenue report.

It added that BlockFi was not a custodian for its Bitcoin (BTC) collateralized leverage loans and the firm has no investments in BlockFi.

To quell investor jitters, Silvergate CEO Alan Lane said, “as the digital asset industry continues to transform, I want to reiterate that Silvergate’s platform was purpose-built to manage stress and volatility.”

Silvergate Provides Statement on Minimal Exposure to BlockFi https://t.co/FoBqzylpr6

— Silvergate Bank (@silvergatebank) November 28, 2022

Silvergate has been the subject of a lot of FUD (fear, uncertainty, and doubt), or “false and misleading statements,” in its words.

On Nov. 29, technical analyst and Swiss investor Walter Bloomberg told his 622 thousand Twitter followers, “Silvergate Capital said to have lent money to BlockFi,” but failed to provide any evidence.

Others have added to the FUD fest with several tweets over the past week. However, most of them were lacking specifics.

On Nov. 28, Cointelegraph reported that BlockFi had become the latest victim of the FTX contagion to file for Chapter 11 bankruptcy.

The filing stated that BlockFi has more than 100,000 creditors, assets between $1 billion and $10 billion, and similar liabilities. The latest high-profile crypto bankruptcy appears to have fuelled this recent round of FUD, which Silvergate has seen fit to refute.

Earlier this month, the WSJ ran an article on Silvergate, claiming that the company was battling the contagion fears. The crypto bank has seen its stock prices plunge this year but that has been the case for most publically listed crypto companies.

SI prices declined 11.1% on the day to finish at $24.45 in after-hours trading, according to Market Watch. Silvergate stock has slumped 83.6% since the beginning of the year.

On Nov. 23, Cointelegraph reported that Block.one CEO, Brendan Blumer, had purchased a stake in Silvergate Capital.

FTX will be the last giant to fall this cycle: Hedge fund co-founder

This bear market has seen the collapse of Celsius, Three Arrows Capital, Voyager, and now FTX, but the worst is likely over, a hedge fund executive suggests.

While the FTX crisis is continuing to unfold, the former head of risk at Credit Suisse believes the exchange’s fall from grace should be the last catastrophic event — at least in this market cycle.

CK Zheng, the former head of valuation risk at Credit Suisse and now co-founder of crypto hedge fund ZX Squared Capital said that FTX’s fall was part of a “deleveraging process” that began after the COVID-19 pandemic and further accelerated after the fall of Terra Luna Classic (LUNC), formerly Terra (LUNA).

“When LUNA blew up a few months ago, I expected a huge amount of deleveraging process to kick in,” said Zheng, who then speculated that FTX should be last of the “bigger” players to get “cleaned up” during this cycle.

Before its collapse, FTX was the third largest crypto exchange by volume after Binance and Coinbase.

“I’m sure there are multiple players that will probably get impacted […] in the following weeks, you know, small, large — but I would say this one in terms of magnitude will be one of the larger ones before the whole cycle really ends.”

On Nov. 14, crypto exchange BlockFi admitted to having “significant exposure” to FTX and its affiliated companies. A day later, a Wall Street Journal report suggested it was preparing for a potential bankruptcy filing.

A number of exchanges have also halted withdrawals and deposits this week, citing exposure to FTX, including crypto lending platform SALT and Japanese crypto exchange Liquid.

On Nov. 16, institutional crypto lender Genesis Global said it would temporarily suspend withdrawals citing ‘unprecedented market turmoil.’

The fate of these businesses are yet to be determined.

Zheng noted that moments like this are all normal signs of a lengthy, stressful crypto winter which “basically wipes out many of the weak players.”

On a positive note, however, Zheng said that the FTX collapse is unlikely to shake institutional investor confidence, at least for those investing in blockchain technology and certain cryptocurrencies such as Bitcoin and Ethereum.

“For many of the institutional investors […] as long as they think about the longer term, they think about how blockchain technology is going to advance in the future to help the financial industry […] that’s still in place.”

CoinShares’ head of research James Butterfilll in a Nov. 14 note revealed that inflows into cryptocurrency investment products rose sharply last week after institutional investors bought the dip triggered by FTX’s collapse.

