Crypto trading firm Cumberland argues that the sudden recovery of the overall market is due in part to whether distressed assets can be transferred from bankrupt firms to firms that are unable to pay their debts.
Crisis not over yet
It is in deep trouble as a protracted bear market has hit the crypto industry, with its collateral depreciating and promptly leading to liquidation. As a result, this ripple effect spreads across the industry and can topple one firm after another. When users are all in a hurry to withdraw funds, some firms may have to take drastic measures, such as suspending withdrawals and transactions.
Many companies that have already halted withdrawals, cut headcount, and sought restructuring have argued that the worsening market condition is in a state of uncertainty, as more troubled companies may soon collapse due to massive debts.
Worse-managed firms are required to liquidate their assets to “partially offset their outstanding debt,” the report said.
Prices will continue to drop as more crypto assets are liquidated, which means a bigger crisis for the industry.
He saw the ongoing crisis as very similar to what was happening in traditional markets, as “the underlying economics is no different from textbook examples.”
Additionally, the firm believes the recovery of the severely damaged crypto market is down to how these bankrupt firms manage their “distressed assets”.
For example, FTX sent BlockFi a $250 million revolving line of credit weeks ago to fund its operations and repay existing loans. He later increased the amount to $400 million with the privilege to purchase the failing loan firm at a future discount of $240 million.
Defi vs Cefi
When investors are hesitant about investing capital in the crypto space, volatility tends to increase as asset liquidity decreases. Cumberland noted that unlike CeFi for capital allocation, DeFi shows relative strength when it comes to transparency regarding liquidation levels and distance from the spot market.
DeFi protocols, known for their mechanism that executes smart contracts despite market conditions, will automatically cash out collateral when thresholds are touched. It partially explains why they outperformed central firms offering similar off-chain services during the massive market crash.