One after another major player in the crypto world toppled over since spring 2022. Crypto exchange FTX was the latest (for now?). Crypto prices took a nosedive during this period. Are we at the end or could some more corpses fall out of the closet?  

'Only when the tide goes out, do you discover who is swimming naked' is a famous quote by Warren Buffett. Ever since the US Central Bank (Fed) began aggressively raising interest rates in early 2022 and the monetary tide has receded, we have been discovering which emperors in the crypto world have no clothes on.

In other words, certain market players have been taking too much risk, in particular by speculating with borrowed money. This goes unpunished in times of abundant money but becomes a problem when monetary conditions become tight. Crypto hedge funds like 3 Arrows Capital (3AC) and lending platforms like BlockFi and Celsius borrowed too much money during the bull market and did not hedge the risk against price drops. They are now bankrupt. 

Grayscale Bitcoin Trust as underlying problem

A central role during the past bull market was played by the Grayscale Bitcoin Trust (GBTC). That is a publicy traded trust that issues shares. If you buy those shares, Grayscale buys Bitcoin for them. Currently, the trust has a massive amount of 600,000 BTC on deposit with Coinbase. Especially institutional investors bought shares of this fund, as it was the only way for them for a long time. There was (and is) no US Bitcoin ETF yet. 

An important feature of the trust is that the shares roughly - but not exactly - follow the price of Bitcoin. In 2020, the shares were in such demand that they were more expensive than the underlying Bitcoin. That enabled an arbitrage trading strategy, which milked this price difference. At the time, it was possible to exchange 1 Bitcoin for shares in the trust. Six months later at the earliest, you could sell the shares again at a profit. At a profit... provided that the shares were still worth more than 1 Bitcoin. And that would change soon.

The aforementioned arbitrage trade came to an end when the price of trust shares fell below the price of Bitcoin in early 2021 (currently, the price difference is as much as 40% in Bitcoin's favor). And that's where the problem started for the big borrowers. The collateral for their borrowed Bitcoin (from Genesis, a sister company of Grayscale that issued GBTC shares) had fallen hard. Not only had the price of Bitcoin fallen, also the price of GBTC fell even harder. The tide was retreating and hedge funds like 3AC were exposed.... 

Who else will be exposed naked? 

What market issues could still depress share prices in the coming weeks and months? We already mentioned Genesis briefly. This is the only trading house where institutions can do crypto business: buy crypto, borrow, etcetera. Genesis halted withdrawals last week and started looking for a billion-dollar loan. Both Genesis and Grayscale fall under parent company Digital Currency Group (DCG). The question currently hanging over the market is whether Genesis/DGC can keep its head above water. 

There are other (probably smaller) market risks. For instance, it is possible that MicroStrategy, company of Bitcoin bull Michael Saylor, could be forced to sell a good number of Bitcoin at some point. This is because they bought some of their Bitcoin with borrowed money: the issuance of corporate bonds. If their operating results were to be very disappointing and their dollar reserves depleted, it is not inconceivable that they would get a margin call on part of their 130,000 Bitcoin. 

Another well-known risk is capitulation of Bitcoin miners. Many mining companies are currently so unprofitable that those who borrowed to buy equipment are struggling and could be forced to sell Bitcoin.

Conclusion

The common thread of this story of the receding monetary tide is the risk of borrowed money deployed to speculate on price appreciation, leading to bankruptcy. It is possible that there will come a last wave of forced sellers. While that would be bad news for the price in the short term, it is good news for bargain hunters. If the last victims of the bull market are forced to sell, the final phase of the sell-off is in sight....