DeFiSafety is an independent rating organization that evaluates Decentralized Finance products to produce an overarching security score based on transparency and adherence to best practices. DeFiSafety’s Process Quality Reviews (PQRs) follow a clear, standardized, and established process, allowing users to directly compare scores across different projects. DeFiSafety’s PQRs allow users to make informed decisions about the protocols they invest in and provide developers with clear, achievable goals for improving code, documentation, and transparency.
SEC declines Grayscale and BITWISE spot Bitcoin ETF Applications
Spot ETFs for BTC and ETH are top of mind for many advisers. This is likely the vehicle they will choose when it comes available for many reasons. Two of the highly anticipated applications were from industry leaders Grayscale and BITWISE. Grayscale applied to transform its flagship fund GBTC into a spot BTC ETF. BITWISE had applications in for a futures and spot ETF but withdrew their futures ETF application in late 2021 to focus efforts on pushing a spot ETF application through.
On Wednesday, June 29th, 2022, after many delays, the SEC finally decided to reject these applications. The SEC has denied now over a dozen spot bitcoin ETFs with the list of names including Fidelity, SkyBridge, and Valkyrie. The rejections have focused on applicants lacking surveillance-sharing agreements with regulated markets relating to the spot funds’ underlying assets.
Later that day Grayscale announced its intention to sue the SEC after its decision. “The SEC is failing to apply consistent treatment to bitcoin investment vehicles as evidenced by its denial of GBTC’s application for conversion to a spot ETF, but approval of several bitcoin futures ETFs,” Grayscale said. “The SEC is acting arbitrary and capricious by continuing to approve bitcoin futures-based ETFs while continuing to deny spot bitcoin ETFs,” Grayscale CEO Michael Sonnenshein said in an interview with CNBC. Sonnenshein also mentioned that because the defendant is a regulator, the case goes straight to the appellate court and a decision should made be within nine to 12 months.
Also, important to note in the SEC rejection, that “The SEC’s rejection of Grayscale’s application did not reflect an assessment of whether bitcoin or blockchain technology more generally, has utility or value as an innovation or an investment.”
What does this mean?
It means advisors across the US will have to wait a lot longer for a spot BTC or ETH ETF. Many regulatory dominoes will have to fall before a spot ETF meets the regulatory requirements that the SEC say are missing. The main piece is the regulation of centralized digital asset exchanges.
Although a spot ETF is further down the road, advisors can still gain access to an efficient investment solution, like Arbor Digital’s SMA, on behalf of clients.
Effects of Digital Asset Markets Deleveraging
Goldman Sachs is attempting to raise $2 billion to purchase Celsius’ distressed assets. There are rumors that Celsius was working with Citigroup to help deal with their recent struggles but didn’t like the advice they received and are looking elsewhere for help. It remains to be seen if Goldman actually wants to get into the digital asset lending game or if this is a pure buying of cheap assets opportunity.
FTX and CEO Sam Bankman Fried are taking advantage of the company’s bad risk management in search of deals as evidenced by the recent news they are looking to buy BlockFi, centralized finance (CeFi) digital asset lender. Earlier this month, FTX agreed to provide a $250 million revolving credit facility to BlockFi. Bankman-Fried has also been acting as a lender of last resort for other crypto companies and provided credit lines to Voyager Digital Ltd., which is exposed to bad debt by Three Arrows Capital.
As reported by FTX, they are paying roughly $25 million, and a term sheet is almost complete, citing unnamed sources. Zac Prince, chief executive officer of BlockFi, responded in a tweet, saying “I can 100% confirm that we aren’t being sold for $25M.” Prince didn’t comment in the tweet on whether BlockFi was in acquisition talks.
What does this mean?
Digital asset companies with high leverage and low capital levels are vulnerable. You can expect this is the opportunity the big traditional finance incumbents have been looking for to either acquire assets, poach talent, build their own solutions, or a mix of the three. We expect this is just the beginning of consolidation in this crypto winter.
Managing Though Crypto Winter
Last week we dove deep into On-Chain metrics we pay attention to. Today I’d like to share a few other pieces we pay attention to but are especially important in a crypto winter:
- Protocol Revenue and Fees
- Protocol Treasury Management
- Estimated Leverage Ratio
CryptoFees.info shows how much users are paying to the protocol on a daily basis. This is the revenue these networks generate on a basic level.
OpenOrgs.info shows the balance sheets of protocols. Based on the holdings, transactions, and governance activity we can gain insights into how the treasury is being managed.
Estimated Leverage Ratio (ELR) is defined as the ratio of open interest divided by the reserve of an exchange. ELR for a derivative exchange tells us how much leverage is used by users on average. This information measures traders’ sentiment whether they take a high risk or low risk. The value itself can be interpreted as the degree of leverage in the market with a high value translating to an over-leveraged market and increased volatility and a low value translating to a low leverage market. This also serves as a trend indicator to show the tendency of total investors’ urges to use leverage. Increasing in values indicates more investors are taking high leverage risk in the derivatives trade. Decreasing values indicate more investors are taking off leverage risk in the derivatives trade. Also, if the ELR value is low compared to the last couple of days, it indicates traders are changing their views or finishing their positions. If the ELR value is high compared to the last couple of days, it indicates traders are quite confident in their positions.
We monitor these pieces as part of our ongoing due diligence and analysis of protocols regardless of if we are in a bear or bull market. Given what we have learned over the 18-month long bull market protocols who are well-capitalized, not over-levered, and diversified in their treasury have shown to be great performers from a business standpoint. Pairing this with a measure, albeit not nearly complete given we can’t see leverage in CeFi institutions, like ELR, helps us separate the noise from reality.
What does this mean for the portfolios?
This means we will be taking what we have learned and applying it to our portfolios. For Flagship, we will continue to use this and other on-chain data to determine to buy zones for cash coming onto the platform. For the Compass portfolio we will be decreasing exposure to protocols we are less convicted of and consolidating to protocols that we are extremely convicted of given what we have learned. You can expect specific communication on actions in the coming weeks.
Webinar: Crypto State of the Union: Trading & Risk Management, 12:00 pm ET, Thursday, July 7th, 2022
Presented by Blockworks: Risk management may not be sexy in bull cycles. But in periods of high volatility, guardrails look attractive. In this state of the union, we will survey market conditions and what we can expect going forward.
Reading: The Chainalysis State of Web3 Report
Blockchains are ushering in the next phase of the internet. We’ll uncover what you need to know. Web3 promises a new, decentralized internet built on blockchains, where users can take more control of their data, content, and finances. But how much progress has been made in this journey so far? Who’s leading the way? And how does it all work? We’ll answer these questions and more in our State of Web3 webinar. The report covers:
- How DEXs power DeFi
- The promise of digital real estate and NFT gaming
- How DAOs democratize ownership – at least in theory
- The layer 1 blockchains that undergird web3
- Digital identity, market risks, and more!