Monthly Macro Update (Oct/Nov 2022): The House of Crypto has fallen

We are sure you have heard about the news of the now defunct #2 exchange in the world, FTX. Words cannot describe the sheer craziness of what has been unfolding for the past 10 days since the first coindesk article that leaked the company's troubled balance sheet. However before we get into the details (which is still developing) and our opinion about the state of the cryptocurrency industry, let's quickly recap what happened in October.

Uptober was true

It appears that October has followed the expected outcome of being a statistically green month, with BTC and ETH rising as much as 5.5% and 18.3% month over month respectively. To be fair, the market was still stuck in a range for the first three weeks of October, when market makers baited late shorters with one of the largest 24hr liquidations we have in a while (800mm USD):

Overall crypto showed strong strength over legacy markets after FOMC as the market read the Fed signalled to slow down the pace of rate increases. The majority of October were bulls and bears waiting for the CPI / PCE, FOMC rate decision or non-farm payroll, of which the bulls finally prevailed:

The majority of the focus has been on Elon Musk's takeover of Twitter, which benefited DOGE coin with a +140% rise, dragging related meme coins up (such as SHIB).

With the overall market sentiment where inflation is expected to be lower and a FOMC decision that will cap its speed of tightening (which did happen), legacy markets and crypto were poised for further upside in Q4. Even looking at the BTC monthly chart below as of 31 October, we actually formed a very nice bullish divergence against RSI too - which was the first time to happen in BTC history.

November's CPI print did help US equities continue their uptrend (S&P +3% as of writing). Unfortunately crypto faced a different fate after the first week of November.

The Contagion

Source: Beeple - everyday artwork

For those who wanted a quick backstory and a quick timeline building up to the implosion of FTX, Bybit has a great unbiased and quick summary to get you up to speed. Once FTX halted withdrawals, we continued to see events unfolding as if we are in a Hollywood movie.

Given the estimated damage so far to be $8-10 billion USD, we expect more carnage from other players in the industry as the story continues to develop.

Sam? SAM?

The best description we can make out of this using previous financial frauds would be: a Lehman-style blowup by a Theranos-like founder who utilized methods similar to Bernie Madoff. We, along with our industry counterparts, are left stunned and speechless. We would assume that most of the skeletons were out of the closet post 3 Arrows Capital contagion. We were wrong. Given FTX and Alameda's size, reputation with institutional money and US government, no one would have thought they were in trouble despite a rough Summer triggered by the LUNA unwind. It was even further revealed most of the FTX employees are unaware of the ongoing fraud of their management.

What exactly went wrong with FTX/Alameda? How could they put themselves in such a huge hole? While there are many theories surrounding failed bets in other investments, the most logical explanation to us would be how Alameda, as a market maker to FTX, ran an unprofitable business with regards to handling liquidations (especially during times of extreme turbulence such as the LUNA and 3AC crashes). SBF may have continued to fund Alameda's losses with customer deposits, whilst continuing to go out to raise funding while acting business is strong through continued acquisitions of other failed businesses (Voyager being the most recent case). Coupled with borrowed funds using collateral printed out of thin air (FTT), this becomes a recipe for disaster in a bear market when your collateral value drops significantly, forcing lenders to margin call one's loans.

Sample ponzi-like flywheel flow diagram (allegedly used by Celsius)

Needless to say, the 2022 bear market is far worse than any previous crypto bear markets, combined. This event puts a serious dent in the development of cryptocurrency adoption, both from retail adoption and institutionalisation angle. Sure, ongoing narratives now push for the importance of Defi over Cefi; however Defi also faces its own issues of infancy being easily hacked with funds stolen.

As much as the quote "Don't trust, verify" flies around in this world, there still needs to be a basic degree of trust to do any sort of business / financial transaction. That trust has clearly been breached by one of the leaders in crypto that championed for institutionalisation. All the glamorous sponsorships in Celebrities, Sports Arenas, focus on philanthropy, and its "DC-friendly" image fell like a house of cards all within a few days. How would the industry continue to grow without the trust of the institutions that once believed in FTX?

Does that mean crypto is done? With all that said, while the short-term outlook of the market looks bleak, this too shall pass. We still believe in the power and disruption of digital assets. Markets will always have a cycle, and they will eventually come back. Time is always the best medicine, and by nature, Crypto moves 10 times the speed of tradfi, we do hope the crypto industry as a whole heals itself and engages in better self-discipline. If there's any point in time to point out a market cycle capitulation, we do hope this could be it (not investment advice).

We're still not ruling out a bear market rally here. Technically if FTX didn't implode, our charts (as mentioned in the above section) would have suggested BTC spring to $24,000-$26,000 area. Perhaps FTX going bankrupt may be the last inning of the credit contagion, which could fuel a relief rally.

Moreover, with ETH recently becoming a deflationary asset, this could potentially set up for a nice recovery happening before the next Bitcoin halving occurrs in mid 2024.