5MF (WEEK 9): SILVERGATE’S DYING BREATHS, WHY COINBASE BUILT ‘BASE’, MORE
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Let’s see what’s going on this week:
- Silvergate’s Dying Breaths & What it Means for Crypto
- Why Did CeFi Coinbase Build DeFi ‘Base’?
- Explained: BlackRock Favors Value Stocks Ahead of Recession
- Bitcoin Liquidity Dries Up Amid Sharp 5% Drop Overnight
- New Findings in FTX Accountancy
Final Weeks for Silvergate?
- Silvergate Down 30%+ After Delaying 10-K Filing In Wake of FTX Collapse (link)
- Silvergate Slaughtered in Thursday Trading as Major Crypto Partners Jump Ship (link)
Key Crypto On-Ramps Dwindle
When Bankman-Fried’s FTX exchange crashed, it caused a seismic shift in the crypto space.
And no — we’re not talking about the $8.9 billion hole in customers funds, nor the intense FUD it caused.
Rather, just as GME’s short squeeze brought to light the underbelly of stock trading, FTX spotlighted the underlying money infrastructure for crypto companies.
And at the center of it was (the term ‘was’ is becoming increasingly important) Silvergate Bank (SI).
Founded in 1988, the bank reinvented itself in 2019 when it went public to position itself at a strategic intersection between traditional finance and the rapidly evolving crypto space.
Exchanges needed banking services and the Silvergate Exchange Network (SEN) provided it with a 24/7 flow of US dollars.
Centralized crypto ecosystem centered around Silvergate’s SEN payment rail. Image credit: Silvergate
That center is now crumbling. On Wednesday, the bank delayed the submission of its required 10-K filing (comprehensive annual financial report) to the SEC, citing concerns of being “less than well-capitalized”. This is not surprising.
The FTX crash left an $8 billion hole in Silvergate’s holdings, leaving it with a $1 billion loss in Q4. Equally predictably, the bank’s SI shares dropped like a rock.
Silvergate Capital Corporation (SI) weekly performance. Image credit: Trading View
As Silvergate scrambles to seek “additional time for its independent registered public accounting firm to complete certain audit procedures”, everyone is jumping ship.
So far, Coinbase, Paxos, Circle, CBOE Digital, Galaxy Digital, Bitstamp, and Crypto.com announced their withdrawal, no longer accepting or receiving payments via Silvergate.
To preempt potential Bitcoin FUD, MicroStrategy assured that its BTC collateral (4x) isn’t custodied with Silvergate. Reminder, last March, Michael Saylor took a $205 million loan from Silvergate to buy more BTC.
If Silvergate goes bankrupt and the FDIC takes a hold of the assets, MicroStrategy (MSTR) would then just have to repay the loan to the new creditor. The more pressing issue is, who would take the load now?
Yesterday, Coinbase (COIN) announced the switch to Signature Bank (SBNY) to secure dollar payments for institutional customers. This is likely a patchwork solution as the bank banned SWIFT transactions over $100,000 last month.
That’s why Kraken exchange announced on Wednesday that non-corporate clients would no longer be able to make deposits/withdrawals through Signature Bank.
If this is starting to smell, you wouldn’t be the only one to take note. Twitter is rife with speculation that all of this is a part of Operation Chokepoint 2.0, a reference to an intitiative originally started by the Obama Administration to cut banking services from online casinos and other sectors deemed ‘high risk’ for fraud and money laundering.
Operation Chokepoint 2.0, some say, is a similar initiative in new form, with lessons learned, now aimed at the crypto sector.
In the UK, HSBC announced yesterday that it will prevent customers from making crypto purchases with credit cards.
If HSBC rings a bell, it’s the bank that was heavily involved in money laundering for drug cartels, having been fined $1.9 billion in 2012 for such activity.
In total, HSBC has paid $6.5 billion in fines since 2000. Image credit: ViolationTracker
At the end of the day, what is happening has been predicted by many as soon as FTX was exposed as fraudulent. Regulators seized the rare opportunity to bring down the hammer and reshape the crypto space.
We are now watching this transformation unfold in real-time — and whatever happens with Silvergate will be very influential in terms of where the space goes next.
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Coinbase Building DeFi Base
- Optimism’s Token Nears ATH After Coinbase Launches L2 Built on the OP Stack (link)
Base Buildup for More Revenue Streams
Last week, Coinbase dropped the bomb dubbed Base.
In essence, Base is Coinbase’s attempt at building DeFi as a CeFi platform.
