The Breakdown - The Second Horseman of the Cryptopocalypse

Episode Date: June 15, 2022

This episode is sponsored by Nexo.io, NEAR and FTX US.    On today’s episode, NLW looks at the market’s reaction to Celsius’ struggle to remain solvent. He also examines to what extent the recent downturn is being driven by Celsius and other crypto-specific considerations, compared with being a by-product of larger macro trends.  - Nexo is an all-in-one platform where you can buy crypto with a bank card and earn up to 16% interest on your assets. On the platform you can also swap 300+ market pairs and borrow against your crypto from 0% APR. Sign up at nexo.io by June 30 and receive up to $150 in BTC. - NEAR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NEAR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Find out more at NEAR.org. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell, research by Scott Hill and additional production support by Eleanor Pahl. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsors is “Catnip” by Famous Cats and “I Don't Know How To Explain It” by Aaron Sprinkle. Image credit: Catya_Shok/Getty Images. Join the discussion at discord.gg/VrKRrfKCz8.

So the issue here, in a nutshell, is the exposure of customer funds on this theoretically safe platform to these exotic new defy protocols. Again, in times that are good, this can lead to lots of yield. In times that are bad, it could be catastrophic. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.com. near an FTX and produced and distributed by CoinDesk. What's going on, guys? It is Tuesday, June 14th, and today we are talking about the second

horseman of the Cryptopocalypse. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also a disclosure as always, in addition to them being a sponsor of the show, I also work with FTX. So, Sunday Night Into Around Now, frankly, has been one of the more brutal periods of this cycle. Eath was down nearly 15%. Bitcoin fell as low as mid-21K, which is around 30% down from where it had been at the end of last week.

The joke on crypto Twitter was that it wasn't Black Monday, but McDonald's Monday, as everyone was going to have to go look for jobs. Now, there has been a very minor bounce after another cratering last night, but still, markets are bleak. So what has been going on? As tempting as it is to blame it all on things going on inside crypto, which is the core of what we'll be discussing today, there is more happening in the larger macro context. It started on Friday, which brought us the May inflation report. April's inflation had been 8.3 percent, and economists had expected, it to stay the same or go down slightly to 8.2%. They were also expecting the month-over-month CPI to rise by about 0.7%. Well, at 8.30 a.m. Eastern time, we got a surprise to the upside.

Instead of staying flat or declining, inflation went up to 8.6%, a fresh 40-year high. Month-over-month CPI was up a full percent. So what does this mean? Well, at the very least, it likely confirms the Fed's plan to hike 50 basis points in June and July. However, it also might even prompt them to think about being more aggressive. The Wall Street Journal reported Fed likely to consider 0.75% point rate increase. Now, some of this conversation came from investment banks in their research houses. Quote, a handful of Wall Street forecasters, including at investment banks, Barclays and Jeffries, said Friday, after the inflation data were released,

that they expected the Fed to raise rates by 75 basis points this week. Now, ultimately, this is just speculation, but still, markets were effectively reading reports like this as the Fed, prepping the market for a shift in strategy. Zero hedge, who, of course, you have to take with a grain of salt, tweeted panic, yield sore after Wall Street Journal Fed leaker, says odds rising of 75 basis point rate hike. The point is that there is so much going on in the macro that's shaping risk assets everywhere. Interestingly, for the first time in a while, headlines started coming out yesterday suggesting that the Fed is actually paying attention to the stock market and what's happening there, which they basically scrupulously said they weren't doing.

But at the same time, basically no one thinks that the Fed is really ready to care about anything other than those top-line inflation numbers. Indeed, some think they're trying to break specific demand in other areas. Raoul Paul said it's going to be an unpopular opinion here, but the market position that the central banks want to see liquidated the most is the long in energy. Until that breaks due to demand destruction, everything else will remain under pressure. Macroscope built on the same theme as well, saying today is an example of the Fed's predicament. Markets crushed, but oil steady. Years of policy errors have led to this moment. People should be outraged. I've said the Fed will

eventually stop even with inflation uncomfortably high, a new normal. Days like this reinforce that. ultimately the macro train that we are on was perfectly captured by Ben Carlson who tweeted, The Fed needs to raise rates as quickly as possible to tame inflation by sending us into a recession, where they can then cut rates to save us from the recession. So of course, the point of all this is that what we're seeing in crypto is not just about what's going on in crypto. It has a distinct macro context that is bigger than crypto, but it is also about what's going on in crypto. So what's happening over here? If you've been paying attention at all since the weekend, everyone is discussing Celsius.

