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Editor’s Note: Readers of TradeSmith Daily should be familiar with TradeSmith’s Chief Research Officer, Justice Clark Litle. Yesterday, Justice shared his insights on the impending downfall of the over-hyped, over-leveraged cryptocurrency market. What is happening in the crypto space is unprecedented, so we are sharing his perspective, once again, with our TradeSmith Daily readers. Keith will be back tomorrow with his insights on the breakout stock that has jumped nearly 50% in three weeks due to a massive price surge in uranium.
El Salvador adopted Bitcoin as its official legal currency on Sept. 7. The rollout process did not go well. There were problems with the government’s official crypto wallet, forcing it to be disconnected for maintenance.
Worse still, crypto markets saw another flash crash — an out-of-the-blue price meltdown that occurs at lightning speed — and multiple large crypto exchanges went down or temporarily stopped processing orders. The crypto space overall shed roughly $300 billion in market cap by way of multiple billions in liquidation.
Bitcoin itself had a wild 24 hours, losing 17% against the U.S. dollar at one point and shedding 10% of its value within an hour.
During the drop below $50,000 — from which Bitcoin has only partially recovered as of this writing — Nayib Bukele, the president of El Salvador, sent out a tweet with a wink emoji saying that the El Salvadoran government was “buying the dip.”
This was surely the first instance of the president of a country conducting monetary policy in real time via Twitter while directing the country’s treasury to purchase a cryptocurrency.
Heading into this event, Decoder’s guidance could be summed up in three words: “Get Out Now.” Do not pass go; do not collect $200. Just get out.
The crypto space overall is headed for a meltdown of catastrophic proportions.
This meltdown will happen because public participation in crypto has reached a full-blown mania that surpasses anything ever seen before.
It will also happen because a small group of obscenely rich crypto insiders — crypto is more or less controlled by a group of people small enough to fit inside a conference room — have grossly overextended themselves, piling leverage on top of leverage in their effort to exploit public greed that has reached mania levels.
And last but not least, the crypto meltdown will happen because of an observation from the philosopher George Santayana: “Those who do not remember the past are condemned to repeat it.”
There is a scenario that plays out in financial markets over and over again, almost like a movie script.
- The public grows wildly enthusiastic.
- The insiders become insanely greedy.
- A sense of invincibility takes hold.
- Leverage gets piled on top of leverage.
- Fraud and corruption make things worse.
- The whole thing blows up spectacularly.
It happened with junk bonds in the late 1980s, sending Michael Milken to jail. It happened to the savings and loan industry in the late 1980s and early ’90s, and in 1994 to hedge fund lenders known as “shadow banks.” It happened in 1998, blowing up a multibillion-dollar hedge fund called Long-Term Capital Management. It happened in 2002, in the aftermath of the dot-com bubble, via spectacular fraud implosions like Enron and Worldcom. It happened in 2006, blowing up another multibillion-dollar hedge fund called Amaranth Advisors. It happened in early 2008, wiping out the investment bank Bear Stearns (whose carcass was sold to J.P. Morgan for $2 per share).
And of course, it continued in late 2008 on a global scale.
This pattern is now playing out in crypto, and when the 2008-style blowup happens — not for all markets, just for crypto — it will land like a nuclear bomb.
In crypto right now, there are glaring red flags everywhere you look. The biggest one is Tether, a supposedly dollar-backed stablecoin that is likely insolvent. We’ve written a fair amount about Tether these past few months, and will have more updates on it soon.
But Tether is only the beginning. Just look at what played out with the recent flash crash associated with El Salvador’s rollout.
As El Salvador ran into wallet glitches, multiple crypto exchanges went down partially or completely in the midst of all the selling.
This “glitch” sure is convenient, because it seems to happen in every major crypto crash episode. One would think that a major job — if not the No. 1 job — of a crypto exchange would be to make sure that its bandwidth is solid enough to handle a spike in orders under extreme conditions.
Instead, we get these outages in the midst of meltdown episodes on a repeat basis, with no fix to the problem. Perhaps that is because an outage isn’t a “problem,” per se, in the eyes of the exchanges, if customers are prevented from entering sell orders when the crypto marketplace is under stress.
