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Difficult start to March for the cryptocurrency market. While it is always complex to isolate the reasons behind any pullback, there is no doubt that two main topics influenced prices during the week. The tumult began with the growing difficulties of Silvergate Bank on Friday. Jerome Powell’s comments on inflation and upcoming interest rate hikes added another layer yesterday. Let’s take a closer look.
Silvergate is a financial institution that provides banking services to fintech companies, including those in the cryptocurrency sector. Specifically, Silvergate offers services such as wire transfers, ACH transfers and deposit account solutions to cryptocurrency exchanges and other digital currency businesses. Silvergate’s services are designed to help these businesses manage their fiat currency transactions and access liquidity, which is crucial to the functioning of the cryptocurrency ecosystem. Now, the company delayed filing its annual 10-K report with the U.S. Securities and Exchange Commission on Wednesday, telling the commission that it “needs additional time” to allow an independent accounting firm to complete certain audit procedures. As noted in the comments, Silvergate highlighted several factors that are expected to negatively impact the timing of its 10-K report. These include the sale of investment securities in excess of estimates and information previously disclosed in the press release. This includes the sale of investment securities that exceeded previous estimates and disclosures in the company’s earnings release. In addition, the company’s recent sale of debt securities in January and February 2023 is expected to result in further financial losses, according to Silvergate’s forecast.
The move had immediate effects on the resolve of various industry players with ties to Silvergate. Coinbase tweeted that “In light of recent developments and out of an abundance of caution, Coinbase is no longer accepting or initiating payments to or from Silvergate.” Crypto.com follows suit, announcing that “deposits and withdrawals via Silvergate have been temporarily suspended.” Gemini, founded in 2014 by the Winklevoss twins, also said it has stopped accepting withdrawals and deposits from its customers or making transfers via Silvergate on its platform.
Silvergate now appears poised to become the next victim of FTX’s bankruptcy. According to earlier reports, Silvergate experienced a notable drop in bank deposits following the collapse of FTX. The bank reported a 68 percent drop, equivalent to $8.1 billion, in January 2022, which occurred in the last quarter of the previous fiscal year. To handle the large volume of withdrawals during this period, the bank used a $4.3 billion loan from the Federal Home Loan Bank and sold approximately $5.2 billion in debt securities. This allowed Silvergate to meet the high demand for withdrawals, despite the significant decline in its bank deposits.
It has been reported that regulators have entered into urgent discussions with Silvergate in an effort to save the cryptocurrency-friendly bank from potential closure. According to sources familiar with the matter, the Federal Deposit Insurance Corporation (FDIC) has been in talks with Silvergate management to explore potential solutions. Bloomberg reported on March 7 that the discussions were aimed at finding ways to save the bank and prevent its closure.
Silvergate’s (SI) stock was trading at $13.53 at the close of trading Wednesday, before the announcement of the postponement of its 10-K report. Before the markets open today, its price is at $5.21, down 98% since its November 2021 high. During the bulk of the drop on Friday, meanwhile, bitcoin opened at $23,470 and closed at $22,350.
This Wednesday, the price of bitcoin dropped to a three-week low, due to hawkish comments by U.S. Federal Reserve Chairman Jerome Powell during his testimony before Congress. Traders reacted by adjusting their expectations for a “terminal rate” hike, which contributed to the decline in bitcoin’s value. During his testimony, Powell announced the central bank’s intention to raise interest rates above previous estimates, citing the protracted process needed to reduce inflation to the target rate of 2 percent. The Fed has already raised rates by 450 basis points since last year. Following these remarks, traders in Fed funds futures raised their projections for the top or terminal rate to 5.65%, up from about 5.47% at the start of the week and 4.9% a month ago. This indicates that traders are now anticipating further tightening in the coming months, with the central bank raising rates by at least 100 basis points before reaching the end of the tightening cycle.
Needless to say, this persistent inflation and negative outlook weighed on the overall markets yesterday, as it did for the vast majority of 2022 for that matter.
As part of that same testimony, Powell also addressed the topic of cryptocurrencies directly. The Federal Reserve chairman said that innovation should not be stifled, but that financial institutions should be “very careful” in how they interact with cryptocurrencies. “Like everyone else we’ve been watching what’s been happening in the crypto space and what we see is quite a lot of turmoil, we see fraud, we see a lack of transparency, we see run risk, we see lots of things like that,” Powell said. “What we’ve been doing is making sure that the regulated financial institutions that we supervise and regulate are careful and taking great care in the ways they engage with the whole crypto space.”