Nexo lets you easily buy crypto with your bank card and earn industry-leading interest rates. Earn up to 16% on crypto and up to 12% on stable coins. Nexo makes passive income easy with interest paid automatically and daily. With Nexo, you can also borrow against your crypto at 0% APR and exchange over 300 pairs. receive a welcome bonus of up to $150 in Bitcoin until June 30th at nexo.io. That's nexo.io. This episode is brought to you by Mir, a climate neutral, high speed, and low transaction fee, layer one blockchain platform.

NIR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NIR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Reimagined your world today at neared.org. The breakdown is sponsored by FTXUS. FTXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets, with up to 85% lower fees than competitors.

There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FTCSUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. Celsius is a company in the same space as companies like NXO or BlockFi. By the way, I will say here, not that you could really forget, Nexo is of course a long-term sponsor of the show.

So whatever grain of salt that makes you want to take anything I say with, I totally support. I'll only say that I hope at this point you believe me when I say that I'm always going to strive to give dispassionate, clear-eyed thoughts that share lots of perspectives, not just mine, regardless of sponsorship of the show. Anyway, this is a category of companies that do a few different things, but are best known for one, being able to give customers short-term liquidity in the form of cash or stable coins without actually having to sell their crypto, and two, offering yield for customers who deposit their crypto.

The second use case has been a real target for you. U.S. regulators. BlockFi has very publicly had these issues, but Nexo and Celsius have as well. Celsius has seen multiple state regulators issues cease and demands. Within this framework, however, different companies in this area have been on either more conservative or more aggressive ends of the spectrum in terms of the yields they offer and the strategies they use to get that yield. As an aside, our conception and discourse around quote-unquote yield is going to be one of the biggest reflection points during this bear market. It's deserving of a full, more than a whole show. But for now, the relevant thing is that there has been a sense within the

crypto community that Celsius's practices to get yield have been, shall we say, more on the aggressive side. The gambit here is offer higher yield as a way to attract more customers, which works if we're in the world of number go up. But what about when number go down? How do each of these outlays put customers' assets at risk? John Wu did a great thread about the whole Celsius situation, and put it this way. There are two extremely bad behaviors Celsius. undertook that have combined to put it and its millions of retail investors in a bind. One, use of on-chain leverage and two, STEth. In terms of on-chain leverage, John goes on to say that in order to provide low-rate

borrowing for users, Celsius itself accesses leverage through permissionless on-chain money markets like Maker-Dow. That means taking user deposits in assets like wrapped Bitcoin and depositing them to borrow dye. Maker is a collateralized lending protocol, put in 150 of volatile collateral, e-g. E.th. And borrow the die-se. stable coin. If the value of collateral falls below a liquidation threshold, it is liquidated to repay the loan and prevent bad debt. Now back to Celsius, having a nine-figure loan on maker is a bit troubling, but normally it shouldn't be a problem. If Celsius's lending collateral is falling in value, then so is Celsius's customer's lending collateral. Liquidate your customers' loans and

repay your own. He then goes on into the ST-Eath problem. In TLDR, STETH is a product of Lido finance. As Wu describes, it allows anyone to earn ETH-staking yields without running stake infrastructure. The issue is that while ST.Eth can be traded for ETH on the open market, it can't be redeemed for ETH until about six to 12 months after the merge happens, which obviously hasn't come yet. So the issue here, in a nutshell, is the exposure of customer funds on this theoretically safe platform to these exotic new DeFi protocols. Again, in times that are good, this can lead to lots of yield. In times that are bad, it could be catastrophic. And thus for a long time, been an undercurrent of conversation around Celsius's approach to their business and whether it was a

risk for the industry. That chatter has gone up more recently with rumors of insolvency. Sources had recently told publications like The Block that SELSIUS only had a few weeks of financial resources to meet customer withdrawals. This is not a conversation that Celsius lets happen without a battle. CEO Alex Mashinsky has always been very aggressive at accusing people of fudding and was doing so all the way up to Saturday night, yelling at people like Mike Dutus and Dylan LeClair for spreading rumors. By Sunday night, however, the company had paused withdrawals. citing, quote, extreme market conditions they released a note, we're working with a singular focus to protect and preserve assets to meet our obligations to customers. Our ultimate objective is

