First Mover Asia: When Crypto Rebuilds After This Cold Winter, Firms Like Three Arrows Capital Won't Have a Place; Bitcoin Sinks Toward $20K

Bitcoin and Other Cryptos Tumble

So much for the rebound.

Cryptos, which had risen Wednesday after U.S. Federal Reserve Chair Jerome Powell struck a determined inflationary tone, returned their gains Thursday amid fresh investor worries about rising prices, global tumult and a looming recession.

Bitcoin was recently trading just above $20,300, down more than 10% over the previous 24 hours and again raising questions about whether it might soon break support at $20,000 and spur a fresh round of liquidations. Ether, the second-largest crypto by market cap after bitcoin, was testing the $1,050 waters where it last waded over a year ago, and was off over 15%. Other altcoins assumed various shades of red, with DOT and UNI recently down over 16% and 13%, respectively.

"Investors and traders should be prepared that [Wednesday’s] rebound could choke out rather quickly," FxPro senior analyst Alex Kuptsikevich wrote early Thursday. He said investors need to be ready because "cryptocurrencies and risky assets in financial markets are unlikely to reliably bounce back before there are signals the economy has stopped slowing."

Cryptocurrency prices, which have correlated with stocks in recent months, once again tracked major equity indexes. The Dow Jones Industrial Average, despite its bevy of blue chip stocks, plummeted below 30,000 for the first time in 18 months after closing down 2.4% for the day. The S&P 500, which entered bear market territory earlier in the week (meaning it has fallen at least 20% from its previous high), was off 3.3% while the tech-heavy Nasdaq plunged a whopping 4.1%.

Gold, a traditional risk-off asset, rose 1.2%.

For the cryptocurrency industry, the day was another forgettable one. Celsius watchers continued monitoring the latest fallout from the lending platform's decision to halt withdrawals and other news. CoinDesk reported that Texas, Alabama and other states rel="noopener">are investigating Celsius' decision in light of investor needs. “I am very concerned that clients – including many retail investors – may need to immediately access their assets yet are unable to withdraw from their accounts,” Rotunda told Reuters. “The inability to access their investment may result in significant financial consequences.”

Meanwhile, Crypto lender BlockFi confirmed Thursday it recently liquidated a “large client” amid reports that troubled crypto hedge fund Three Arrows Capital failed to meet margin calls. The crypto hedge fund (see Insights below) has historically been among the industry’s most prolific investors in new protocols and is also a large borrower. And exchange giant Coinbase's (COIN) stock tumbled more than 7% to a new closing low just two days after announcing the layoff of about 1,100 employees. Other crypto exchanges, including the Winklevoss twins-led Gemini and Latin America-based Bitso and Buenbit, have also recently cut jobs.

Entrepreneur and Shark Tank host Kevin O'Leary told CoinDesk TV that Celsius' strategy was proving wrong. "It looks like when it came time for a liquidity event, they weren't able to provide liquidity," he said. "The concept of gating, shutting down is completely against the concept of decentralized finance. If I had an account there, I'd be a pretty pissed off cowboy."

O'Leary sees bitcoin continuing to drop, perhaps 20%, yet he struck an optimistic note about crypto's future, noting among other developments WonderFi Technologies becoming the first crypto exchange to list on a major institutional stock exchange in Canada, the Toronto Stock Exchange, and similar initiatives in other countries. He was also encouraged by the introduction of three, bi-partisan, crypto bills in recent months in the U.S. and called crypto's recent problems and price drop "the beginning of a bottoming out process."

"It's a birthing thing," he said. "It's the beginning of a nascent industry. The bad ideas need to be weeded out. You need to strip the Band-Aid off the wound. This is all good."

Markets

S&P 500: 3,666 -3.3%

DJIA: 29,992 -2.4%

Nasdaq: 10,646 -4.4%

Gold: $1,857 +1.2%

Insights

After the Crypto Thaw, Firms Like Three Arrows Capital Will Struggle to Find a Place

In market downturns, cash will always be king. That was true for firms battling liquidations at the height of the 2008 financial crisis, and firms caught in the crossfire of this summer’s crypto meltdown.

Singapore-based Three Arrows Capital is now at the center of everyone’s attention. The crypto hedge fund has historically been one of the industry’s most prolific investors in new protocols and is also a large borrower. But now it’s in trouble: Facing $400 million in liquidations on its positions, it’s now ghosting its counterparties and liquidity providers. Messari’s fund profiler says the firm is down approximately 58% on the year, which has no doubt compounded its problems. On-chain data suggests the fund is trying to pay down debt by liquidating staked ether.

The question is, how much cash does Three Arrows Capital have? What’s the value of its assets under management?

Both those questions are hard to answer. The best clue to Three Arrows’ cash position comes from its registration with the Monetary Authority of Singapore. There, MAS says that it’s registered to manage assets under S$250 million (US$179.9 million). A December 2020 filing with the Securities and Exchange Commission shows that Three Arrows’ position in the Grayscale Bitcoin Trust – worth $1.2 billion at the time – was split between its Singapore and British Virgin Islands entity.

(New York-based Grayscale is owned by Digital Currency Group, the parent company of CoinDesk.)

But again, this doesn’t demonstrate how much cash Three Arrows has. Using leveraged bitcoin has always been an option to buy-in to GBTC and for the longest time it was possible to premium harvest GBTC and churn it into a source of yield.

