The collapse of crypto hedge fund Three Arrows Capital (3AC) indicates that the ramifications of this year's cryptocurrency market slump continue to reverberate, JPMorgan (JPM) said in a report Wednesday.
While it is hard to assess how much more deleveraging still needs to happen, the bank said, its indicators suggest the process is already well advanced.
Multiple failures among companies in the industry should not surprise given the backdrop of deleveraging and the 70% drop in digital asset market capitalization since November, the report says.
The entities that employed higher leverage in the past are now the most vulnerable, the bank said. “Whether it is miners having borrowed to expand operations using their bitcoin as collateral, or corporates such as MicroStrategy (MSTR) having borrowed in the past to invest even more heavily into bitcoin, or hedge funds using futures to lever their positions, or retail investors borrowing via margin accounts to invest in various cryptocurrencies.”
The failure of 3AC is a manifestation of this deleveraging process, the note says, adding that the process seems well advanced, “making the bottom formation process in crypto markets more volatile.”
Bitcoin (BTC) miners are another source of stress for crypto markets, JPMorgan said, given the pressure to sell their tokens to deleverage or to cover the cost of their operations. Selling of bitcoins by miners intensified in June and will likely continue into the third quarter, it said.
The weakest crypto companies, those with high leverage and lower capital levels, are the most challenged. Conversely, those with the healthiest balance sheets are most likely to survive and will emerge stronger once this current phase is over, the report says.
JPMorgan identifies two reasons to suggest that the cycle may not be very protracted: Stronger crypto companies with more robust balance sheets are stepping in to help contain contagion, and the continued healthy pace of venture capital (VC) funding, an important source of capital for the digital assets ecosystem.
The leader in news and information on cryptocurrency, digital assets and the future of money, CoinDesk is a media outlet that strives for the highest journalistic standards and abides by a strict set of editorial policies. CoinDesk is an independent operating subsidiary of Digital Currency Group, which invests in cryptocurrencies and blockchain startups. As part of their compensation, certain CoinDesk employees, including editorial employees, may receive exposure to DCG equity in the form of stock appreciation rights, which vest over a multi-year period. CoinDesk journalists are not allowed to purchase stock outright in DCG.