Crypto bull Barry Silbert has warned of existing leverage in cryptocurrency markets that could pose counterparty risk to investors adding the digital assets to their portfolio.
Counterparty risk is the probability that the other party in an investment, credit, or trading transaction may not fulfil its part of the deal and may default on the contractual obligations.
In cryptocurrency, counterparty risk comes from holding coins on centralized exchanges as it controls your private keys, and thus, may or may not have enough funds on hand to cover every depositor.
“There is a daisy chain of borrowers and lenders in the crypto space — most well capitalized, but some are not. Lots of leverage still in the ecosystem…including in some non-obvious places,” Silbert tweeted on June 25. “Important to understand counterparty risk and where are the weak links in the chain.”
The Founder and CEO of Digital Currency, Silbert made these comments in the wake of Custodian Prime Trust ditching cryptocurrency lending platform Celsius Network from its platform, citing “red flags,” according to people familiar with the matter.
Celsius operates similarly to a bank in that it takes deposits of cryptocurrencies from one set of customers and lends crypto and dollars to another. The borrowers pledge other crypto assets as collateral.
The lender has been using Nevada-based Prime Trust to store assets for some of its customers since March 2020.
A Celsius spokesperson denied claims of rehypothecation — which happens when banks and brokers use, for their own purposes, assets that have been posted as collateral by their clients. Clients who permit rehypothecation of their collateral may be compensated either through a lower cost of borrowing or a rebate on fees.
Silbert recently tweeted that cryptocurrencies are “99% overpriced” in response to a question from a Bloomberg journalist.
Typically, an investor takes a short position when there is anticipation that the value of a stock will decrease in the short term.
Silbert is not the only one predicting the bubble will burst as Dogecoin prices soar. Some 74 percent of professional money managers said they see crypto assets as being in a bubble right now, InvestorPlace reported.
Just like Bitcoin and other cryptocurrencies, Dogecoin slumped last week after China’s central bank intensified its ban on banks and financial institutions from crypto transactions and from dealing in crypto-related services. Dogecoin was trading at $0.2562 on Tuesday after a $0.16 low early last week, but still down from an all-time high of $0.73 in May.
Experts have said the huge swings in the crypto market are characteristic of a leveraged market. In highly leveraged markets, upward movements get boosted, but the same happens on downward spirals. Selling begets more selling until the system finds an equilibrium, Finance Feeds reported.
“While this (leveraging) allows for greater gains in speculative trading, it also accelerates losses exponentially”, said Natallia Hunik, Chief Revenue Officer at Advanced Markets.
A high unchecked degree of leveraging can however be detrimental. In the case of Lehman Brothers, their high leverage – debt to equity ratio – led to bankruptcy and eventual collapse.
Lehman Brothers was thought to be leveraged 30-to-1, meaning their liabilities and risk exposure was $30 for every $1 of assets.
Listen to GHOGH with Jamarlin Martin | Episode 74: Jamarlin Martin Jamarlin returns for a new season of the GHOGH podcast to discuss Bitcoin, bubbles, and Biden. He talks about the risk factors for Bitcoin as an investment asset including origin risk, speculative market structure, regulatory, and environment. Are broader financial markets in a massive speculative bubble?
It is still not yet clear how much some of the crypto markets are leveraged, but it is estimated that Bitcoin traders liquidated $12 billion in levered positions in mid-May during a market rout as the price of the cryptocurrency spiraled, according to bybt.com, a cryptocurrency futures trading platform.
In Asia, where leveraging is more rampant, firms such as BitMEX allow 100-to-1 leverage for cryptocurrency trades, according to Brian Kelly, CEO of BKCM.
“De-Levered markets get crushed. Doesn’t matter what the asset is. Stocks. Crypto. Debt. Houses. They bring forced liquidations and lower prices. But crypto has the same problem that (high-frequency traders) bring to stocks, front-running is legal, as gas fees introduce latency that can be gamed,” entrepreneur Mark Cunab said in a tweet in May.