The fund has always been coy with its assets under management (AUM), never disclosing it in public and never denying estimated numbers published by research houses.

On-chain analytics house Nansen at one time put that number at $10 billion, but it would be difficult to get an exact number without being able to identify all of Three Arrows’ wallets. Nansen has identified many, but not all, making it impossible to determine this number precisely – or figure out how much leverage is being used.

What we do know about the black box of Three Arrows is that virtually every lending platform from Celsius to Aave has exposure. After all, that’s how they were able to generate the double-digit yield on their deposits. An eventual haircut from Three Arrows will be tough, especially as it comes during a general market drawdown.

Of course, if Three Arrows had a cash position that was more reflective of its crypto AUM, there would be less of an issue overall (let’s not count stablecoins in this as many are fighting hard to maintain their peg).

When crypto rebuilds after this deep correction there will certainly be less tolerance for these black boxes. The entire industry is based on transparency; it’s the defining attribute of the blockchain. Future hedge funds will have no problem putting everything on-chain for the world to see, making surprise liquidations a thing of the past – in theory.

Technician's Take

(Editor's Note: In place of Technician's Take, First Mover Asia is republishing a column by Tusk Venture Partners co-founder Bradley Tusk and head of legal at Dibbs, Thomas Mack)

The cliche is that the only things unavoidable in life are death and taxes. We can probably add new technology to the list, too. Artificial intelligence (AI), the metaverse, autonomous vehicles, flying cars – they’re all coming.

Lawmakers, if they want to be on top of a paradigm shift, should approach tech regulation in a way that is thoughtful, perceptive and comprehensive. But reaching consensus in our statehouses is challenging and finding any sort of common ground in Washington, D.C., is virtually impossible.

Making matters worse, a comprehensive approach to tech policy typically occurs only after some crisis forces legislators’ hands and the media is all over them, only increasing the risk that the law is hasty or ill-conceived.

While new regulatory frameworks will be needed in some areas of Web3 – the version of the internet driven by blockchain – there are other areas where innovators and investors can move the ball forward on the basis of existing laws and regulations, all the while simplifying the task for policymakers.

So let’s talk about technological neutrality.

By “technological neutrality” in the context of Web3 and tech innovation, we mean this: If new technology enables activities that are mostly the same as existing activities, let’s start with an assumption that the law treats the two activities similarly.

Said differently, wherever possible, the law should be neutral to the tech and any variations in legal treatment should come from (and be tailored to) material variations in the business or risks associated with the technology.

U.S. President Joseph Biden’s recent executive order on crypto, while leaving a whole lot unsettled, gives an implicit nod to this approach when declaring, “same business, same risks, same rules.” The crypto community will likely hate the approach the Securities and Exchange Commission (SEC) takes, but at least it’s now in a context we can all understand.

In Web3 and crypto, regulators and innovators alike have at times gotten this backward. For instance, in the midst of the initial coin offering (ICO) boom; an SEC chair once said every ICO token he had seen was a security. That suggested, although digital tokens on distributed ledgers are infinitely variable and could represent anything from book club points to stock in a corporation, legal risks in Web3 stem from the technology rather than what lawyers call a substantive activity.

Under this paradigm, tokens on distributed ledgers were/are “high risk.” However, that hardly makes sense. This type of thinking is no doubt part of the U.S.’s inability to effectively regulate crypto currently and – if we don’t learn from it – Web3 in the future.

Seeking a unified regulatory scheme to oversee “distributed ledgers” – a general purpose technology with highly variable uses – is like seeking a unified regulatory scheme for uses for spreadsheets.

Appropriate oversight

Rather than starting with the technology as the bucketing function, let’s start with how people actually use the technology (their substantive activities), and the presumption that blockchain tech is irrelevant.

What is the business? What rights are being created between parties? How are those rights communicated from seller to buyer? What risks are associated with the business?

If we start with these questions, we usually find that there is relevant precedent in the existing laws, regulations or case law. And more importantly, if innovators, investors and regulators can use this as a shared starting point, we could take a couple of significant steps.

First, tech innovators and investors should have a common framework to assess risk associated with leading edge businesses. A vague sense that Web3 businesses are “risky” can be replaced by targeted questions and answers. What existing businesses does this most resemble? How are those businesses regulated? How is this business different from those businesses? Which of those differences are legally significant, and what are you doing to address risks stemming from that? What here actually impacts regular people and how?

Second, the task for policymakers can be simplified. With a technology as broad as Web3 and crypto, asking a regulator for clarity on Web3 and crypto is understandably daunting. The internet is a broad technology, and regulation would, of course, change depending on whether you’re discussing ecommerce or social networking, consumer protection or data privacy, etc.

If our starting point of technological neutrality can get us good answers on most issues associated with a particular Web3 activity, we can then rely on policymakers for a smaller subset of truly novel issues.

There will inevitably be areas where comprehensive rulemaking and legislation are needed – and industry should not be shy about advocating for that. But there will also be vast swaths of Web3 and crypto that are simply new ways to do the same old things. Not everything is revolutionary. And where that’s the case, let’s lean in on what clarity does exist under the law.

In other words if the government’s failure to properly understand and regulate Web2 has taught us anything, it’s that we need to make this a lot easier for them. Even if we do, they still may drop the ball. Or their politics may cause them to favor entrenched interests regardless of the impact of any particular Web3 business.

Protecting consumers, protecting businesses from fraud is what matters. Not passing value judgements on the merits of one technology over another.