Over the weekend, the bitcoin price dipped below the $20,000 per closely watched bitcoin level, more than 70 percent below its all-time high set late last year.
Opaque backroom negotiation
Ethereum and the other top 10 cryptocurrencies BNB, XRP, solana, cardanoand dogecoin have also seen similar declines.
Much of the carnage in recent weeks has come from the suspension of withdrawals from a centralized lending platform called Celsius which was partly inspired by a traditional investment bank, but without a depositor guarantee.
Dr Low said the collapse of Celsius showed the dangers of opaque and hidden trading and reflected the damage caused when deposit-taking institutions lend to each other insecurely using excessive leverage.
“Cryptobanks are the biggest concern, mainly because they present themselves as the safest option for crypto investors, but what they do on the backend is not transparent,” Dr. Low said.
Celsius accepted money from investors in exchange for their CEL token. The US-based organization, founded by engineer Alex Mashinsky and S. Daniel Leon, would then lend that crypto money to other companies willing to pay for the liquidity.
The fees they received for lending that crypto reached 18 percent, but as the global macro-investment picture darkened earlier this year, the demand for crypto loans dried up.
Celsius, which allowed its borrowers to leverage heavily, began to experience widespread defaults on its loans and struggled to find new ways to generate returns for its token holders.
As such, CEL token holders began selling, with the lender forced to halt withdrawals as it struggled to find funds to cover its depositors.
“Essentially, this was a crypto bank run,” Dr. Low said. “And there were no requirements for Celsius to have capital backing in reserve, so they got caught.”
One of Celsius’s biggest investors, Singapore-based hedge fund Three Arrows Capital, was ordered liquidated after it was shown to have heavily leveraged itself by making bullish bets on everything from Celsius to Bitcoin to Luna, a cryptocurrency. linked to the Terra Stablecoin crash in May.
Unlike stock markets, falling crypto markets do not have “circuit breakers” to stop sharp declines in asset prices. Dr. Low compares this to the Great Depression of the 1930s, when the stock market went into free fall.
Regulators stepped in and installed “circuit breakers” that would stop trading if asset prices fell too low.
“The difference between that and the crypto world is that the crypto world has thousands of exchanges all over the world,” Dr. Low said.
Unlike stock prices, which are tracked by regulated exchanges like the Australian Stock Exchange or the New York Stock Exchange, cryptocurrency prices are largely an aggregation of thousands of exchange data points. .
Unregulated securities lending
Dr. Low says that the lending practices of “crypto banks” like Celsius, and another called BlockFi, mirrored those of securities lending.
For decades, asset managers like BlackRock, which own thousands of shares through its ETF business, can lend them to short sellers and derivatives traders for a fee.
The securities are wrapped in financial products that are then sold by other banks, but BlackRock has a fiduciary duty to ensure that those borrowed securities can be replaced if the borrower defaults.
“It’s a way to monetize your holdings,” said Dr. Low, whose doctorate looked specifically at how much capital is required to support a securities lending business.
“But crypto lending companies don’t have any regulations or requirements to back the crypto they are lending.”
Calls for crypto regulations have gotten louder recently as the public collapses from tokens like TerraUST show the inner workings of these financial engineering products.
Until regulation is in place, many cryptocurrency-backed products that mimic those in the traditional financial world would cause widespread damage when they crashed, Dr. Low said.
“This will keep happening over and over again,” he said.
“Until there are capital requirements, those running these businesses will be tempted to take on more and more leverage to generate more returns. When the market changes, we will see them disappear again.”