Crypto crashes under its own nonsense

Plus Fed minutes worry, Colombia shuts down, Epic takes on Apple

Welcome to another week of Contention! This time we’ve got six and a half minutes of decentralized dissident business news. We cover:

  1. Fed minutes, supply meltdowns freeze markets

  2. Crypto crashes under its own nonsense

  3. Rapid Round: Colombia’s uprising costs billions, Cook wraps Epic v. Apple

Next Monday is a market holiday in the United States, so we’ll be delayed a day too. In the meantime, share Contention far and wide!

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Fed minutes, supply meltdowns freeze markets

U.S. equity markets ended a choppy week with mixed returns -- the Dow down 0.5%, the S&P 500 down 0.4% but the Nasdaq rebounding late in the week to finish in the green, up 0.3%. 

Two stories dominated trading: a major selloff in cryptocurrencies and the release of minutes from the Federal Reserve’s April meeting. Both narratives reflect investor fears that the present speculative frenzy might soon be coming to an end. 

We cover the crypto rout below, but the worst of it peaked Wednesday, the same day the Fed’s minutes dropped. The minutes raised the specter that interest rates could be heading upwards in the months to come, a headwind to asset prices. Despite Fed Chairman Jerome Powell’s insistence after the April meeting that “now is not the time to talk about tapering” the bank’s massive capital interventions, the minutes revealed that the Federal Open Market Committee (FOMC) had done precisely that. 

Even a highly-hedged whiff of a withdrawal -- “a number of participants” suggesting that maybe the committee should “begin discussing a plan” to taper -- was enough to weigh on equities. Monthly $120 billion purchases of Treasury bonds and mortgage-backed securities push down interest rates, pushing up “capital market risk appetite.”

A shift like this out of market support in 2013 led to the “taper tantrum” in bond markets, sending interest rates up 140 basis points in a matter of weeks. Such a move now could combine with extraordinary levels of leverage debt in the stock market to produce a major plunge. The Fed’s minutes warned of “adverse implications for the real economy” should this come to pass. 

So why are they thinking about talking about a rotation out of asset purchases? Rising inflation. The familiar threat showed up again last week in housing market data. Housing starts dropped 9.5% month-over-month in April on a seasonally-adjusted basis. Analysts expected an annualized construction rate of 1.7 million new homes, but got 1.57 million instead. 

Extremely high lumber prices -- up 300% in a year -- crushed builder margins and choked off the industry. Backlogs mounted, as the number of projects authorized but not yet begun hit its highest level since 1999

These rising commodity prices are not limited to lumber. Shortages in nearly every major input category have inspired a “buy in advance mentality,” setting off a self-perpetuating cycle where businesses snap up more than they think they need since they don’t know when they’ll be able to get more, increasing demand and persistently soaking up supply. 

Politicians think they have a solution for the most important commodity of all: labor-power. Last week saw three more states -- Texas, Indiana, and Oklahoma -- all announce an end to enhanced unemployment benefits. This brings the total to 22, all led by Republican governors, with Democrats in Kansas and Wisconsin also exploring the move. The hope is that ratcheting up desperation will force workers back onto the market at lower wages.

The plan is unlikely to work. A new paper from the Federal Reserve of San Francisco estimates that unemployment benefits are only a “small but noticeable” factor in workforce troubles. The paper calculates that if seven out of 28 unemployed workers received a job offer, only one of the seven would decline it because of their benefits. 

All 28, however, would lose income that could be the difference between homelessness, hunger, and security. Meanwhile, prices will still be rising.

That’s when the actual solution will start to kick in: a supply crunch fixed by withdrawn demand, i.e. a recession. This could happen organically, as more industries move like construction has, shutting down output because they can’t afford supplies. The Fed could also be forced to use its vaunted “tools” for dealing with inflation -- raising borrowing costs, slowing investment and forcing defaults. 

Markets seem to think it will be both: tapering driving up rates, bursting bubbles, spurring margin calls, forcing selloffs, freezing credit, bankrupting businesses, and laying off workers. Until then, politicians and bankers will pretend like they know what they are doing to extend the profits at least one more week. Stay tuned. 

Crypto crashes under its own nonsense

Cryptocurrencies also sold off last week, with bitcoin ending the week below $40,000. Things got even worse for the crypto benchmark over the weekend, as it dipped below $32,000, a 50% drop from its April high point. 

Behind the dive: new scrutiny from regulators and blowback from the sector’s own speculative excess. 

The plunge was bitcoin’s third drop of at least 25% this year, and the 10th time it has fallen 30% or more since 2017. Nonetheless, its price has increased 50x in that same period, and remains up 300% year-over-year

Media reports focused on three main motives behind the downturn: 

  • Tweets from Tesla CEO Elon Musk

  • New regulatory pressures in China

  • Proposed increased tax scrutiny in the United States

On May 16, Musk replied to a Twitter thread suggesting he might sell off Tesla’s $1.5 billion stake in bitcoin with the word “Indeed.” Bitcoin lost 8% immediately after the tweet, later regaining some ground after Musk “clarified” that he had not sold his bitcoin. 