stabilizing liquidity and restoring withdrawals, swap, and transfers between accounts as quickly as possible. There is a lot of work ahead as we consider various options. This process will take time, and there may be delays. No timeline for resuming withdrawals was included. The community has been focused on almost nothing else since. They've been trying to track what Celsius is doing with their funds, how much capacity do they actually have to make customers whole, and how much are they trying to do that versus trying to keep the party going. One thing in particular that people are looking at is Celsius loans outstanding with those

protocols like Maker, whereas the price of Bitcoin or ETH go down, they have to post more collateral to avoid liquidation. Zero X Fubar says all on-chain indications point to Celsius repeatedly topping up their leverage, hoping to make it all back in one trade rather than closing underwater positions. Not great. Les Moscovsey says Celsius has posted another 1501 BTC as collateral and pushed its liquidation price down to 17,211. Dylan LeClair, however, points out the problem. This likely ends with Celsius liquidated and me buying their liquidation candle. Machinsky, cover the loan if you know what's good for you. The lower you push the liquidation price, the more aggressively whales will sell to make sure it hits.

Larry Sermak from the block also points out the bigger implications for Defi. I don't think people realize how much of DeFi is actually just Celsius parking their client money. If they wind all of that out, TVL, total value locked, will tank so badly. Also, a lot of prop funds and market makers borrowed uncollateralized from them. The impact would be massive. Whatever the truth of the situation, competitors are definitely moving to distance themselves. Zach Prince from BlockFi says all products and services at BlockFi continue to operate normally, including loans, interest earning, trading, credit card, and deposits and withdrawals.

We have zero STEth exposure and exited the principal positions we had in GBT last fall. Nexo went even farther. In a tweet, they write, After what appears to be the insolvency of Celsius Network and mindful of the repercussions for their retail investors in the crypto community, Nexco has extended a formal offer to acquire qualifying assets of Celsius Network after their withdrawal freeze. Now, this is obviously a strong move towards what appears to be a pretty distressed company. John Wu sums up the current state of the Celsius situation thusly. TLDR, Celsius had all the opakness of Tradfi and all the degeneracy of defy. Take retail money, lever up, bet it on black,

convince everyone it's safe until the moment it's not. They were ignorant, negligent, or both. It's getting real for them, and now for all of us. So again, it has felt too crypto like this is the only story and it's big. Still, maybe we close with a little helpful contextualization from Alex Kruger. Realize how little this crypto dump has to do with Celsius and the STETH drama and all to do with the widespread panic and risk assets, equities in crypto alike, and broken charts. My guesstimate is Celsius added 1.2x to the fuel. Everyone making it about Celsius, watch the media tomorrow. But without Friday's CPI numbers and equities collapsing, this would not have happened. Still, of course, whether internal to crypto or just based on the macro, the pain is real.

Yesterday, BlockFi announced that they were laying off 20% of their staff. Today, Coinbase announced cuts of a further 18%. In his note, Brian Armstrong took on some of the blame himself, saying that they had grown too quickly, but ultimately, it was about larger market conditions. Quote, we appear to be entering a recession after a 10-plus-year economic boom. A recession could lead to another crypto winter and could last for an extended period. In past crypto-winter's trading revenue, our largest revenue source, has declined significantly. While it's hard to predict the economy or the markets, we always plan for the worst so we can

operate the business through any environment. If this feels like we are settling into something protracted, you are not alone in that sense. Later on this week, we'll have a deeper discussion of the stages of the bare market and what the hallmarks are and what other signals like OTC are telling you. But for now, again, remember, the worst thing you can do is panic. The best thing you can do is get clear about what. why you're here and where you have long-term conviction. Also, listen to a great song. Hug your kids. Go touch some grass. Do whatever it takes. If you are among the people who has been

laid off, there are still plenty of companies in this space that are hiring, and what's more, bare markets are where really interesting things get built. I don't want to be glib about the pain that is here and more pain that will come, but there is another side to this. I want to say thanks again one more time to my sponsors, nexo.io, near and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.