FIVE MINUTE FINANCE: CRYPTO’S LEHMAN MOMENT, WHAT CPI MISSES IN MEASURING INFLATION, MORE
The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.
Let’s see what’s going on this week:
- In 7 Days, Over $340B Wiped from Crypto Market Cap
- Inflation at 8.3%, but How Accurate is CPI in Measuring Inflation?
- UST and LUNA: Crypto’s Lehman Moment
- EA Breaks Up with FIFA as Stock Slides 18%
- Coinbase Under Scrutiny for ‘Hostile’ Market-Making
Is There a Bottom Beneath the Bottom?
- MicroStrategy Down 46% YTD, Will Get Margin Called if BTC Falls Below $21k (link)
- Crypto Market Cap Down $144B after Stocks Plunge (link)
Crypto Crash Explained
Since last Friday, the crypto market has lost roughly 20% of its value. That’s a total of $340 billion, which, for perspective, is 35% larger than Ethereum’s current market cap ($250B). While everyone will point to the UST / LUNA saga as a cause, there are other factors at play, too.
At $1.2 trillion, the total crypto market cap returned to a level not seen since July 2021. Image credit: coinmarketcap.com
What kind of a pool is crypto floating in for such severe drainage to happen?
Let’s keep this analogy going (stay with me). Imagine an olympic-sized USD pool, with a (much) smaller crypto pool floating in it. The USD pool has been flooded to enormous proportions for the last two years, resulting in sky-high water levels, i.e., inflation. As a result, the diluted USD keeps losing its buying power, leading one to think that a separate crypto pool would be more stable.
Yet, everything in the world directly or indirectly floats in the USD pool, including crypto and even China’s export-oriented economy. What happens when the Fed comes in and starts draining the pool to combat inflation? All other markets start to flush with it. We are seeing that full drainage in force right now.
After all, a complete drainage of the USD pool means the end of world’s current economic world order. Moreover, other fiat currencies will perish long before USD does, as exemplified by the vampiric rise of the Dollar Strength Index (DXY).
Weighted against other currencies such as euro and yen, DXY is at a 20-year high. Image credit: Trading View.
For many investors that got into the crypto pool, they feel more comfortable by jumping into the USD pool as a less rocky container. In turn, they signal weak hands (short-term holders) to do the same, triggering investors to jump out of the kiddy crypto pool. Does this mean that even crypto whales like Michael Saylor will get flushed due to the draining sell pressure? Would they then completely deplete the crypto pool with their own selling pressure?
Not likely. Although MicroStrategy’s CFO said their BTC-backed loan may be margin called if Bitcoin goes under its realized price (under $21k), Saylor later claimed that the bottom would have to be extremely shallow, at under $3,562 per BTC. As the flushing continues, strong-hands have a firm grip, picking up the slack of those who jumped out.
Continuing with the liquids theme, Bitcoin’s liquid supply change turned negative. This not only foreshadows a bullish turn within a historical context, but the loss of profitability is not that severe compared to previous periods.
Image credit: Glassnode via Twitter
The lesson? You will get wet if you jump into the bigger pool prematurely.
Is CPI an Accurate Measure of Inflation?
- US Annual Inflation Lowers to 8.3% But Falls Short of Expectations (link)
- US Futures Drop on Inflation Worries; Dollar Gains: Markets Wrap (link)
Measuring Different Periods By Different Standards
The most common way to measure the loss of USD’s buying power is through the Consumer Price Index (CPI), calculated by surveyors who go out to households and record their expenses. An even more extensive metric is Personal Consumption Expenditures (PCE), which takes into account a wide range of expenses, commonly used by the Fed.
In April, CPI was pegged at 8.3% while PCE reached 6.6%. CPI declined for the first time in 7 months, but not by very much, considering CPI peaked at 8.5% in March. Before any conclusions can be gained from this, we have to ask how this inflation figure is calculated in the first place.
