Comment by chollida1
3 years ago
The crypto community continues to speed run the history of traditional finance.
This weeks lesson is that in an up market its leverage that makes you money and in a down market its the unwinding of leverage that kills you.
They are also learning that interconnectedness will hurt more in a downturn. You can be perfectly delta hedged( don't care which way the market moves) and its the counter party risk that will sink you.
Now as these firms start to unwind they spill over to the next one. The collateral taht you lent to the failed firm is now gone and your once well hedge d and collateralized position is now in shambles because someone else can't pay you.
TradFi normally solves this by having a firm have oversite on everyones positions and have everyone pay money into a pot to help bail out failed counterparties so they don't spill over to other firms.
Crypto has tried to solve this by strict liquidation rules that tend to make things worse by turning firms into forced sellers when they may have been able to ride things out, thereby forcing markets down even more. To the point where its a profitable trading strategy to intentionally force the market down to liquidate leveraged longs.
As more crypto firms fail, they'll end up selling their best collateral first(BTC and ETH) forcing down the price even more.
$5,000 BTC and $200 ETH are in site if Tether starts to fail. Tehter has lent money to almost all these firms but doesn't mark down its positions from what it originally held them at.
If tether holds we may get out of this with $10-15,000 BTC but if Binance/FTX walk away from Tether then we'll be down another 80% from here I bet.
TL/DR its going to get alot uglier than it currently is due to the interconnected nature of the crypto markets. We'll find out that pretty much everyone was linked to everyone else as there are only so many ways to make money in crypto and everyone piled into them.
Defi is about to find out how hard it is to make money when no one wants to stake.
> Crypto has tried to solve this by strict liquidation rules that tend to make things worse by turning firms into forced sellers
This is literally how traditional finance works as well. If you have a leveraged position at a futures or options exchange, you absolutely will be liquidated as soon as your position gets close to being in the red. I 100% guarantee you that the CME or Goldman will not let you "ride things out".
You don't have to take my word for this. Look up the history of what happened to the energy hedge fund Amaranth.
Individual investors tend to get liquidated, but for hedge funds larger investors the story is more complex. See <https://www.bloomberg.com/opinion/articles/2021-07-29/archeg...>:
> In the traditional financial system, very few things work like this. One thing that mostly does is a margin account at a retail stock brokerage: If your stock declines, you will get a margin call, and if you don’t post margin within a defined and fairly tight time frame your broker will sell the stock, and this really might all be done by a computer in a pretty formulaic way. But if you have a big enough account — if you are a big hedge fund or family office — it doesn’t work that way. When Credit Suisse Group AG decided that Archegos Capital Management did not have enough collateral in its margin account, a Credit Suisse representative called Archegos and asked it to post more collateral, and Archegos said, sorry, we are really busy this week, let’s discuss next week. In theory Credit Suisse could have liquidated Archegos’s positions, but in practice that would have been rude, so it didn’t. Credit Suisse did not extend credit to Archegos based on some defined formulaic function of the value of its collateral; Credit Suisse extended credit to Archegos based on some fuzzy holistic relationship-based function of how much business it hoped to do with Archegos, how much the Credit Suisse people liked the Archegos people, how its traders felt about the collateral, when its risk committees had meetings, stuff like that.
Credit Suisse may thought it was rude, may have been thinking about maintaining the relationship long term or may have suspected liquidating the assets would net it less than what was owed with no recourse for the other part.
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That old saw is evergreen: If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.
Not really true, collateral is decided at the end of the day and not mid day.
You aren't liquidated immediately the moment your needs more liquidity.
We wait till the end of the day short of absolute emergencies.
I know Amaranth well being in Canada and Calgary specifically at the time:)
And for tradfi a typical hedge fund gets a call and is told to post more collateral and they make real efforts to allow the fund to post collateral. There is almost never an immediate liquidation as this tends to cause more trouble than it fixes, even on the CME or CBOE:)
>Not really true, collateral is decided at the end of the day and not mid day.
Ho ho ho - no it's decided as soon as your lender things that it needs to liquidate you, and if it does it will know that you're not going to be able to go to court to fight afterwards.
A lot of nasty scenes start with someone on a phone shouting "you can't do that for another 2 hours".
Yup. Yup we can.
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Especially when one of the main reasons for needing to post more collateral isn't necessarily that your position is underwater but rather volatility has picked up and risk needs to be brought down. This happens because futures especially trade with very high leverage.
Also generally the amount of collateral that needs to be posted is in the millions of USD so people tend to understand that isn't instant, especially if those funds are currently in money market funds or bonds held elsewhere.
>> Not really true, collateral is decided at the end of the day and not mid day.
Depends on your CSA (Credit Service Annex/Agreement) and what the joint agreement was. Also depends on the type of position (daily settled via exchange vs contractual)
> You don't have to take my word for this. Look up the history of what happened to the energy hedge fund Amaranth.
