Trust is the Lesson to be Learned
Bank runs, contagion, and carnival barkers: the last two months have been a masterclass in financial education.
The bloodbath in the crypto market over the last couple months has been incredible to watch; both as a participant and as a spectator. As a participant, it’s been humbling and educational. As content consumer, the last month or so has been fascinating to watch. I have to admit, Twitter has been essential for crypto spectators. It’s such an important tool for gauging sentiment because all of the well known crypto participants and builders are on Twitter sharing information.
Some are keeping a level head. Others are not. Many in the crypto community have turned on each other, which is something that I’ve already written about and won’t rehash. My take on the maxi vs “alt-coiner” argument is simple: what was probably always deep shielded resentment of tokens and players in the game who aren’t “pure” enough has become far more apparent in the crypto evangelists. Conversely, what was probably always deep resentment of Bitcoin maximalism has become far more apparent in those searching for yield from the non-HODLers.
There’s quite a bit of “crypto slang” in the last paragraph. None of it actually matters. While the crypto influencers argue online, what has happened is actually pretty simple to explain: crypto is experiencing it’s Lehman-contagion bank run moment. It really is that simple. When Terra LUNA blew up in May, things started to unravel and we found out who was swimming naked. Celsius Network, while not dead, appears to be in serious jeopardy. BlockFi was bailed out by FTX. Voyager just filed for Chapter 11 this morning.
What do each of these three entities have in common? They’re all essentially crypto banks. They’re custodial enterprises that secure customer assets. Celsius had poor risk management procedures and is struggling to survive after halting customer withdrawals. A run on Celsius assets is something I specifically foreshadowed in September when Celsius received a cease and desist order:
My opinion, as more states serve Celsius and Blockfi these kinds of orders, the chances of an old school bank run on those platforms increase.
Voyager is bankrupt because the company lent over a half a billion dollars to Three Arrows Capital (3AC); a crypto investment fund that turned out to be a Madoff-style Ponzi scheme - the loan is obviously in default. BlockFi, which claims to be a victim of exchange run contagion, was bailed out by a much larger crypto company (FTX). I can only speculate, but BlockFi’s sheet must have been in better shape than those of Celsius and Voyager. Despite that possibility, BlockFi wasn’t spared from bank run contagion.
This Glassnode chart shows the price of Bitcoin (black line) with the net asset flow of centralized exchanges represented by the green and red bars. Green is inflow. Red is outflow. What those historically low outflow bars indicate is a move to self-custody. Market participants are finally realizing counter party risk isn’t necessary when the database is public and the wallet address (essentially your account in traditional banking terms) doesn’t require a custodian to access.
This is the beauty of Bitcoin and other cryptocurrencies. You don’t need a bank. You are the bank. Some people save in dollars with a custodian. Others save in Bitcoin without one. Both have risks. But self-custody is a critical concept to understand. Look, I have crypto with custodians. I hold most of it myself. But I like being diversified and betting on just myself for security is a single point of failure. You just have to be very selective with your custodians. If the custodians are paying you yield, they’re probably leveraging your assets for that yield. That’s risky. If they’re not paying you yield, they’re probably taking much less risk and you theoretically have less to worry about. Just be aware of who you’re doing business with and how they make money. And remember, every single decision you make has risk.
The Traditional System Isn’t Safe Either
One of Bitcoin’s biggest critics is Peter Schiff. Peter, who usually tweets about Bitcoin several times per week, hasn’t tweeted about Bitcoin since June 30th. But it isn’t because he hasn’t tweeted at all. It’s because his focus has shifted entirely to his legal issues involving the denied sale of his Puerto Rico-based bank by regulators.
Since July 3rd, Schiff has detailed how the sale of his bank was denied and then shut down by regulators due to solvency concerns. According to Schiff on Twitter, his bank has been targeted by the IRS because of concerns of money laundering and tax evasion. Peter and that bank were the focus of a 60 Minutes Australia piece in late 2020 because of those same IRS concerns. His full response to that piece can be seen here.
