Crypto Long & Short: The End of Extreme Leverage

Insights, news and analysis for the professional investor

By Marc Hochstein, Executive Editor

August 29, 2021

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True story: Around 1999 or 2000, I went to a mortgage bankers' conference at a Disney resort in Orlando, Fla. One company was handing out fliers proclaiming, "Leverage is the American way!"

That lender didn't know how right it was. Less than a decade later, the U.S. real estate meltdown triggered a global financial crisis. Wish I'd kept and framed that flier.

In this week's essay, I take stock of leverage in the crypto markets. The consensus among market participants I spoke to is that it has been declining since the spring, well before some offshore exchanges pulled their most egregious offerings from the market.

Which is probably a good thing. Crypto is volatile enough on its own; adding copious amounts of debt financing seems as wise as spiking energy drinks with alcohol.

As always, if you like what you read, please forward Crypto Long & Short, and reply to this email with feedback and questions. You can also find me on Twitter. Have a great rest of your Sunday.

– Marc Hochstein, Executive Editor

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The Briefing

The proverbial punch bowl known as 100 times leverage has been replaced with a weaker blend. Nevertheless, the party is picking up again in the cryptocurrency markets.

Leverage, or trading with borrowed money, is a time-honored method of juicing investors' profits (or compounding their losses, depending which way the market moves). In traditional markets like stocks, investors typically put up half the value of the trade.

But crypto loves to live dangerously, and until recently exchanges such as Binance and FTX allowed traders to enter into futures or perpetual contracts with as little as 1% down. That changed last month amid growing regulatory and press scrutiny of the market.

FTX lowered its maximum leverage for these derivatives to 20 times, and Binance quickly followed suit. BitMEX, whose former executives are facing trial in the U.S., still offers 100 times leverage, but its current CEO said in July that such aggressive borrowing is "very rare" on the platform.

While these actions seemed to signal the end of an exuberant era, they arguably capped off a trend that began months earlier.

"Overall, the amount of leverage in the system is significantly less than it was early in 2021," said Kristin Boggiano, co-founder and president of CrossTower, a digital asset trading platform that caters to institutions and professional traders. "As prices moved significantly lower from the highs in April, we saw long leverage flushing out of the market."

Winds of change

And flushed out it has stayed, even as prices rebounded.

"The recent run-up off of the lows in July does not appear to be based upon leverage," said Boggiano, a former regulator and Wall Street lawyer.

Her inference is based on a comparison between the markets for these derivative instruments and the underlying assets.

"Earlier in the year, we saw the futures market trading significantly above spot [prices], indicating leverage," she said. "Today, the difference between the spot and futures or perpetuals is much less."

Indeed, according to data from derivatives analytics firm Skew, the last time bitcoin broke above $50,000, in mid-February, the average one-month futures premium across exchanges was more than 40% on an annualized basis. Now, as bitcoin flirts with the $50,000 mark again, the premium is down to 8%.

Another sign of decreased leverage is that funding rates (the cost of holding long positions in perpetual futures) has dropped to three to four basis points per eight hours from 15 basis points per eight hours back in February.

Lower systemic leverage, in turn, suggests the crypto markets, famous for their wild swings, might become a touch tamer.

Read the full column here.

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Chain Links

Business analytics software provider MicroStrategy bought another $177 million of bitcoin, bringing the firm's total holding to 108,992 BTC. TAKEAWAY: MicroStrategy's stock is used by some investors as a way to gain indirect exposure to bitcoin, given the company's bullish bets on the cryptocurrency.

Bitcoin technology firm Blockstream raised $210 million in a Series B funding round, valuing the company at $3.2 billion. TAKEAWAY: The number of unicorns in the cryptocurrency space is rising at a rapid pace, now totaling 18 for the year. For reference, in the first half of 2021, 200 new companies were valued at $1 billion or more, up from 163 unicorns at the end of 2020.

U.S. banking giant Citigroup is awaiting regulatory approval to begin trading bitcoin futures contracts on the Chicago Mercantile Exchange (CME). TAKEAWAY: Among crypto derivatives products, CME bitcoin futures may be one of the safest to offer institutional clients due to strong regulatory oversight by the Commodity Futures Trading Commision (CFTC).

Anheuser-Busch's Budweiser moved into the NFT space, purchasing the Beer.eth domain name NFT and accompanying art. TAKEAWAY: After Visa announced its CryptoPunk purchase on Monday, corporate and retail interest surged. An already record month for non-fungible tokens is finishing strong, doing hundreds of millions in volume since Monday.

Markets are preparing for the Federal Reserve's Jackson Hole Symposium as the U.S. dollar shows strength. TAKEAWAY: Bitcoin cracked $50,000 for the first time since mid-May before pulling back into the $40s. Equity and crypto markets may have clearer direction after the Fed provides inflation guidance at the Wyoming confab.

Digital Currency Group announced approval to buy up to $750 million in shares of its Grayscale Bitcoin Trust. (Disclosure: Digital Currency Group is the parent company of CoinDesk. Grayscale is owned by DCG.) TAKEAWAY: DCG looks to utilize the Grayscale discount, while GBTC trades 15% below net asset value (NAV). The transition to an exchange-traded fund (ETF) or an inflow of institution interest would narrow the gap between GBTC and the underlying funds.

The U.S. House of Representatives is set to vote on the $1 trillion infrastructure bill, including the controversial crypto provision, on Sept. 27. TAKEAWAY: An amendment to the crypto broker definition failed to gain unanimous support in the Senate, torpedoed by a single senator. As the bill moves through Congress, the crypto industry is again marshaling bipartisan support that likely will not be enough to amend the bill.

– Teddy Oosterbaan