Amaranths positions were sold to Citadel and JP to wind down gently. That's pretty different from forced liquidation at the exchange.
CME, the exchange, is not the one closing on you.
Your prime brokerage is.
https://www.investopedia.com/terms/p/primebrokerage.asp
Of course, crypto didn't invent margin trading. I think the OP was referring to central counterparty clearing, which typically provides an additional layer of insurance against defaults.
As per Matt Levine:
...The way the traditional system works is that if you have a margin loan, and the value of your collateral declines, your broker calls you up and says “hey we need more collateral,” and you either post more collateral and it’s fine, or you don’t post more collateral and your broker liquidates your position. Or sometimes you say something like “hang on I’ve got another call, I’ll call you back after lunch,” or “sorry I don’t have the money right now but I am a good customer and you know I’m good for it,” or “I don’t have the money right now but I’m pretty sure prices can only recover from here so why don’t you let it ride for a day or two,” or whatever, and you don’t post more collateral but your broker doesn’t liquidate your position because you’re a human and your broker is a human and everyone is embedded in a repeated social game with fuzzy rules
For every seller, there must be a buyer. With a defi "code is law" approach, if every contract automatically tries to execute a sell at the same time, the price will fall until there are enough matching buyers, and if there still aren't enough buyers when BTC hits $0.0000001 then the sell orders will just not execute. Smart contracts do not eliminate the problem of liquidity risk, they merely assume it away.
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>> This is literally how traditional finance works as well.
Most recent case is that Archegos guy over-leveraged at Credit Suisse not to mention the LME or GME fiasco. The "traditional" market is rigged/bended by various individuals ALL THE TIME.
https://www.reuters.com/markets/commodities/elliott-associat...
>> I 100% guarantee you that the CME or Goldman will not let you "ride things out".
That is indeed generally the case. There are, however, monthly collateral agreements in some cases where you can ride it out for a month before getting margin called. Also, there are sometimes credit-rating based collateral calls. The most famous would be AIG's -- they eventually had margin calls of over $100B when their credit rating fell and the housing market also fell and liquidity dried up.
Funny thing in such cases -- when the borrower owes banks those sums of money, it ceases to be the borrower's issue and becomes the bank's issue
What follows is loose speculation, but I do not think the equilibrium price of a single bitcoin after a crash is any more likely to be $100 than $1. This is due to the anatomy of a bubble.
A belief in the long term value of cryptocurrency is very tightly correlated with ones current cryptocurrency position. The demand curve, then, for cryptocurrency, is extremely steep, and the "buy pressure" for cryptocurrency will not increase tremendously with falling prices, since the people who would generally be willing to buy at these reduced prices, have just lost their life savings.
Likewise, even the poeple who think that crypto is valuable long term know that you can't pay your taxes in it. If people don't believe that it's worth anything, then it isn't. They all know that the price falling could indicate that right this second is the most your cryptocurrency will ever be worth. The more the price drops, the more likely this is to be the case, and the more likely I am to sell. If the sell pressure is greater than the buy presssure at some price, then it is very likely to be the case at every lower price, resulting in catastrophic collapse.
This inversion event is more likely the longer the asset has remained in bubble status, since the optimism proportion of the inflated asset is strictly increasing with price.
Guess that’s the difference between a bubble and spike?
But this IS traditional finance, in a very key sense: the money loaned to 3AC was NOT done using defi. When I have collateral I loan out using actual-defi the liquidation rules are transparent and the holdings are transparent and if something starts crashing I get to cause the liquidation before all of my money just disappears into a black hole of people lying to me. That 3AC then took their traditionally-loaned money and did something dumb with it involving crypto is not an argument that defi is broken but that people shouldn't be using tradfi: what is stupid here was people trusting 3AC instead of using their own tooling (a problem that I fully admit is so endemic in the cryptocurrency industry that I have to CONSTANTLY complain to my own business partners that our using Coinbase Custody to hold any of our currency is flat out embarrassing).
>$5,000 BTC and $200 ETH are in site if Tether starts to fail.
IMO, pre-2017 prices for BTC (<$1000) returning is inevitable. If Tether fails, then pre-2014 prices (<$100) are more likely. BTC was at $5K a little over 2 years ago, anyone who thinks the bottom is at that level is deluding themselves.
You could be a millionaire if you are right.
You can be right and still go broke shorting something. "The market can stay irrational longer than you can stay solvent." And shorting crypto has additional challenges beyond shorting traditional securities.
I'll take that bet. I say BTC doesn't breach $5,000 in the next 18 months.
What do you want to bet?
What's the counterparty risk?
A bunch of crypto fintechs had lent to 3AC are in a spot of bother.
https://www.ft.com/content/126d8b02-f06a-4fd9-a57b-9f4ceab3d...
