The bankruptcy cascade

In May 2022, the collapse of a protocol called Luna kickstarted a cascade of liquidations across the whole industry which lasted for 9 months. For the first few weeks it appeared to have been contained but slowly people came forward declaring losses and in some cases bankruptcy. Some of them were very large. Luna losses were around US$2 billion. Thanks to its leveraged positions, crypto hedge fund 3AC managed to lose US$3 billion. There was another pause before finally taking out FTX, whose losses were US$8 billion.

The question was, and to some extent still is, where does the contagion end? At what point do the losses hit someone rich enough to survive? We may have got there. Here’s a thread from Cameron Winklevoss of Gemini;

For the avoidance of doubt, Genesis has filed for bankruptcy and is a sister company of the Grayscale Bitcoin Trust. The deal says two things, the Digital Currency Group, parent of Grayscale and Genesis have enough money to survive. How couldn’t they, given the $200m+ in management fees they make annually. Also, the Winklevoss brothers are throwing $100m of their own to protect the reputation of Gemini (there was never a suggestion Gemini itself was in difficulty).

Contagion generally ends when it reaches someone rich enough to wear the loss. Which in traditional finance is normally a central bank bailout. Although the process has been ugly between Barry Silbert (owner of the Digital Currency Group) and the Winklevii, we may have reached that moment.

I’m surprised the lack of airtime this has received. I view it as overwhelmingly positive.

Hopium

The United States Treasury recently published a forecast of who they expect to be the future holders of US bonds. US citizens hold roughly 100% of GDP in bonds at the moment, which is forecast to rise to 300% in 2050.

What will it be I wonder that will drive euphoric levels of investment in these instruments? It seems insane but the Japanese experience suggests it isn’t. Enough people can be convinced to buy these “very safe” investments and it remains true that you will always get your (nominal) money back because the US can print it.

These kinds of projections are likely there to soften people up for the new normal, and the new normal will be a US budget dominated by interest payments resulting in a debt spiral.

Talk is of 5%+ rates in America this year. 50% of US debt needs refinancing in the next three years. Interest payments on that debt alone are $1.5 trillion. At 5% interest, that would make it the largest spending item.

It’s not that America will go bankrupt or default, it will just be a slow and painful process. Talk everywhere is that you can get 6% here and 5% over there with pretty much no risk. Clearly, those rates are a massive increase on what we were seeing 12 months prior and it’s great news for pensioners. For everyone else it’s a trap.

I retain my view on bonds. They have zero asymmetric properties, but you will lose your money slowly and comfortably while bearing no risk and serving no productive capacity.

Bitcoin by ARK

Following up last week’s 2023 themes, ARK has published a bitcoin-specific update. As we know, ARK is intensely bullish on all things Bitcoin so perhaps it’s more helpful to share some of the themes they are negative on.

There are 20 pages of up-and-to-the-right but their bearish slides are more interesting.

First, M2 money supply. Why should it matter to bitcoin? Well the more growth in this the more relevance there is to bitcoin’s limited supply. Ultimately this will turn, possibly quite sharply but for now the taps are off at levels not seen in a century.

The recession harbinger, not everyone believes in this one but its record as a predictor has been very good. Again, you would want to see this turn the corner before momentum really gets going.

Ordinals

Long-time bitcoiners will recall the block size wars that preceded the contentious fork of bitcoin in 2017. That whole story is covered in an excellent book, The Blocksize War. The most recent twist in the tail has been the invention of what are known as ‘Ordinals’.

An Ordinal is an inscription in the bitcoin blockchain that records data which can then be interpreted as an image. The transactions are large and correspondingly expensive and were only enabled (by accident) through the Taproot upgrade in 2021 (we covered it here, rather prophetically as it turns out).

The red bar in the chart below shows the explosion in images in bitcoin over the past week. We have reached 50% of all records now relating to these kinds of inscriptions. The backlog of bitcoin transactions has exploded as a result.

Is this bad? Arguably yes, because the inscriptions do not facilitate value transfer in the way other transactions do and so the blockchain is filled with data unrelated to bitcoin’s core purpose.

In the end though the system is permissionless. If you want to pay money to inscribe an image in this way then the software allows you to do that, the miners get paid for mining the transaction, and people who want to perform financial transactions have to pay slightly more or use the Lightning Network.

If you want to take a look at an ordinal here is the eponymous monkey jpeg now living on the bitcoin blockchain. The main objection is that the data set relating to the image has nothing to do with the transfer of value but that is only true if you don’t think the monkey picture is valuable. Plenty of people think it is.

Take your pick; it matters not. The likelihood is these will be wildly popular particularly because they exist entirely in the blockchain whereas an NFT does not.

Personally, I believe it is inevitable that digital value finds its way into the most secure blockchain. It’s unavoidable and some of the things that happen we will like and support and some we won’t which is both annoying and also exactly how it should be.

Euro-Trash

Some niche-amusement for you in the form of letters from the ECB to parliamentarians in Europe. This letter from Christine Lagarde to Mr Bas Eickhout (a Dutch MP) sets out the methodology by which the ECB selects which corporate bonds it will purchase and in what quantities, based on their perceived ‘greeness’.

A “best-in-universe approach”.

I hope whatever you are doing this afternoon, that you approach it with your own “best in universe” methodology. Shoot for the stars people, like the ECB does.