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The entangled contagion continues to spread

The market is still feeling the aftereffects of the demise of FTX. One can argue that it's only been a month since the exchange collapsed, but as the infamous saying "one month of crypto is equivalent to one year in tradfi", the fact that there are continued new revelations on everything that led to and after the event, have been mind blowing to say the least.

As we continue to see exchanges, institutional players and brokers continue to fail, one of the latest (and more important) victims of the contagion that was not covered during our last monthly update was Genesis Trading's parent, Digital Currency Group (DCG). DCG was founded in 2015, of which has many crypto related subsidiaries which included Grayscale (creator of GBTC), Genesis, and Coindesk (the media company that ironically leaked the FTX story, which now has shot its parent co in its foot).

Initially, the market thought the damage to Genesis Trading was limited, given from our last update, they only mentioned a $175m USD position stuck in FTX. In a matter of days, Genesis started to halt withdrawals, scrambling to find additional funding and announcing risks of bankruptcy without additional funding. It was then later revealed that DCG, being its parent, owes Genesis a total of $1.7B ($575m in loans + roughly $1.1b in 'promissory notes'). What does DCG use for collateral on the loan? Grayscale GBTC shares.

To understand how this messy situation resulted in yet again another death spiral for this crypto conglomerate, here we attach a 'simpler' version of the flow diagram to explain the relationship between, DCG, its subsidiaries and its contagion partners, which started with 3arrows Capital (3AC). Simply put, the parent borrowed money from its subsidiary (Genesis), which was likely used to support the failing GBTC prices during 3Arrows Capital liquidation. It uses the same asset created by another subsidiary (Grayscale) as collateral (GBTC), only to realize the value of its collateral has been declining in value and is highly illiquid. It is widely known GBTC cannot be redeemed back into BTC (at the time of writing), can only be traded through OTC and now faces a record discount at -48%.

Source: Ram Ahluwalia

This crypto contagion wouldn't be as critical should the damage only be limited to its subsidiary Genesis Trading only. However, now that the market found out its parent has been a debtor to its subsidiary with $2 billion of overall loans outstanding, all eyes are now focused on what happens to GBTC if DCG cannot stay in business. The worst possible scenario, would be for DCG to apply for Reg M, meaning GBTC would then be redeemable back into BTC - which the market would naturally assume be sold to repay debtors in cash. The effect would be catastrophic for the overall crypto market, as it holds more than 632,000 BTCs ($10.82B USD) in the trust.

On the bright side, with Grayscale earning 2% in management fees annually, it was projected to make around $800m USD in revenue this year from its products. From our perspective, it wouldn't make much sense for DCG to take the dissolution route unless they cannot find new external investors for a potential debt restructuring deal on time.

As we continue to wait on the developments (which could take weeks as hinted by Genesis), the crypto market refocuses back to macro as we await this year's final CPI print and FOMC decision on December 13th and 14th respectively, which should dictate the overall direction of crypto for the rest of the year.

Macro Recap and Outlook

Everyone working in crypto wanted a decoupling from traditional markets, but not in the way that happened in November. It was certainly painful to see tradfi markets massively outperforming crypto due to the Fed signalling potential pivot in its monetary policy as US markets start to show signs of housing credit weakness and the overall slowdown in economic growth. The median Bloomberg survey forecast of November’s inflation print is 0.30% MoM (7.3% YoY). We also don't expect much surprise from the Fed with a market expectation of a 50bps hike (vs 75bps from prior meetings) which is mostly the consensus from the street. The Wall Street Journal reported that some board members are considering a terminal rate above the 5% that the Fed Funds futures curve implies at the end of 1H23 (i.e. an additional 110bps of hikes over the next four meetings).

What's even more painful is many would expect the market to stop trading with 'bad data being bullish' to 'bad data being bearish' because the macro market is weakening faster than expected. History has showen that the market resulted in a crash after the Fed pivoted and lowered interest rates. This meant that crypto had a chance to go higher (we expected $25-28k BTC with macro trading 5-8% higher month on month) before potentially continue to trade lower with macro in ensuing weeks/months.

What does this mean for BTC? The black swan event of FTX definitely messed up our projections in the past, however as covered in our telegram BTC still managed to form a nice weekly divergence towards the end of November, as we hope it can reach W1 10EMA (orange line) around 17.9~18k as target before deciding on next direction.

ETH, being a beta version of BTC, should largely follow its footsteps on any upside or downside with bigger swings. From a technical perspective, it does look like its consolidating in a triangle formation, looking for a potential breakout in early 2023 perhaps?

With the amount of unexpected events stemming from FTX plus the seasonal holidays nearby, exchange volumes continue to decline and volatility has been bleeding. We refrain from calling too many high time frame analysis for now until we see more clarity out of the crypto credit contagion.

Lastly, we leave our readers with a more detailed version of the contagion for those who wanted a bit more detail on the entanglement since the LUNA crash back in April 2022.

Disclaimer: Information in the article may be compiled from news reports and unofficial sources without independent verification. AGAM does not guarantee the accuracy, completeness, timeliness or correctness of any information and is not responsible for any errors or omissions in the results obtained from the use of such information.

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