I have no idea if Peter’s bank is on the up and up or if there was some sort of money laundering happening. It seems as though that concern wasn’t the reason given for the closure of the bank. If what Peter says on Twitter is true, the bank is potentially being targeted because Peter Schiff is an outspoken dissenter. I won’t attempt to opine on that, all I’ll say is the depositors are the ones who now can’t get their funds out. While I’ll admit that it’s possible some of those depositors are criminals, I think it would be a stretch to say innocent people aren’t getting hurt by this. For innocent depositors, it’s the same situation as Celsius and Voyager. They trusted their funds with an institution, and now they can’t get their funds back.
“Don’t Be Silly”
Before I start taking whacks at one of the biggest financial media punching bags in the game, I want to share a brief history of Jim Cramer. Jim Cramer is the host of Mad Money on CNBC. I’m not being sarcastic when I say this; Cramer is one of the most interesting specimens in all of media. He’s everything that is right and everything that is wrong with cable news stations and financial media all at the same time. Cramer is probably famous in finance for two comments he has made on live television:
“They know nothing!”
My issues with Cramer aside, this rant is phenomenal. However, there was something important that he said in that video that was largely forgotten because of the more bombastic “they know nothing” line. The more important quote was when he was talking about his banking buddies talking to him off the record:
let them be calm and then have them call me on the way home like they do every night and tell me, Cramer, what are you gonna do about it? Are you gonna help us?
The context of this was that central bankers like Ben Bernanke were acting like things were fine in a public facing environment. Beneath the surface, those in important positions at banks knew there were very serious problems. The Fed was seemingly unware of these issues because they weren’t communicating closely enough with the actual market participants. The banks wanted a more truthful message in the media because it would have likely meant the Fed would be forced to lower rates - which would have been better for the banks. This is an important tell because it speaks to why Cramer’s second most well known comment happened:
Don’t move your money from Bear! That’s just being silly. Don’t be silly!
While Cramer has been justifiably lambasted for this comment publicly, I think it’s important to remember that what pushed Lehman over the cliff was a bank run on assets. Whether Cramer was talking about deposits or common stock equity in this video can be debated; he later assured he was talking about deposits. What can’t really be debated is he was trying to help his banking buddies at Bear by not causing panic - essentially the same position arguably taken by Bernanke that Cramer criticized.
Institutions get in these kinds of messes when they have bad risk management. That’s the bottom line. When you trust your assets with a custodian, you’re trusting your assets in the hands of an entity that could theoretically make poor decisions with those assets. While US dollars in a legitimate bank have FDIC protection, that insurance doesn’t help somebody who needs their cash in a moment’s notice if the bank has to halt withdrawals to limit a run. And as we can see from Cramer’s behavior, trust isn’t just granted or lost in the institution, it’s granted or lost in the messenger as well.
The end result
Poor risk management positions like overleveraging ultimately lead to insolvency. Insolvency can lead to contagion. And contagion can lead to larger systemic meltdowns. These things are awful when they’re happening and a lot of people can get hurt pretty bad financially. We’re certainly seeing some pretty sad things on social media right now when it comes to Voyager. I’m not going to share them, because I don’t think it’s necessary.
The larger point is trust. When we take financial positions, we have to understand who we’re putting our trust in. That can be a custodian. That can also be a person. At the end of the day, doing your own research is critical. It isn’t just a throwaway line that people put in disclaimers. It’s important. Trust yourself first and foremost. Carnival barkers? Maybe less so. In the last two weeks alone, Cramer has flip flopped on crypto TWICE. This is from two weeks ago:
This is from yesterday:
Today, he seems to like it again.
Trust. Be careful where you place it. Recognize that what Cramer was crucifying Ben Bernanke for over a decade ago is probably now happening again. Powell and his gang of academics don’t see a recession. Oil and copper seem to be saying the opposite.
Disclosure: I’m not an investment advisor. I merely share what I do and why I do it. You shouldn’t take anything I say as investment advice and always do your own research when making investment decisions. Cryptocurrencies, tokens, STONKs, and digital trinkets could all go to zero.