How Ledn deals with volatile markets. DeFi Index drops 62% in one week. Federal Reserve hints at “easy-money” Policy Review.
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The Bitcoin Economic Calendar:
Week of Monday May 24th to Sunday May 30th.
Market Commentary:
Bitcoin: Last week saw the second largest weekly drop in Bitcoin’s history, finishing the week at $34,706. The -25% drop for the week was just a few percentage points shy of matching the March 12th, 2020 weekly drop.
Bitcoin price effectively halved in the last 2 weeks, from a high of ~$65k to a low of ~$29k.
The move has delivered a “reset” to the futures markets, and futures’ implied yields are now approaching their “normal” levels - where they were trading a year ago.
After catching a bid on Thursday, the news that the Biden administration plans to tax large crypto transactions, sent the markets to a re-test of the lows on Friday. The tax news is relevant as many investors likely had large built-up profits in their holdings and rushed to book them ahead of the tax rule taking effect next year. This may continue to be a headwind for asset prices in the sector.
S&P 500: The S&P 500 finished last week down -0.42%, although we may see more red in the coming weeks. Last Wednesday’s FOMC meeting minutes suggested that the Federal Reserve might consider a policy shift soon - “if the economy continued to make rapid progress toward the Committee’s goals”. This means that they may start to taper their treasury asset purchases, the first step in letting interest rates rise.
Why has this had such a big impact on the markets? Let’s break it down.
To start, when the Fed references “the Committee’s goals”, as it did in the meeting minutes, it is talking about 2% annualized inflation. The actual Federal Open Market Committee meeting was held on April 27-28th. The meeting minutes were released on May 19th. But there was a very important development between those dates. On May 13th, the Consumer Price Index results for April were published, and they came in at +0.80% annualized. Additionally, inflation for all-items increased 4.2% month-over-month, the largest increase since 2008.
What the market is reacting to is the fact that the Fed is getting closer to its targets, and that it will start the process whereby it lets the interest in the far-dated bond maturities rise. The next step would be to raise the target for the overnight interest rate, currently set at 0.00-0.25%.
It would not be surprising to see the selling pressure from Bitcoin and crypto bleed over into capital markets this week. Which would, in turn, continue to put downward pressure on crypto markets and asset prices in general.
On that note, there are three speeches by Fed members this week. on Monday 23 get Governor Lael Brainard presenting at 9 AM EST at the Consensus Conference by Coindesk. On Tuesday at 10 AM, Vice Chair Randal Quarles presents on Supervision and regulation. On Wednesday Randal Quarles also speaks at 3 PM to speak about his economic outlook.
Gold: Gold seems to be the only asset having “its moment” in the current environment. It finished last week up +2.07% at $1,880/oz.
The price chart continues to show continuation from a technical level, after breaking out of the multi-month down trend that it was displaying since August.
While the current “tightening” backdrop is just as bad for gold as it is for bitcoin, gold may benefit from a “flight-to-safety” tailwind if equity markets turn in earnest.
DeFi: It was a bloodbath in DeFi last week. The FTX DeFi index lost 67% of its value intra-week before settling at -50.35% for the weekly candle. The move sent the index back down to the levels where it started the year 2021.
Ethereum also dropped 41.48% for the week. Furthermore, the often-quoted “Value Locked” in DeFi protocols dropped 45% in 9 days.
These types of meltdown moves typically happen because of cascading liquidations. This was to-be-expected in DeFi, as participants often place one asset as collateral to borrow another, and can do this multiple times over using different decentralized smart contract platforms. When the collateral assets drop in value, and transactions get clogged, it creates a domino effect for liquidation sales across venues.
Once all of the leverage winds down, the market will catch an organic bid and should be able to rebuild from that base. We may be getting close, but it does not feel like we are out of the woods just yet. More pain could be still to come - and the sector overall will face the headwinds of the proposed U.S. tax law for the near future.
Difficulty Commentary: The bitcoin mempool has ballooned and transaction costs have spiked as tends to happen when we experience a large change in price.
The cost to get a transaction confirmed in the next block is at 10 sats/vbyte at the time of writing. The next difficulty increase is scheduled for next Saturday and projecting a drop of about -5%.
How Ledn Deals with Volatile Markets:
When the price of bitcoin decreases in USD terms, this affects our Bitcoin-backed loans. This past week on Wednesday May 19th, 2021, we experienced a significant decrease in the price of bitcoin. Bitcoin traded from ~$39k USD/BTC at 11:00 UTC to as low as ~$29k USD/BTC at 13:00 UTC. Prices were very volatile during the decline trading in gaps as wide as $1k-1.5k across various exchanges.
Consistency on Ledn’s underwriting and risk management is even more important during price moves like this. When the loan-to-value “LTV” of a loan (meaning the amount of outstanding loan in USD divided by the market value of the bitcoin collateral in USD) reaches 70%, Ledn sends a reminder email to clients to add additional bitcoin collateral. Another such email is sent once LTV reaches 75%. If no action is taken and the loan reaches 80% LTV, Ledn sells the necessary bitcoin required to repay the loan. The remaining bitcoin collateral is returned to the client’s Savings account.
Staying consistent on this process is very important both to (i) provide certainty to each client on known thresholds for their loan(s) and (ii) to protect Ledn’s capital and all of our clients who hold assets on our platform.
It is this consistent underwriting that allows Ledn to attract capital to our business to provide our services. To date, Ledn has experienced no loan losses and this is an important statistic that allows Ledn to continue to grow our product mix.
Further to this point, if Ledn was to extend credit to specific clients (by allowing collateral thresholds to lapse), Ledn would be putting pressure on our financials in the event that the loan was not repaid or re-collateralized.
For this reason, Ledn standardizes its thresholds to ensure both financial stability and that all clients are treated fairly and consistently.
Our commitment to our savings clients is that we will continue to improve our risk-systems to ensure that we maintain our 0% loan losses. This ensures the longevity and robustness of our savings products.
Our commitment to our loan clients is to continue working diligently to educate our clients about the risks and benefits of bitcoin-backed loans, and how to plan accordingly so that they can be prepared for these types of price moves. And in the unfortunate event that these price moves happen, we will ensure that all affected clients were treated fairly and consistently.
It's a big week coming up, and as always, we'll keep you posted on any relevant news throughout the week right here and from our Twitter account @hodlwithLedn
Canadian Central Banking Updates:
Current Target Interest Rate: 0.00 - 0.25%
Current Overnight Money Market Rate: 0.23%
Source: https://www.bankofcanada.ca/rates/
U.S. Central Banking Updates:
Current Fed Interest Target Rate: 0.00 - 0.25%
Current Effective Federal Funds Rate: 0.09%
Source: https://apps.newyorkfed.org/markets/autorates/fed%20funds
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This article is intended for general information and discussion purposes only, it is not an offer or solicitation of any kind, and is not to be relied upon as constituting legal, financial, investment, tax or other professional advice. A professional advisor should be consulted regarding your specific situation. The information contained in this publication has been obtained from sources that we believe to be reliable, however we do not represent or warrant that such information is accurate or complete. Past performance and forecasts are not a reliable indicator of future performance.