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It's interesting to watch Tether's market cap decrease in this downturn - presumably as more and more Tether is redeemed by major holders. The question is: how much liquidity does Tether have to fund these redemptions? Is it 20B? 50B? Maybe it is fully-backed?
>> TradFi normally solves this by having a firm have oversite on everyones positions and have everyone pay money into a pot to help bail out failed counterparties so they don't spill over to other firms.
I'm curious -- in traditional finance, there are often daily collateral settlements which force both parties to change collateral based on valuations shifts by way of the exchange. is there such a concept in crypto? Wouldnt this resolve a lot of the issues you're speaking about?
> tend to make things worse by turning firms into forced sellers when they may have been able to ride things out
What do you mean, may have been able to ride things out? They owe money they don't have...
Oh, you mean, if you wait long enough crypto might come back up and they're solvent again? Right, after they lost more than they had on the first bet, you wanna let them bet again that it might come back up?
There are plenty of firms that run full reserve and are not subject to this contagion.
Good to know,
Who are these fully capitalized crypto firms?
Good question. Finding that out would take a lot of on-chain analysis.
I have no love for these firms so I really don't care if they are solvent. For those that took major risks with leverage and mismatched their risk on duration, let them fail. Some in this thread seem to be saying that having humans involved in liquidations is preferable because it prevents contagion. To me, that sounds like letting someone get away with bad decision-making and safe-guarding them against the previously defined consequences. Sounds like the same kind of philosophy that makes some firms in traditional finance "too big to fail." This kind of thinking kicks the can down the road instead of addressing the problem and feeling the pain now.
I say liquidate them. Maybe that's easy for me to say because my only exposure has been through defi protocols that I interact with directly and with risks that I've considered. These Cefi companies take retail money, use it to take risky positions in defi, then take a large cut of the profits. Works great until a market downturn and people start asking for the their Eth back and, whoops, we don't have access to it until 6M+ post-merge (Celcius). That's called piss-poor risk management and I don't want these kinds of actors in the market long-term. I feel bad for the retail that is getting screwed in all this but in the end, we need regulators / DOJ to come down very hard on these companies. If we clean house now, the space will be stronger in the future. Yes it will be painful in the short term.
> Tehter has lent money to almost all these firms
Do you have a source for this?
Yep the Tether Papers from Protos. [1] On-chain analysis which accounts for 70% of all Tether issuances.
[1] https://protos.com/tether-papers-crypto-stablecoin-usdt-inve...
https://assets.ctfassets.net/vyse88cgwfbl/1np5dpcwuHrWJ4AgUg...
The points you're looking for:
> Secured Loans (none to affiliated entities) $3,149,732,368
> Other Investments (including digital tokens) $4,959,634,446
Your link is to an attestation, not an audit, and it was performed by a company in the Cayman Islands that changed its name and is still under investigation by the United Kingdom government
https://www.coindesk.com/markets/2022/01/26/tethers-new-acco...
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> Defi is about to find out how hard it is to make money when no one wants to stake.
I have often described DeFi as Decentralized 2008.
Can you explain what you mean by crypto's forced liquidation rules? Not familiar with how that works at all.
As the other comment says, liquidation in tradfi has manual intervention - the loans will say things like "IF the collateral mark-to-market value drops below $X, the lender MAY call the loan and force sale of the collateral" - the key being the IF.
In a case where there's contagion [549] the banks or even the government can work to negotiate what's happening, and slow down the collapse (or even prevent it) - an example being the subprime mortgage backed securities which got to the point that nobody knew how to value them, so the government bought them all (and eventually actually "made" money by riding it out).
DEFI has algorithms that lock up the capital and will automatically liquidate it if certain parameters are met - which others can use to "attack" it - if the oracle sees bitcoin fall below $20k in a flash crash, it triggers the selling of ten thousand coins, say, which floods the price down further, you snap them up, the crash is over, you slowly sell at $25k or whatever. Bitcoin itself is pretty resistant to this, but the other coins, not so much, especially the side coins.
As a side note, most US home loans do NOT have a "call" clause and the bank can only initiate liquidation after you've missed payments and gone delinquent for a certain number of days; this was instituted in the US after calling mortgages contributed to the Great Depression. Some business loans can be called after a period of time for any reason (usually, interest rates have gone up).
[549]: https://en.wikipedia.org/wiki/Financial_contagion
When you get margin called in traditional/centralized finance, humans intervene and liquidation is not immediate (except Interactive Brokers, who are closer to how crypto manages margin, and will liquidate you without a margin call). Maybe you put up more collateral, maybe you borrow from a line of credit, there is a buffer. As an individual, you work with your broker. As a larger participant, you work with the clearinghouse (of meme stock fame).
