What is happening to Crypto?

This is warranted with the tail winds the crypto markets have received under the current administration. Crypto was able to survive the Biden’s administration hostility to the industry due to Elizabeth Warren and continue to build. It was expected once we had regulation change institutions would start investing into crypto and we would have another euphoric moment like 2021. Sadly, this was not the case, this article will provide you with a breakdown to help you have some materials for the dinner table on Thanksgiving night.

10/10, The Tariff Catalyst

In the evening of Friday October 10th Trump went on to his social media platform Truth Social to post about his plans to impose a 100% tariff on China. This was in response to China’s tightening control on rare Earth minerals, these minerals are important as they are needed for EV batteries, semiconductor, smart phones, military hardware, etc. You might be thinking what does this have to do with the crypto markets?

In the evening of Friday October 10th Trump went on to his social media platform Truth Social to post about his plans to impose a 100% tariff on China. This was in response to China’s tightening control on rare Earth minerals, these minerals are important as they are needed for EV batteries, semiconductor, smart phones, military hardware, etc. You might be thinking what does this have to do with the crypto markets?

If you look at when Trump posted on Truth social, it was at 1650 EST. The U.S. stock market stops trading at 1600 EST, if you’re an investor and see this news and want to be risk off, where do you go to trade on the news? While traditional markets operate within banking hours, crypto markets operate 24/7. Easiest way to get exposure to the market has been through DeFi protocols that offer perpetual futures such as HyperLiquid, Lighter, Ostium and Aster to name a few. Some other options are centralized exchanges with deeper liquidity are Binance, Bybit and OKX.

As investors raced to flock into cash or short the market this created the largest single day liquidation event in crypto history, nearly $20B USD was liquidated on Friday evening. To put things into perspective the crypto market cap is about $3T and the DeFi market market cap is about $115B. This type of strain in the system caused many of the perpetual future markets to Auto Deleverage (ADL) users positions to protect themselves from any bad debt, while lending markets had to liquidate loans with a high Loan to Value (LTV) ratio.

When liquidations happen in crypto they tend to happen in a cascading event, this is because DeFi protocols allow investors to expose themselves to high amounts of leverage through perpetual futures offering 50x leverage and lending markets through recursive lending.

(Source: https://www.coinglass.com/pro/futures/liquidation-events)

FED October Meeting

The Federal Reserve is in charge of the United States monetary policy and the board members meet every 6 weeks. The FED has many roles to play in the US and global economy, one of their primary roles is to set the interest rate banks can borrow from the FED, these FED rates affect the interest rates of loans such as home mortgages. Essentially, the FED controls what is the risk free rate for the cost of capital. In the last meeting in October the FED lowered interest rates by 25 bps (0.25%) and hinted at no more rate cuts for the rest of the year. You can see how the market changed on Polymarket right after the FED meeting. This brought more negative sentiment to investors.

(Source: https://polymarket.com/event/fed-decision-in-december?tid=1764092212055)

DeFi Hack

On November 3rd, a long standing DeFi protocol called Balancer was hacked for $120MM. Balancer's code has been live for over 4 years with dozens of code audits by reputable auditing firms such as OpenZeppelin. DeFi has an ethos of immutability and ensuring protocols are unable to move investors funds. However, there is always a risk to the smart contract being hacked. Smart contract hacks have been a struggle for some time for DeFi, totaling $15.6B USD of funds lost due to hacks; the industry has gotten better with smart contract hacks and recovering investors funds through entities like Security Alliance. You can read a more in depth detail on the hack from Rekt here and Balancer’s post mortem report here.

(Source: https://defillama.com/protocol/balancer)

Stream Finance

Stream Finance was a fund manager wrapped into a synthetic stablecoin (xUSD) offering double digit yields. Investors would deposit stablecoins into the Stream Finance contract and would be issued xUSD in return. The stablecoin would be deposited to a Fordefi wallet, the Stream Finance would deploy these stablecoins into various DeFi strategies to earn yield, Stream Finance had full autonomy to investors funds with no guardrails. While promising double digit returns Stream Finance grew up to $200MM, as they grew the founder provided capital to an external fund manager. This fund manager lost $93MM of investors funds. You can read a full detailed report of the house of cards from Rekt here.

(Source: https://defillama.com/protocol/stream-finance)

ETF’s

There are 2 sources of capital that fueled crypto’s bull run Digital Asset Treasuries (DAT’s), which will be covered later and ETF’s. When the SEC approved the Bitcoin ETF it allowed many investors access to BTC and ETH exposure without having to create an account on a crypto exchange and manage their digital assets. These ETFs provided an easy way to earn on BTC and ETH upside exposure within the convenience of their broker dealer for a small management fee. As you can see from the data provided by DeFi Llama, ETF inflows have stopped and there are more sellers than buyers. The reason for this? Many investors are securing their gains before the end of the year, some might suspect a bear market coming to the crypto markets, investors are preparing for tax season or all of the above.

(Source: https://defillama.com/etfs)

What are Digital Asset Treasuries (DAT’s)

DAT’s refer to a publicly traded company that starts to invest a large amount of their treasury reserves into digital assets like Bitcoin, Ethereum or Solana, instead of traditional assets such as cash or bonds. This isn’t a new strategy, according to the Digital Assets Council of Financial Professionals (DACFP) four years ago there were only about 10 publicly traded companies that held Bitcoin on their balance sheet. Michael Saylor was the first person to aggressively pursue this strategy with his publicly traded company Strategy (MSTR), Saylor started to put Bitcoin on his company's balance sheet back in 2020.

Saylor and his team were creative in finding ways to raise funds to purchase Bitcoin for their balance sheet between preferred shares and corporate bonds, using every financial instrument available to them. This created a mNAV premium between MSTR’s balance sheet and the market cap. There was a premium because investors could not access exposure to the crypto markets and MSTR was a proxy to getting Bitcoin exposure.Once you are able to create a repeatable strategy, other follow suit, this spurred a boom in DAT’s spinning out of publicly traded companies from sectors such as pharmaceuticals, gaming, and event furniture.

Lets fast forward 4-5 years, MSTR has been listed in the S&P500, this creates massive buy pressure for MSTR, every index tracking the S&P 500 had to buy MSTR in proportion to the S&P 500 breakdown. So far, everything is going great, but what happens when a DATs mNAV is at a discount? You either have to dilute your share holders or you have to sell assets from your balance sheet. The second biggest catalyst pushing the crypto markets into a bull market is now selling to keep the mNAV at a premium and not dilute their share holders. Lastly, there are rumors of MSTR getting delisted from the S&P 500.

Conclusion

In one paragraph, Trump’s tariff post on Truth social created the biggest one day liquidation event in history dragging crypto prices down, this forced a cascading sell off within the DeFi markets. ETFs no longer have net inflows and investors are selling their gains. DATs mNAV went flipped from a premium to a discount due to crypto prices causing DATs to sell their digital assets from their balance sheet to not dilute shareholders.

I would like to thank the following platforms for their data that helped with this article: DeFiLlama, Coinglass and Polymarket.