Per the CPI, inflation more than doubled since the Fed retired the embarrassing “transitory” phrase last year. image credit: TradingEconomics.com
At the end of 2021, the US Bureau of Statistics made a policy shift in how inflation is calculated, to make it more accurate. The question then is, if the metric changed, is it applied retroactively? If not, does it make sense to talk of inflation as achieving a 40-year high, a period which had been calculated under a different metric?
These statistical sleights of hand (calculation updates) are nothing new. In April 2011, CNBC reported that inflation is “actually near 10% using an older measure”. Meaning, current inflation is most likely already in double-digit territory. The market seems to respond to the latest inflation report as if this is the case.
S&P 500, Nasdaq 100, Dow Jones Industrial Average and MSCI World index all fell after the report. Investors anticipate further Fed interest rate hikes because it is unlikely that minor percentage hikes are going to sustainably tame inflation. In historical terms, this certainly hasn’t been the case.
Historically, interest rates (green line) had to far exceed PCE in order to squash inflation (red line). Image credit: fred.stlouisfed.org
Regardless of where inflation actually is, there’s some good news here. If we’re to see a recession anytime soon, it will be a government-induced recession. When it comes to recession textbooks, this is the best kind to have — it generally suggests the Fed will steer us towards a soft(ish) landing. Let’s hope this is the case.
UST Exposes Major Weakness in Algorithmic Stablecoins
- The World’s Biggest Stablecoin (USDT) Has Dropped below Its $1 Peg (link)
- LUNA Falls Below $1 After Do Kwon Endorses Proposal to Save UST (link)
Not All Stablecoins Are Created Equal
Just as one would stress test a new computer by running the most intensive applications for long periods, crypto crashes test virtual ecosystems.
With the Bitcoin foundation becoming fragile, two have failed to withstand the scrutiny. Interestingly, they are both stablecoins — USDT and UST — one asset-backed and the other algorithmic. The first one, Tether USDT, is the largest and oldest stablecoin, backed by “cash and other equivalents” at 84%, which is an improvement from 2019’s 74%. If this sounds suspicious, it’s because it is.
In case of a bank run caused by a panic-selling market, are those equivalents liquid enough to qualify as 1:1 reserve backing, which could soon be required per a draft on stablecoin regulation? The loss of USDT’s dollar peg to $0.95 suggests not.
Tether USDT stablecoin during the height of the sell-off. Image credit: CoinMarketCap.com
However, the temporary peg loss suggests USDT is backed, but that it takes time to withdraw the reserves immediately. The same cannot be said for Terra’s UST/LUNA ecosystem which suffered a complete collapse this week.
UST — an algorithmic stablecoin — no longer functions as a stablecoin, having lost its USD peg to an astonishing $0.17. Likewise, Terra’s UST stablecoin went from last week’s $18.6 billion market cap to under $2 billion.
At the moment, the Luna Foundation Guard (LFG) is trying to proactively defend its UST peg by issuing a BTC loan (worth $750 million) to over-the-counter (OTC) trading firms.
This hasn’t resulted in a recovery yet, and LUNA, the native crypto of the Terra ecosystem, lost -99.98% of its value since last week. In early April, LUNA’s market cap exceeded $41 billion. As of May 13th, that number is under $245 million.
Terra’s validators have now halted its blockchain multiple times to plot next steps.
To make matters worse, the world’s largest exchange, Binance, halted the trading of both UST and LUNA. Image credit: LFG.org
There is some speculation that hedge funds are involved in the death spiral of the once second-largest smart contract ecosystem after Ethereum. Gemini exchange denied these accusations which suggested it suppled 100k BTC to BlackRock and Citadel Securities.
However, even if malignant forces were afoot, they too are natural economic agents. Therefore, the most important insight here is that prey such as algorithmic stablecoins have yet to evolve sufficient defenses.
Lastly, this was not the first failed stablecoin rodeo for Terraform Labs. The founder, Do Kwon, reportedly launched a previous algorithmic stablecoin Basis Cash (BAC). It failed in early 2021, similar to how UST failed now.