In crypto, there is no buffer. Auto liquidation of undercollateralized positions occurs. All of those humans in the loop, “unfair rules”, and settlement delays crypto proponents complain about are the very things that make traditional finance stable. This is why traditional finance doesn’t take seriously the idea of immediate settlement, and why end of day settlement is as good as it’ll get.
> In crypto, there is no buffer. Auto liquidation of undercollateralized positions occurs. All of those humans in the loop, “unfair rules”, and settlement delays crypto proponents complain about are the very things that make traditional finance stable.
Is auto-liquidation a bad thing? It leads to more volatility in the short-term, but it seems that there might be long-term benefits of ensuring that players with unresponsible business practices will be forced out of the market.
"Traditional" crypto holders will be affected too (the value of their investment goes down while people are forced to sell), but this looks more like a temporary impact. As long as they don't trade on margin they won't be forced to sell and as long as they hold their own keys they are unaffected if exchanges are crashing.
From a "price" perspective the current events might be bad for the crypto ecosystem, but from a "health" perspective I think that they could be positive, as only the responsible players with healthy business practices are going to survive.
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Say you have 100 USD, but want to make a bigger bet on crypto than that. You borrow another 900 USD from a crypto lender and invest the 1000 USD in some cryptocurrency. If the currency you invested in goes down by 10%, your original position of 1000 USD will be worth 900 USD, and you will still owe the lender 900 USD so your original 100 USD stake has been lost completely. The lender will then protect their loan by forcing you to sell the 900 USD in crypto that you still have and repaying the loan. This is in itself not unique to crypto (google the term "margin call" if you want to know more), but crypto is usually more automated about it and exchanges will sell positions without manual intervention. This sell pressure can push the coin even lower, leading to a chain reaction of liquidated positions.
Often, the lender is also the exchange through which people hold their crypto so they don't even have to contact the holder before they sell their holdings.
Two things to add:
1. The price of an asset need not be a nice continuous line. It can jump.
2. That's why liquidation occurs not at -10%, but at some point before that, to manage this gap risk. Might be at -7%, or whatever. This reduces, but does not eliminate gap risk. For that, the crypto exchanges have insurance funds.
Here's a concrete example. AAVE is a protocol that allows lenders to lend money to borrowers in a decentralized manner.
So as a borrower, today, if you were to borrower 8000 USDC and deposit 10 ETH as collateral, the AAVE protocol would automatically sell your collateral if the ETH price went to 941$. So your position is "auto liquidated". https://aavecalculator.com/
AAVE currently has ~$9.9B in assets locked into its protocol.
That no different from any margin loan
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Not sure if that's what parent is about, but the reference may be to on-chain lending solutions that use price oracles to determine liquidation prices based on amount of collateral deployed.
There are 9-digit lending positions in $ of crypto collateral that will be forcefully sold into the market if BTC/ETH keep dropping. Unless more collateral will be deployed, which lowers the forced liquidation price.
DeFi - Contracts are code.
TradFi - Your word is your bond.
This ! The "idea" of Defi was that w wouldn't need "regulations and rules" since we could 'just' look at the actual deployed code(eth contract for example) to see if you going to get screwed.
Of course few ppl actually look at the code, or sometimes the code is just bad and you get bad actors willing to exploit this.
That being said: In practice and real life there are a bunch of dodgy companies and badly written eth-contracts(code).
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Congratulations you are the 1 millionth person on Hacker News to say "speed run the history of traditional finance"
Congratulations! You are the seventh person on HN to say the words "speed run" and "finance" in the same comment :o )
https://hn.algolia.com/?dateRange=all&page=0&prefix=true&que...
Umm, thanks?
Would love to see a citation on this.
I don't understand why everything needs a citation on every comment on the internet. Imagine you're at lunch with a coworker and they say this.
We go, "Wow, that's pretty interesting. Hope it doesn't happen" and we continue to eat our soup.
I enjoy reading stuff like this without the need for them to publish a study.
Sure, on what specifically?
A nice narrative that falls apart when you remember LTCM, Archegos, etc. I don’t understand why you think crypto funds don’t arrange the same kind of “oversite” you describe.
LTCM was bailed out with government (Fed) coordination. Archegos was only survivable because it was in a huge bull market and the losses were just a few billions dollars which was possible to be absorbed by the big banks.
> I don’t understand why you think crypto funds don’t arrange the same kind of “oversite” you describe.
Because they don't. Because it's a wild west. TradFi has it's failures as well - but that's "whataboutism".
DeFi is collapsing in real time and we'll probably see oversight and regulation around this in the near future.
>DeFi is collapsing in real time and we'll probably see oversight and regulation around this in the near future.
From the perspective of people who support the mission of DeFi and aren't just in it for the money, this is a feature, not a bug. We want these dodgy, extractive institutions to go under and not have to bail them out.
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