deen

24 Januar 2022

Market Opening: Risk management after last week’s crypto sell-off

Patrick Heusser

Patrick Heusser

CEO bei Crypto Finance (Brokerage) AG

Über den Autor

There’s no easy way out / There’s no short cut home

This is one of the best Rocky movies, by the way …

Yes, there is blood on the street. However, as far as I can tell, there was no systemic or infrastructure carnage. Liquidations took place in an orderly manner on CEXs as well as on DEXs. The exact amount is difficult to say due to the imposed restrictions on many exchanges (e.g. Binance). My guess is that we are in the $1bn region for CEXs, and somewhere between $250-500m for DEXs. On a MKR vault, we were very close to roughly $600m in liquidations. This did stir some panic.

For two months now (last ATH for bitcoin), we have been grinding lower steadily. The trend line for BTC$ is nearly at a 45 degree angle.

Volumes spiked on December 4, 2021 and January 21, 2022. Looking a bit further back, in February and May of 2021, we saw days with bigger volumes than on January 21, 2022. However, one should not underestimate the shift of CEX to DEX volume. Therefore, my guess is that last week’s sell-off (in terms of the combined CEX and DEX volume) was probably the largest we have ever seen. This is something that is totally reasonable, when we factor in that the crypto market has attracted additional capital over the past 12 months.

Now, let us focus on the potential drivers of the lower crypto prices. In general, it followed suit with traditional risk assets (equities mainly). Especially during down days or in times of dramatic shifts in equity prices, crypto tends to follow correspondingly. Equities are driven by a major shift in the G10 yield curves. Rates are on the rise due to higher inflation, which funnily enough does not seem to be transitory (as a funny aside), but rather sticky and a touch out of control (i.e. check some energy and commodity price charts).

Geopolitical tensions are also not helping, with Russia sending a very large number of troops to the Ukraine border. Incidentally, Friday was one of those days when we saw some behaviour similar to the time of the GFC in 2008, when a proper “risk off” day occurred. Even the USD currency lost big time on that day versus so-called safe haven currencies (e.g. CHF and JPY).

In addition, the news that Russia will ban all crypto activities, incl. mining and cryptocurrency payments, has not helped the already ailing crypto market. The reaction was similar to what we saw when China imposed bans: large spot selling activity, which probably came from mining operations, but clearly also from private individuals.

Since most of us are not able to influence global rates or political leaders, we need to focus on our risk management to safeguard our investments and trading positions. First and foremost, if you are not only dealing in spot (cash market), you must keep your leverage in check. Additionally, if you play around in DeFi, you need to take many more additional risk factors into account. Here is a list of the ones that are the most crucial:

  • Liquidity buffer (collateral on the side)
  • Infrastructure risk (congested chains, overloaded platforms)
  • Inter platform dependencies (yield faults are a good example)
  • Inter protocol dependencies (bridges)

The liquidity buffer is actually an easy one, but you have to be consistent. If you store stablecoins as your so-called “dry powder”, that capital must be in a hardware wallet. You need to be able to access it quickly and not have to depend on any service provider (e.g. a CEX). How many times when markets are volatile have we seen delays in CEX withdrawals and deposits? Sometimes, they are even completely locked up, and you are put in a waiting loop with no ETA. Additionally, do not put your stables in a yield farm if you intend to use it as your liquidity buffer capital. If you do, you might experience the same fate as most of the banks did during the GFC in 2008. The vault or yield farm you put your stables into might not be accessible during market stress (like the liquidity buffers of the banks being invested into ABS and MBS).

When it comes to infrastructure risk, my approach is simple. Since I am not a very technically savvy person, my pragmatic precaution is simply to “always be two steps ahead”. I add collateral or stablecoins to my leveraged positions earlier than I should. As with the liquidity buffer approach above, this comes with a price tag attached to it (the cost of not being able to put that capital to work when a new opportunity comes along).

I know that I preach the “get your hands dirty” approach – in order to learn how platforms and vaults work – but it is still very necessary to read up on the technical setups and what the vault or platform is doing with your coins. This is especially true when the vault is interacting with other vaults or platforms (just think of the Alpha Homora, Cream, and Iron Bank fiasco).

If you have spread your invested capital across different ecosystems, you have probably come across “bridges” (e.g. wormhole, terra-bridge, multichain, or allbridge). Bridging your tokens during normal market conditions is risky enough as it is (and some of the risk still persists when the bridging has taken place). But bridging in a hurry during volatile market conditions is like driving a Formula 1 car while texting your spouse to let them know that you’ll be late for dinner. I try to mitigate this risk by placing my liquidity buffers in different ecosystems (chains). Of course, the same price is paid here as well: the price of missing out on a new opportunity for your idle capital.

But don’t forget – after days like these there are many opportunities! But only if your dry powder is ready to deploy.

Weiterlesen