Musk has a large stake in bitcoin competitor dogecoin, and talking down bitcoin could help drive new money into his pockets. Impairing Tesla’s bitcoin assets could also be a convenient way to hide business losses if the company is having a bad quarter.

Shortly after Musk began the slide, three Chinese financial self-regulatory bodies -- the National Internet Finance Association of China, China Banking Association, and the Payment and Clearing Association of China -- issued a joint statement repeating an earlier central bank warning that cryptocurrencies may not be used for any payments in the country. They then went even further, barring member institutions from providing “direct or indirect” services to any crypto-related business activities. 

Forbidding banks, internet platforms, and payment companies from “indirect” services means that businesses will have to increase scrutiny of all currency-related services to eliminate gray area connections to the crypto world. Capital flight from China has been a major use-case for cryptocurrency; this move threatens that revenue stream.

Capping off the week, U.S. Pres. Joseph Biden unveiled a new proposal to require that all cryptocurrency transactions more than $10,000 be reported to the IRS. All other cash transactions already require this, but tax cheating is another major cryptocurrency use-case. The news further shaved value off the asset class.

Beyond these three visible forces at play against the crypto market, the growing “decentralized finance” or DeFi ecosystem also intensified cryptocurrency’s problems last week. 

“DeFi” refers to platforms providing traditional financial services -- lending, derivatives issuance, market making, etc. -- outside of financial institutions, all using cryptocurrency blockchains. Over the last year, DeFi has grown 88x, with its most profitable players engaged in “yield farming.” 

What is yield farming? It is an outgrowth of DeFi’s need for liquidity -- being an investment bank requires lots of money -- across a large number of illiquid “altcoins” and the industry’s practice of issuing “governance tokens,” tradeable crypto assets that confer voting power over platforms’ business decisions. 

The result: a broad array of highly volatile interest rate offers and token price moves that yield farmers can arbitrage to generate profits. This is speculation (yield arbitrage) on top of speculation (DeFi market bets on crypto) on top of speculation (crypto itself). 

As prices fell last week, these speculative bets unwound -- margin calls again -- forcing a 14x increase in DeFi platform liquidations. All-in-all the DeFi sector lost 24% of its “total value locked” last week, a selloff that drove down crypto prices, forcing more DeFi liquidations -- yet another feedback loop.

Crypto has been here before, but the tide may be turning. A money that moves 30% at a time can’t possibly be used for exchange, and besides tax fraud and capital flight, the only other real-world use for crypto seems to be ransom. The Wall Street Journal revealed last week that insurance giant CNA Financial paid hackers $44 million in crypto in March. Crypto-enabled extortion grew 311% last year, with the average payout now an estimated $10-15 million.

With institutional investors moving back into gold as an inflation hedge, business and government now have a huge shared interest in ramping up regulation of the space -- and what they both want, they usually get. This is bad for bitcoin, but maybe good for everybody else.

Rapid Round

Blockades shut down Colombia

One of the largest protest movements in Colombia’s history continued last week. Initially in opposition to a now-withdrawn tax bill by Pres. Iván Duque’s right-wing government, the protests have since evolved into a broader resistance to corruption and police repression.

Colombia’s petroleum and mining industries are also feeling the pinch. Blockades forced multinational oil and gas company Geopark to cut its production by nearly half, and Canada’s Gran Tierra by 18%. The government is trying to make up the difference by importing fuel from Ecuador, but gasoline shortages and blockages by ex-workers and the indigenous Wayuu people have already knocked out Carrejón, one of the largest open-pit coal mines in the world.

The economic impact of the protests and blockades: around $2.75 billion, or $132 million per day. That’s on top of a 14.2% unemployment rate and 42.5% poverty rate before the protests, which human rights activists say the government has reacted to with unprecedented violence

Colombia’s National Strike Committee said they will continue to “convene large mobilizations and peaceful actions, until the government stops the violence.”

Epic v. Apple monopoly showdown

Apple CEO Tim Cook took the witness stand on Friday in Epic Games v. Apple, nearing the end of what may become a landmark antitrust trial. Epic sued Apple last October after the tech giant kicked the developer’s popular game Fortnite from its App Store in response to Epic’s alternative system for in-game purchases.

Epic alleges that Apple has created an unfair monopoly by taking a 30% cut from those in-game purchases, like a car company collecting a fee every time a motorist fills up their gas tank. Cook defended the practice in exchange for Apple providing payment processing, customer service, and using Apple’s intellectual property.  

“We would have to come up with another system to invoice developers, which I think would be a mess,” Cook said during the trial. “We would in essence give up our total return on our IP.”

Apple’s effective monopoly position in the mobile app market allows the company to charge excessive rents on its App Store service. Epic Games is also suing over Apple’s requirement that all apps on their devices come through the Store. Cook said if Apple allowed sideloading, or the direct installation of apps -- bypassing the company’s cut -- then users would be at a much higher risk of catching malware.

Disclaimer

Our only investment advice: Check out this deep dive into Tether’s assets.

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