Investors see the #FTX collapse as an opportunity with crypto inflows totalling US$42mhttps://t.co/neDkmnr6ae

— James Butterfill (@jbutterfill) November 14, 2022

Digital asset investment products saw inflows totaling $42 million in the week ending Nov. 13, the largest increase in 14 weeks.

On the other hand, their outlook wasn’t so optimistic for blockchain equities, which registered $32 million in weekly outflows.

Zheng said it was “mind-boggling” how much damage an MIT-educated, 30-year-old young person can do to the crypto ecosystem — referring to FTX former CEO Sam Bankman-Fried.

He believes the fall of FTX was the result of a lack of clear rules and regulations governing crypto exchanges. Zheng said it may also have been the result of a top-heavy management structure that may not have had the necessary know-how to run a business of such a size.

“Obviously, they’re smart in one aspect, but they’re running a $32 billion company is very different than, you know, when you manage a small company.”

CME Bitcoin futures trade at a discount, but is that a good or a bad thing?

CME Bitcoin futures briefly traded at a 5% discount, alarming analysts, but what does it mean for BTC price?

CME Group’s Bitcoin (BTC) futures have been trading below Bitcoin’s spot price on regular exchanges since Nov. 9, a situation that is technically referred to as backwardation. While it does point to a bearish market structure, there are multiple factors that can cause momentary distortions.

Typically, these CME fixed-month contracts trade at a slight premium, indicating that sellers are requesting more money to withhold settlement for longer. As a result, futures should trade at a 0.5%-to-2% premium in healthy markets, a situation known as contango.

However, a prominent futures contract seller will cause a momentary distortion in the futures premium. Unlike perpetual contracts, these fixed-calendar futures do not have a funding rate, so their price may vastly differ from spot exchanges.

Aggressive sellers caused a 5% discount on BTC futures

Whenever there’s aggressive activity from shorts (sellers), the two-month futures contract will trade at a 2% or higher discount.

*CME Bitcoin 1-month futures premium vs. BTC index. Source: TradingView*

Notice how one-month CME futures had been trading near the fair value, either presenting a 0.5% discount or 0.5% premium versus spot exchanges. However, during the Nov. 9 Bitcoin price crash, aggressive futures contracts sellers caused the CME futures to trade 5% below the regular market price.

The present 1.5% discount remains atypical, but it can be explained by the contagion risks caused by the FTX and Alameda Research bankruptcy. The organizations were together supposedly one of the largest market makers in cryptocurrencies, so their downfall was bound to send shockwaves throughout all crypto-related markets.

The insolvency has severely impacted prominent over-the-counter desks, investment funds and lending services, including Genesis, BlockFi and Galois Capital. As a result, traders should expect less arbitrage activity between CME futures and the remaining spot market exchanges.

The lack of market makers exacerbated the negative impact

As market makers scramble to reduce their exposure and assess counterparty risks, the eventual excessive demand for longs and shorts at CME will naturally cause distortions in the futures premium indicator.

The backwardation in contracts is the primary indicator of a dysfunctional and bearish derivatives market. Such a movement can occur during liquidation orders or when large players decide to short the market using derivatives. This is especially true when open interest increases because new positions are being created under these unusual circumstances.

On the other hand, an excessive discount will create an arbitrage opportunity because one can buy the futures contract while simultaneously selling the same amount on spot (or margin) markets. This is a neutral market strategy, commonly known as “reverse cash and carry.”

Institutional investors’ interest in CME futures remains steady

Curiously, the open interest in CME Bitcoin futures reached its highest level in four months on Nov. 10. This data measures the aggregate size of buyers and sellers using CME’s derivatives contracts.

*CME Bitcoin futures open interest, USD. Source: Coinglass*

Notice that the $5.45 billion record high happened on Oct. 26, 2021, but Bitcoin’s price was near $60,000 then. Consequently, the $1.67 billion CME futures open interest on Nov. 10, 2022, remains relevant in the number of contracts.