It looks like Coinbase is hoping to experience the ‘rising tide lifts all boats’ situation.
If we take a look at Coinbase Q4 ’22 earnings, it is quite clear that the exchange’s revenue shifted from consumer revenue to earning interest by employing customers’ cash in US Treasuries.
Since Q4 ’21, Coinbase increased its interest revenue by 24x. Simultaneously, consumer-based revenue decreased by 7x. Image credit: Coinbase
Base is a continuation of this trend, as a gambit to rely less on market cycles, and more on the crypto ecosystem itself.
So, how does Base work exactly?
- Base taps into the Ethereum network, the largest host for decentralized applications (dApps). One that has generated $15.4 billion in fees and $9.1 billion in revenue.
- But Base links to this ecosystem indirectly, as a layer 2 scaling solution. These networks are akin to highways built on top of existing roads, resulting in fast transactions and lower fees.
- Specifically, Base uses a form of layer-2 scaling, called Optimistic rollups, an open source stack developed by the non-profit Optimism Collective.
At this point, you may be wondering, what’s up with the ‘optimistic’ theme here? It turns out, it’s not just a random name for a blockchain project; it rather tells you how it all works.
Blockchains tend to be slow because many network nodes (computers) need to verify each transaction, which are then added to the public ledger once approved. But with more transactions, the time to process them increases — and so do their fees.
Optimistic rollups come in by processing transactions off-chain (rolling them off), leaving the main chain (Ethereum) unburdened. This is done through a smart contract on Ethereum that stores a summary of transactions that have been rolled out. These summaries are then periodically pushed on Ethereum, to be verified by all nodes on Ethereum.
Now, the ‘optimistic’ part refers to the fact that all those transaction summaries are assumed to be correct until proven otherwise — innocent until proven guilty. This optimistic assumption leaves a light computing footprint that results in fast and cheap transactions.
Built with Optimistic rollups, with Coinbase as one of the code contributors, Base places itself alongside the existing Optimism network to build and deploy dApps in a permissionless manner. Each such chain is compatible with another, and so is Base but without any dedicated BASE token.
Instead, Base will stick to ETH for transaction fees, to avoid getting scrutinized by the SEC.
Optimistic rollups are just one of scaling techniques used for Ethereum’s L2 networks. Image credit: l2beat.com
As you can see, stablecoins make up the bulk of Optimism’s existing value of $1.81 billion, at 30%. And who has the second largest stablecoin by market cap? Coinbase, together with Circle.
Naturally, transactions involving USDC are micro-portioned to Coinbase and Circle, with the extra option of earning USDC interest when lending and staking.
By the end of 2023, we will likely see Base fill up Coinbase earnings report with extra revenue from transactions and USDC trading.
Atypical Macro Shifts Value-Growth Stock Dynamic
- Value Stocks Likely to Outperform Growth in New Marco Regime: BlackRock (link)
Value Stocks Predicted to Buck the Trend Going Forward
Following the hotter-than-expected core PCE inflation report last week, at 4.7% vs. 4.3% estimated, rate cuts (‘Fed Pivot’) are likely swept off the table for 2023.
Let’s examine what that means for stock portfolios, with a little help from BlackRock’s weekly report.
Historically, rising interest rates, as we have seen throughout 2022, favor value stocks. These are companies that have consistent profits, high dividend yields, and often low price-to-earnings ratios. In contrast, a near-zero interest rate regime favors growth stocks, which is why the last decade saw value stocks underperform growth stocks.
Marriage between super-cheap borrowing capital and expectation of future earnings favored growth stocks. Image credit: BlackRock
Case in point, Tesla (TSLA) has been growing into a hybrid value/growth stock due to more consistent earnings. However, Tesla’s growth aspect still weighs heavily due to its high price-to-earning ratio, and the fact that it has never paid dividends.
Tesla fits right into this mold as a growth stock, having gained +743% in 2020 and +49% in 2021, in the middle of the Fed’s massive stimulatory injections. But when the Fed reversed the monetary game, Tesla took a negative dive, at -65% for 2022.
Therefore, in a rising interest rate regime, value stocks are favored by investors for several reasons:
- Value companies have lower debt levels, making them less reliant on cheap capital.
- Value companies are less susceptible to sticky inflation due to having tangible assets, property or cash.
- Without heavy reliance on cheap borrowing capital, value companies can retain stable earnings and dividends.
In short, investors look at the company’s ‘discount rate’ to figure out its present value based on the company’s future cash flows. This also includes the worth of money itself, affected by inflation. So, a higher discount rate would make future cash flows worth less in the present.