Also, in the midst of the meltdown, we saw a tweet that made our jaw drop. It came from FTX, a major crypto exchange. You can see the screenshot below:
What does that mean, “USD is lending at ~25% right now?”
It means that leveraged holders of crypto assets — likely including the exchange itself — were so desperate for liquidity to support their positions, they were willing to pay 25% interest to anyone who would lend them dollars.
Think about it like this. We all want higher rates of return on our cash deposits. Nobody is really happy with the fact that every major bank pays almost nothing on cash in a checking account today.
Now imagine that a bank you’d never heard of — domiciled in a country you’ve never been to — said, “Hey, send us your cash and we’ll pay you 25%.”
Would you do it? No, because you’d wonder if it was a scam, or if something crazy was going on.
The same thing applies — but even more so — to leveraged borrowers willing to pay huge amounts of yield in the middle of severely stressful market conditions.
If someone offers to pay you 25% to lend them your U.S. dollars, and you happen to know that they are desperate for cash to support highly leveraged positions in a partial state of meltdown, you don’t just walk away. You run, as fast as you can.
Unfortunately, the crypto space has become a giant, rocket-fueled Ponzi scheme in too many ways to count.
One of the most direct ways comes in the form of borrowing money to pump up the value of crypto assets, with price appreciation enabling leveraged entities to borrow even more, thus giving them the leverage to pump prices up even further.
At the same time, in the background, crypto insiders running various exchanges and public-facing service businesses are making money hand over fist through commissions, fees, manipulated auctions, and countless other activities designed to milk the public as efficiently as possible.
All of this has happened before. It is the same playbook that has been run multiple times: enthusiasm, greed, invincibility, leverage, fraud, blowup. Various aspects of the technology are new, but the motives of the players, and the basics of their strategies, are as old as the hills.
The story always ends the same way too.
First, the aura of invincibility gets cracked. And second, the leverage on top of leverage starts to come undone.
Any number of events can cause this process to happen. It is like the twig snap that triggers an avalanche.
Greed and a feeling of invincibility are what allow extreme amounts of leverage to build up in the first place, along with business models that are explicitly built on leverage — like, for example, borrowing money at nosebleed rates of interest, and then using those funds to push up the value of crypto assets so as to attract even more retail attention, and even more capital, and thus leverage it all even further.
As the leverage starts to unwind, the snowpack starts to move, and then the sense of invincibility suddenly evaporates as the operators who thought they had control — more often than not insiders of some kind — wind up losing control completely.
This is where we are with crypto right now. What is happening has nothing to do with Bitcoin as digital gold, the future of the blockchain, or the intelligent application of crypto technology to the world’s problems. All of that stuff is still real, and still in existence, but it has been shoved to the back burner by the dangerous feeding frenzy that has taken place.
And when the current crypto mania melts down, it will do so spectacularly.
In fact, we would not be surprised if multiple well-known crypto exchanges that seem to be thriving today no longer exist on the other side of the catastrophe that is coming. And if you have assets with one of those exchanges when it all goes belly up, good luck with that.
We didn’t even get to talk about why the El Salvador experiment is doomed. We’ll get to that soon, in another broadcast.
As a final note, though, it should be stressed that we, at TradeSmith Decoder, are a big fan of crypto, and we have generated huge potential upside from our various crypto recommendations, including a high-conviction stock pick that turned into a twenty-five bagger in less than a year (yes, you read that right).
But the crypto we are a fan of is the real crypto that has temporarily been forgotten — the real technology that can transform trillion-dollar industries, and the real value of Bitcoin as a digital reserve asset — not this wildly distorted mania environment where people are willing to pay $611,000 for a drawing of a rock via the latest crypto fad: non-fungible tokens (NFTs).
The real crypto will be back, and will come with some incredible investing opportunities, in our view — comparable to buying Amazon.com below $7 per share after the dot-com bubble burst.
But first, the inevitable blowup has to happen, in which the ponzified mania promoters see their leveraged schemes get vaporized, in the same manner that has happened countless times before. We’re getting there.