Traders often use open interest as an indicator to confirm trends or, at least, institutional investors’ appetite. For instance, a rising number of outstanding futures contracts is usually interpreted as new money coming into the market, irrespective of the bias.

Although this data can’t be deemed bullish on a standalone basis, it does signal that professional investors’ interest in Bitcoin is not going away.

As further proof, notice that the open interest chart above shows that savvy investors did not reduce their positions using Bitcoin derivatives, regardless of what critics have said about cryptocurrencies.

Considering the uncertainty surrounding cryptocurrency markets, traders shouldn’t assume that a 1.5% discount on CME futures denotes long-term bearishness.

There’s undoubtedly a demand for shorts, but the lack of appetite from market makers is the primary factor leading to the current distortion.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should conduct your own research when making a decision.

CFTC commissioner compares crypto contagion risk to 2008 financial crisis

The commissioner warnes that vulnerabilities seen within the crypto markets are similar to those seen during the global financial crisis and calls for the agency to be given additional authority.

Commodity Futures Trading Commission’s (CFTC) Christy Goldsmith Romero has pointed to the collapse of the Terra ecosystem and its flow-on effects as an example of how contagion risks within crypto markets are similar to those experienced by the traditional financial (TradFi) system during the global financial crisis (GFC) of 2008.

Romero suggested in a speech given at the International Swaps and Derivatives Association’s (ISDA) Crypto Forum on Oct. 26 that increased links between crypto markets and TradFi increases the risk posed by crypto to overall financial stability, noting:

“The digital asset market remains relatively small and contained from the level of systemic risk that would come with greater scale or interconnections with the traditional financial system. But this may not be the case in the near future, particularly given growing interest by traditional finance.”

One area of TradFi the commissioner would prefer to remain distant from crypto is retirement and pension funds. This opinion has likely been influenced by recent events in the United Kingdom, where pension fund issues required intervention from the Bank of England.

I have significant concerns about the possibility of pensions and retirement funds investing in #Cryptocurency

— Commissioner Christy Goldsmith Romero (@CFTCcgr) October 27, 2022

While Romero cautions the United States to not rush regulations, she supports a “same risk, same regulatory outcome” approach as the level of risk posed by the crypto industry increases, suggesting:

“Similar to post-crisis reforms, Congress can address financial stability risks by providing additional authority to the CFTC.”

The GFC came about after banks began to lend recklessly to people without the means to fully pay back their mortgages. These “subprime” mortgages were bundled together and sold as safe investment products before defaults started a ripple effect that spread across the world.

While the CFTC is often regarded as the more crypto-friendly regulator compared to the U.S. Securities and Exchange Commission (SEC), it appears to be attempting to change that image as part of its bid to gain more regulatory oversight after revealing it instigated 18 enforcement actions on the sector throughout the 2022 fiscal year.

One of the more recent CFTC actions was the fine levied at the Ooki DAO and its members, which was heavily criticized by a CFTC commissioner and members of the crypto community, who referred to it as “blatant regulation by enforcement.”

Before this action, decentralized autonomous organizations (DAOs) were regarded by many advocates as being “above the law,” and have resulted in the formation of legal entities within DAOs as a way to limit liability.

Contagion only hit firms with ‘poor balance sheet management’ — Kraken Aus boss

The crypto contagion only hurt entities that poorly managed their treasuries, but didn’t affect the underlying blockchain technology, he said.

The crypto contagion sparked by Terra’s infamous implosion this year only spread to companies and protocols with “poor balance sheet management” and not the underlying blockchain technology, says Kraken Australia’s managing director Jonathon Miller.

Speaking with Cointelegraph, the Australian crypto exchange head argued that sectors such as Ethereum-based decentralized finance (DeFi) revealed its fundamental strength this year by weathering severe market conditions:

“Some of the contagion that we saw across some of the lending models in the space, [was in] this traditional finance kind of lending model sitting on top of crypto. But what we didn’t see is a kind of catastrophic failure of the underlying protocols. And I think that’s been recognized by a lot of people.”