US Video Gaming Industry Consolidates
- EA Discontinues Partnership With FIFA: Shares Down 18% YTD (link)
- EA Revenue Forecast Misses Estimates Following Battlefield Flop (link)
EA Keeps Churning Amid Big Failures
Electronic Arts (EA) has been the staple of the video gaming industry for 40 years. In recent decades, the company gained a negative reputation for gobbling up small studios and wrecking their creative output. Last year, the video-gaming giant made $5.63 billion in net revenue, the most successful fiscal year yet.
However, after the botched launch of its star franchise, Battlefield 2042, EA stock took on the negative sentiment, tumbling 18% YTD. The bug-ridden mess was just one more game that was prematurely released, hoping to get patched after the launch. As a result, the adjusted revenue for Q2 2022 will sit in the range of $1.2b — $1.25b, missing the forecasted $1.45b.
With EA having gained 71% revenue from live services last year, EA investors did not fold to a temporary dip this week. Image credit: Trading View
Yet, a company with pockets as deep as EA has many projects in the works. Despite ending the historic and highly profitable partnership with the FIFA franchise, another shooter, Apex Legends, is making up for Battlefield’s downfall, having filled EA’s gap with $2 billion in revenue generated since 2019.
Meanwhile, FIFA is turning to blockchain integrations for their future gaming projects, hinted at by its partnership with Algorand.
ALGO’s price reaction to the announcement of a FIFA partnership. Image credit: Trading View
By becoming the official blockchain platform for such a prestigious organization as FIFA, ALGO defied the bear market, but it soon joined Bitcoin in the market downturn.
Stablecoins and Exchange Bankruptcy Scenarios
- Jack Dorsey Calls Coinbase a “Casino”: COIN’s Market Cap Down $85B Since IPO (link)
- SEC Chair Gary Gensler Takes Aim at Crypto Exchanges for Trading against Their Customers (link)
USDC Stablecoin Functions as a Safe Haven, but for How Long?
USDC is one of the most regulated and cash-backed stablecoins. As a result, its USD peg remained solid amid the crypto storm. In fact, it even exceeded the 1:1 value due to increased demand.
USDC stablecoin peg overperformed for the selling side. Image credit: Trading View
Both Coinbase (COIN) and Circle maintain USDC’s health, which is why it is not good news when the largest US crypto exchange keeps financially bleeding. Since it went public, Coinbase’s valuation decreased by $85 billion. Even more worrying, COIN’s price-to-earnings (P/E) ratio went from 140 to under 5 within a year.
Of course, because Coinbase depends on cryptocurrencies for its bread and butter, its stock goes down with the bear market. However, COIN is down even more than MicroStrategy (MSTR), which uses large Bitcoin reserves for debt leveraging.
MicroStrategy (MSTR) vs. Bitcoin (BTC) vs. Coinbase (COIN). Image credit: Trading View
If worse comes to worst, what happens if Coinbase goes bankrupt? Due to new SEC disclosure rules, it is now clear that Coinbase’s bankruptcy would result in lost crypto assets. Meaning, crypto funds would be subjected to bankruptcy proceedings, at which point the exchange would use them to bail itself out.
Moreover, old market-making practices have snuck their way into crypto. The SEC Chair, Gary Gensler, has made it clear this Tuesday that exchanges will receive more scrutiny because of their inherent conflict of interest. After all, if they gain fees from trades and then front-run certain tokens, they would be market-making against their own customers.
Tweets of the Week
LUNA VC backers
The Terra blockchain was officially halted at a block height of 7603700.
Terra validators have decided to halt the Terra chain to prevent governance attacks following severe $LUNA inflation and a significantly reduced cost of attack.
If you invested $10,000 in Luna last week, you now have $2
JUST IN: 🇩🇪 Germany will not tax #Bitcoin and #Ethereum sales after one year of possession.
The Fed‘s interest rate hikes and pandemic debt add to the risks for low-income countries. Some are already sliding into severe problems.