THE DAWN OF THE CRYPTO ICE AGE

Part I

“They go down faster than they go up.”

Ben Smith, also known as ‘Sell ‘Em Ben Smith’, after the 1929 stock market crash

With all the …unpleasantness… in the crypto world these days the climate is turning from Crypto Winter to Crypto Ice Age. There’s even a Mastodon stalking around as the Tweets fall into the snow.

So, what’s going to be left in the wreckage of this multiple-spaceship crash? And can we now understand the key weaknesses of the crypto phenomenon?

I think so.

Of course, it’s more fun to pore over the lavish tax-haven houses, the sexual adventures (what’s a polycule?), the mysterious “suicides”, the weeping victims, and the under-diagnosed Asperger’s of the crypto class.

Still, someone has to start the Crime Scene Investigation, so I’m putting on my white booties, sorting through disgusting pictures and picking up clues with my tweezers. What was the key weakness of the crypto market?

What were the trigger events for the crash to happen this year? And how deep are the connections between the crypto world and the “real” economy. For the sake of discussion, we’ll say the “real” economy includes investment banking, consultants, and the Fed’s conventional notions of how the monetary and banking systems work.

I’ll jump ahead of the exposition with my hypothesis. The trigger events were probably in plain sight.

First, the disclosures of US Federal investigations of crypto exchanges and business clusters that leaked out back in March of 2021. That led to an initial wave of attempts at civil litigation.

Second, the Fed’s policy rate increase announced on May 4, 2022. The rate hike quickly led to a less liquid dollar/foreign exchange market, which upset the over-leveraged crypto exchanges and the hedge fund complex clustered around the exchanges.

As the crypto exchanges had more difficulty and expense in translating their crypto multi-billions into dollars and other forms of “fiat” money cash, they began to either cover their costs with customer money or just stop answering customers trying to execute trades. After they had gotten their personal and house trades done, they reconnected after prices had fallen and let the customers know their accounts had taken losses. This behavior is not, you know, “legal” in the conventional fiat money world.

However, I strongly disagree with Sen Elizabeth Warren and her fellow professional scolds, who all think the crypto mess could have been prevented if cryptocurrency assets and trading were fully regulated.

No, we were blessed that crypto was not regulated earlier. If the crypto cowboys had been given the stamp of approval implicit in regulation, then there would be a much closer integration of the regulated conventional banking system and fairy gold traded by the cryptonians. Then the crypto collapse really would have drawn in the banking system.

The banking system is already creaking under the weight of over-leveraged and heavily regulated weak assets, such as housing, LBOs and commercial property. It does not need more junk, naively regulated or not.    

And the decisive weak points, the Schwerpunkt of the crypto trading world, were the exchanges. These did not follow the hard-earned lessons of conventional exchanges. They were really pirate ships. There were weak or nonexistent walls between customer money, the exchanges own capital, and the operators’ personal accounts. Hedging was poorly done where it existed. Short positions were not market making tools but ripoffs. “Arbitrages” were concealed robberies. Technology was weak, for all the pictures of servers and cables. Fundamentally the operators were kidding themselves and the public.

We see the circus of FTX and Sam Bankman-Fried. Other, more notional legitimate exchanges will also fold, though maybe less cinematically. If the founder/sponsor/managers of these exchanges are onshore, in relatively strict rule-of-law countries, they will be professional defendants for many years.

Some exchanges, though, may have founders/sponsors/hidden backers who are able to hop nimbly from one offshore tax haven and non-extradition place to another. Dubai is the plush haven of choice, but then we also have Cuba, Western Sahara, or other fun places with few extradition agreements.

There might be, in other words, crypto kings who get away with it all. That’s harder now than in the seventeenth century, when there were true guns-and-gold pirate/libertarian refuges such as Port Royal, Jamaica. I’ll look at one candidate for successful escapee in the next couple of days….