FTX revealed that it discovered an $8.9 billion shortfall in customer funds that cannot be explained. This is the first time the failed cryptocurrency exchange has been able to quantify the extent of the missing funds. According to a public presentation released Thursday, FTX has identified about $2.7 billion in customer assets, while outstanding balances on customer accounts total $11.6 billion. The estimated value of the company’s assets and liabilities is based on cryptocurrency prices at the time of FTX’s bankruptcy filing in early November. On the same topic, FTX announced that its subsidiary, Alameda Research, is suing asset manager Grayscale Investments to unlock investments that it claims are illegally denied to its clients. FTX’s new CEO John J. Ray III, who is overseeing the liquidation of the defunct cryptocurrency exchange, issued a statement Monday saying Grayscale was imposing an “abusive redemption ban” that prevented clients from accessing their funds.
Judges overseeing Grayscale’s lawsuit against the Securities and Exchange Commission (SEC) questioned the financial watchdog on Tuesday, looking into why the agency denied Grayscale’s application to establish a Bitcoin ETF. Grayscale filed a lawsuit against the SEC in June of last year after it denied a request to convert its Grayscale Bitcoin Trust (GBTC) into a bitcoin spot market ETF. A key part of the SEC’s argument was that Grayscale’s application lacked the data necessary to confidentially determine “whether fraud and manipulation in the cash market has the same impact on the futures [markets].” Yet Judge Neomi Rao said it appears that the bitcoin futures price is a derivative of the asset’s spot price, which moves together 99.9 percent of the time. She said the SEC had not provided evidence that Grayscale’s claims were wrong. “There seems to be a lot of information about how these markets work together,” adding that “the Commission really needs to explain … how it understands the relationship between bitcoin futures and the bitcoin spot price. The price of GBTC reacted favorably to the news, climbing 9% while bitcoin was falling in parallel.
The SEC has received its share of criticism for its stance on cryptocurrencies this week. Finally, it is worth noting that Binance US has been allowed to buy back Voyager’s assets, as a judge has rejected the SEC’s objections. U.S. regulators will not be allowed to sanction executives or advisers involved in the bankruptcy of Voyager Digital Ltd. for creating a new cryptocurrency that would help pay off the bankrupt digital asset lender’s customers, a judge said Monday. The SEC’s position “would leave a sword hanging over the heads of everyone who is going to do this transaction,” the same judge said. “How can a bankruptcy proceeding or any other legal proceeding work with that kind of suggestion?”
According to a recent report from CoinShares, Bitcoin miners’ capitulation has been completely different during this bearish cycle. When market conditions are favorable, Bitcoin miners tend to hold on to their Bitcoins, limiting the supply of new coins during times of high demand and further stimulating the overall upward price trend. However, in difficult times, such as in recent months, miners tend to sell their bitcoin holdings, usually to cover operational costs during less profitable periods of operation when the bitcoin price is low, or to pay off highly leveraged positions. Many miners would then cease operations, creating a real trough until the mining difficulty level was adjusted to allow them to resume operations.
However, this is not the trend seen during 2022.
Christopher Bendiksen of CoinShares explains, “When you had a much less efficient capital market it was probably a lot less orderly and we saw that manifested previously as these big pullbacks in difficulty,” he said, comparing the current network to when the industry was less established. “That just hasn’t happened this time, even though we’ve had spectacular bankruptcies and a bunch of operations struggling.” Yet this time, mining firms have been particularly resilient, continuing to operate and weathering the headwinds without flinching. This is evident with the network hash rate, which continued to climb throughout 2022. This expresses a higher level of industry maturity in this cycle.
New on-chain data seems to indicate that bitcoin is in a transitional cycle, but on the right side of the price floor. The price of bitcoin is very sensitive to changes in interest rates and fluctuations in the U.S. dollar index (DXY), which puts pressure on risk assets. The most effective way for bitcoin to counter short seller pressure is to bring new long liquidity and cash buyers into the market. Looking at net trade flows is a useful indicator for measuring new liquidity, and currently this metric shows a 34% increase since the beginning of 2023. However, it is still below the average daily rate of $1.6 billion for the year.
While some bitcoin investors have taken profits, there have been positive indicators on-chain, revealed by the Net Unrealized Profit/Loss (NUPL) metric. NUPL measures the disparity between unrealized gains and losses in the supply of bitcoins.
According to a recent report from Glassnode, “Since mid-January, the weekly average of NUPL has shifted from a state of net unrealized loss to a positive condition. This indicates that the average Bitcoin holder is now holding a net unrealized profit of magnitude of approximately 15% of the market cap. This pattern resembles a market structure equivalent to transition phases in previous bear markets.”
In short, while March may be blowing a headwind from the early year’s advance for now, it seems that the worst is nonetheless behind for cryptocurrencies, at least in their own cycles.
Rivemont Investments, manager of the Rivemont Crypto Fund.
The presented information is as of March 8th, 2023, unless otherwise indicated and is provided for information purposes only. The information comes from sources that we believe are reliable, but not guaranteed. This statement does not provide financial, legal or tax advice. Rivemont Investments are not responsible for any errors or omissions in the information or for any loss or damage suffered.
