Fundstrat Global Advisors has issued a word of caution to its bitcoin and crypto investing clients, advising them to take some risk off the table, or hedge their bets, over the weekend, due to brewing concerns about mounting leverage in the nascent market.
“We think it’s possible that the selling we’ve seen over the last day or so is related to concerns over leverage and counterparty risk of some lenders,” wrote David Grider, lead digital asset strategist at Fundstrat. Counterparty risk refers to the possibility that a trading partner runs into trouble and is unable to fulfill obligations usually tied to derivatives contracts.
Fundstrat, an independent research shop, co-founded by prominent bitcoin bull Tom Lee, pointed to a Thursday tweet by crypto mogul Barry Silbert, who offered his own words of caution about counterparty risk and leverage in crypto that could potentially translate into further turbulence in digital-asset markets.
Silbert warned that there is a “daisy chain of borrowers and lenders in the crypto space…and warned that it is “important to understand counterparty risk” and where the weak links in the chain are.
Silbert is considered a luminary in the world of digital assets, after founding two of the most widely known enterprises in crypto: Grayscale Investments, which runs the popular Grayscale Bitcoin Trust GBTC, -6.52%, and the Digital Currency Group, which also owns CoinDesk.
Worries about leverage in crypto come amid the broad swoon in crypto that has taken down values in bitcoin, as well as Ether ETHUSD, -8.06% on the Ethereum blockchain, and meme assets like dogecoin DOGEUSD, -8.13%.
Bitcoin is down over 50% from its mid-April peak, Ether is off 60% from its all-time high in May and dogecoin is down nearly 70% from its record high achieved early last month.
To be sure, the appeal of those assets is their outsize year-to-date returns, with dogecoin boasting an over 5,000% gain so far in 2021, Ether up more than 140% in the first six months of this year.
But those gains have been significantly pared, with bitcoin up a relatively pedestrian 9% on the year, compared with traditional equity benchmarks the Dow Jones Industrial Average DJIA, +0.69%, the S&P 500 index SPX, +0.33% and the Nasdaq Composite Index COMP, -0.06%, which are all up by at least 11% in the year to date. Bitcoin had been up by more than 100% in the spring.
Crypto’s recent downtrend has been partly blamed on a crackdown by China on bitcoin mining and trading, but analysts are also warning that the slump may reveal poor positioning by some investors and the dangerous use of leverage, or borrowed money, to amplify returns.
Fundstrat also warned of potential volatility emanating from some popular crypto lending platforms, who promise hefty returns to those depositing digital assets.
“We want to remind clients that crypto lenders are not regulated and insured in the same way as banks are with the [Federal Deposit Insurance Corporation].” The FDIC collects fees from member lenders to provide insurance to depositors in the financial institution runs out of cash.
“Depositors have counterparty risk to the lenders and if they go insolvent, they could lose their funds,” Fundstrat wrote.
“At very worst, we get a run on the banks that causes asset prices fall too far, otherwise good lenders could go underwater. We are not expecting this…But we don’t think it’s a bad idea to take some risk off the table over the weekend,” Grider wrote.