Accordingly, when interest rates go up, discount rates go up, making value stocks and other investments more attractive, such as bonds. In contrast, this makes growth stocks less attractive.
With these factors in mind, BlackRock favors value stocks over growth in 2023.
But there is something atypical in this macro cycle.
Stickier inflation drives investors to seek compensation for holding long-term treasuries (government debt). This drives their yield higher when compared to short-term treasuries, leading to a steep yield curve.
Image credit: CBO (Congressional Budget Office)
A current steep yield curve, in these conditions, indicates much uncertainty and likely a recession. However, because it has been telegraphed as such in advance, giving enough time to prepare, BlackRock is more confident that value stocks will outperform, beating the historical trend of underperforming ahead of a recession.
Bitcoin Liquidity is Drying Up
- Crypto Traders Worried About Liquidity Thinning in Bitcoin and Ether (link)
Bitcoin Falls by Nearly 5% Overnight
Whether Operation Chokepoint 2.0 is exaggerated or not, it counts when it comes to market sentiment.
Alongside concerns of cutting off crypto’s banking and stablecoin rails, there’s also the matter of Fed hikes going higher, faster.
“On the other hand if those data reports continue to come in too hot, the policy target range will have to be raised this year even more to ensure that we do not lose the momentum that was in place,”
-Fed Governor Christopher Waller
Neither stocks nor Bitcoin likes such announcements. In this chilled landscape, we are seeing Bitcoin’s chilled order book.
Image credit: Kaiko
When market depth is shallow, there are fewer buy and sell orders at different price levels. This puts whales in a more influential position as it requires fewer orders to either move Bitcoin price up or down. This makes for a highly unpredictable and volatile market.
Gensler’s recent remarks at Thursday’s Investor Advisory Committee don’t help either,
“Just because a crypto trading platform claims to be a qualified custodian doesn’t mean that it is,”
As if on schedule, Bitcoin fell -5% from Thursday to Friday, with bearish sentiment taking hold.
On the other hand, have Bitcoin’s fundamentals changed? After SEC Chair Gary Gensler reiterated that Bitcoin is likely the only commodity out of thousands of cryptocurrencies, one could say that Bitcoin’s position is now stronger.
Yet, macro pressures are the same as always — negatively correlated to the Dollar Strength Index (DXY) and positively correlated to stocks.
As it becomes clear that markets are floundering amid stickier inflation and more Fed hikes, on-risk assets are unlikely to perform well, whether it is Bitcoin or stocks. In turn, hard cash and treasuries continue to function as solid lifeboats on monetary rapids.
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FTX Bankruptcy Saga Update
- FTX Debtors Publish Second Presentation for Stakeholders (link)
Massive Shortfalls and Absent Accounting
As Bankman-Fried awaits trial in his parent’s home in California, FTX CEO, John Ray III, has been busy sorting out his colossal mess.
On Thursday, ‘FTX Debtors’ released the second presentation for stakeholders.
The situation is not favorable to ‘make investors whole’:
- Alameda Research siphoned $9.3 billion from FTX.com wallets.
- FTX.com’s total assets account for $2.2 billion, but only $694 million could be deemed as the most liquid ‘Category A Assets’, such as cash, stablecoins, BTC or ETH.
- FTX.US total assets account for $191 million, with $28 million in customer receivables.
Overall, FTX Debtors contrasted $7 billion in customer payables against $580 million in located assets.
The price of Category B tokens has collapsed, while every token in Category A has a deficit. Image credit: FTX Debtors
To no one’s surprise, Ray painted the whole FTX ordeal as a clown show:
“The exchanges’ assets were highly commingled, and their books and records are incomplete and, in many cases, totally absent,”
Tweets of the Week
Sometime between March and May you will have a confluence of
- Shanghai Fear/Dumping
- Equities reaching a local bottom
- Market less optimistic about soft landing/rate cuts
- Bottom shorting
At that point if $ETH is $1400–1500 it will be a comfy max long
This is admittedly the scariest chart in global macro right now
Thanks to @MichaelMOTTCM for reminding us of it ahead of tomorrow ISM Services
Wait — since 🚀📈💰 are in our previous tweet, does the tweet constitute investment advice?
Asking @SECgov for clarity.
What just happened? CEO resign?
The Fed’s balance sheet hit its lowest level since August 2021 this week, down $626 billion from its peak in April 2022.
Some perspective on how much the balance sheet expanded in 2020–21: it’s still $4.2 trillion higher than where it was at the end of 2019.