“Platforms like Ethereum did not fail when the volatility hit. You saw decentralized markets, decentralized lending models, DeFi in general, not fall over. There was no contagion there. What you saw was poor balance sheet management from closed shop trade fee lenders,” he added.

Miller’s comment comes despite CoinGecko reporting a 74.6% market cap decline in DeFi during Q2 2022 following the collapse of Terra and a rise in DeFi exploits. Though the crypto data aggregator also noted that the industry managed to retain most of its daily active users.

Miller also added that blockchain projects only ran into issues when the design of their underlying protocols was “obviously poor,” such as the case of Terra’s algorithmic stablecoin TerraUSD Classic (USTC).

“I think that’s a trade off. There’s a Treasury management problem, not a blockchain problem,” he said.

Questioned about how Kraken fared through the crypto bear market this year, Miller suggested the company was well primed to deal with the volatility. He noted that the company has survived many downturns in its 11-year history and notably didn’t blow a lot of money on marketing during the bull run last year.

“We’re in a slightly different position as perhaps some of the other exchanges that have been out there spending lots of money on advertising. We’ve got a really strong word-of-mouth business model,” he explained.

Miller was also optimistic about the current state of the Australian crypto sector, stating that there are a lot of “bullish underlying signals from businesses who are still building products.”

He pointed to major banks such as ANZ recently testing the use of its own stablecoin on Ethereum and major payments giants such as Mastercard joining the Blockchain Australia Association, signaling strong “intent to become involved in crypto and blockchain.”

“So you know, institutions making use of the underlying tech, maybe some heat out of some of the speculative characteristics, that we saw through 2022, which is potentially even a good thing.”

Better days ahead with crypto deleveraging coming to an end — JPMorgan

A strategist at JPMorgan predicts that the worst of the bear market could be over as stronger crypto firms have come in to bail out the industry in the midst of major deleveraging.

The historic deleveraging of the cryptocurrency market could be coming to an end, which could signal the close of the worst of the bear market, according to a JPMorgan analyst.

In a Wednesday note, JPMorgan strategist Nikolaos Panigirtzoglou highlighted the increased willingness of firms to bail out companies and a healthy pace of venture capital funding in May and June as the basis for his optimism. He said key indicators support the assessment:

“Indicators like our Net Leverage metric suggest that deleveraging is already well advanced.”

The deleveraging of major crypto firms, where their assets have been sold either willingly, in a rush or via liquidation, began largely in May when the Terra ecosystem collapsed and wiped out tens of billions of dollars. Since then, crypto lenders BlockFi and Celsius and investment firm Three Arrows Capital have run into their own problems.

Panigirtzoglou added that the severity of deleveraging of some crypto firms could be so severe that they “suggest that the tremors from this year’s crypto market fall continue to reverberate.”

However, Panigirtzoglou argues that deleveraging may be coming to an end, with crypto entities stepping into to bail out struggling companies, stating:

“The fact that crypto entities with the stronger balance sheets are currently stepping in to help contain contagion.”

Amid the calamities befalling several blockchain firms such as Three Arrows Capital and Celsius, Sam Bankman-Fried’s FTX exchange is reportedly positioning itself to expand its influence across the industry. Rumors are swirling that FTX is offering to buy the BlockFi crypto lending platform for $25 million, according to a June 30 report from Cointelegraph. However, BlockFi CEO Zac Prince has denied the rumors in a Thursday tweet.

Panigirtzoglou also sees the healthy pace of venture capital funding in the crypto space as a good sign. According to JPMorgan’s estimates, there was about $5 billion in VC funding to crypto firms in May and June. Fundraising metrics tracker Dove Metrics, using Airtable’s data, estimates crypto funding is higher, at $8.6 billion in the same period.

This rate of funding is down $2.2 billion from March and April, but up $3.4 billion from May and June 2021.

The latest predictions from JPMorgan should blow fresh air into the hearts of crypto investors in 2022 who have endured what Glassnode has deemed the worst bear market in the history of crypto trading. Since November 2021, when the total crypto market cap topped $3 trillion, it has fallen below $1 trillion to $934 billion, according to CoinGecko.