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JPM: ‘A new wave of crypto deleveraging underway’

Wild times. Even TradFi people are stuck gawping at the crypto cluster right now, but JPMorgan’s Nikolaos Panigirtzoglou has been following the “asset class” longer than most sellside analysts, so we thought we’d share some of his latest report.

He point out that what makes this latest crypto puke extra poignant is that JPEG Morgan itself has now imploded.

Earlier in the crypto winter of 2022, Sam Bankman-Fried’s FTX and its connected market-maker Alameda Research swooped in for several failed projects. Now, the list of potential crypto saviours is looking pretty thin, Panigirtzoglou points out:

What makes this new phase of deleveraging more problematic is that the number of entities with stronger balance sheets able to rescue those with low capital and high leverage is shrinking within the crypto ecosystem. FTX and Alameda Research had emerged last May/June as the main entities with apparently strong balance sheets to rescue weaker and more leveraged entities such as BlockFi, Voyager Digital and Celsius. Now that the balance sheet strength of Alameda Research and FTX is under question only a few months after being perceived as strong balance sheet entities, it creates a confidence crisis and reduces the appetite of other crypto companies to come to the rescue.

Regarding ‘balance sheet strength under question’, we should point out that the latest news is that SBF is currently going around asking for eight billion real dollars of emergency funding.

There is basically no balance sheet left worth speaking of.

FTAV is a (reluctant) member of some crypto discussion groups, and there is a lot of chatter of trapped money in FTX and class action law suits. Many hedge funds used FTX because it was perceived as more “legit” than many of its rivals.

Inevitably, then, the debacle is going to raise regulatory questions again, and force a lot of the crypto trading infrastructure to be more transparent about their holdings, Panigirtzoglou argues.

What is certain is that the collapse of Alameda Research/FTX will increase investor and regulatory pressure on crypto entities to disclose more information about their balance sheets, to safeguard client assets, to limit asset concentration and will induce more diligent risk management including management of counterparty risk among crypto market participants. FTX in particular has been preferred over Binance by institutional clients such as hedge funds, so the past days’ events will likely change the way institutional investors interact with exchanges to ensure their assets are protected. It is encouraging that nine exchanges including Binance, Gate.io, KuCoin, Poloniex, Bitget, Huobi, OKX, Deribit and Bybit have issued statements that they would publish their Merkle tree reserve certificates to increase transparency. Merkle trees allow Exchanges to store each user account’s hash value of assets in the leaf nodes of the Merkle tree. Assets on a leaf node can be audited and verified by a third party.

However, Panigirtzoglou thinks this wave of crypto deleveraging is going to be less acute than the one that followed the collapse of Terra/Luna, 3AC and Celsius earlier this year, simply because the crypto universe has already shrunk so much.

He says that JPM’s proxy for bitcoin futures positioning stands at the lowest since January 2020, “pointing to rather advanced deleveraging”.

The deleveraging phase that followed the Terra collapse had induced a 50% decline in crypto market cap from around $1.7tr at the beginning of May to a low of $0.86tr by mid-June. With the crypto market cap standing at just above $1tr before the FTX/Alameda Research collapse, our guess is that the crypto market will find a floor above $500bn in the current deleveraging phase. Another way of thinking about the downside from here is the bitcoin production cost which historically acted as a floor for the bitcoin price. At the moment, this production cost stands at $15k but it is likely to revisit the $13k low seen over the summer months. A production cost of $13k implies 25% downside from here which would bring the crypto market cap to a low of $650bn.



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