No holiday break for crypto

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Programming note: We’ll be off this Monday for the Fourth of July but will be back in your inboxes on Tuesday.

HOLIDAY WEEKENDS ARE A GREAT TIME TO UNWIND — If you’re on a trading desk at a crypto lending platform, “unwind” will mean something very different to you this Fourth of July.

The swift collapse of digital asset prices over the last two months sparked a cascade of liquidations at multibillion-dollar crypto businesses after they were caught flat-footed on highly levered bets on Bitcoin and digital startups.

The downturn has already forced at least one major crypto hedge fund, Three Arrows Capital, into liquidation. Celsius Network, a popular lending platform that promised retail customers double-digit yields for deposits, has frozen trading and withdrawals. Other online trading and depository businesses like BlockFi and Voyager have had to take on rescue financing from entities linked to FTX founder Sam Bankman-Fried.

“Most of [the troubled businesses] were leveraged — or they had loaned to someone who was leveraged and now can’t repay that loan,” Bankman-Fried, a billionaire and political megadonor, said in an interview on Thursday. He added that FTX is looking for opportunities — no doubt on favorable terms – to “bail out, you know, places where customers would otherwise be underwater.”

Against that backdrop, the SEC on Wednesday announced that it was blocking Grayscale Investments’ application to convert its $12.9 billion Bitcoin trust – the largest Bitcoin-holding investment fund globally – into an exchange-traded fund whose shares would be available on NYSE Arca.

That decision has a bearing on the liquidity crises facing certain troubled firms like Three Arrows and BlockFi, both of which held shares in the trust (GBTC) prior to their recent troubles. (Both firms did not respond to requests for comment).

Shares of Grayscale’s Bitcoin trust are currently traded over-the-counter and subject to restrictions that limit their ability to be bought and sold. Since early 2021, those shares have traded at a steep discount to the value of the Bitcoin tokens held in the trust.

That wasn’t always the case. When the share price was above the trust’s net asset value, investors could buy up shares with Bitcoin – which make up the trust’s underlying assets – and flip them to other investors at a premium.

Once that premium went away, “leveraged traders shit their gym shorts,” Ryan Selkis, a crypto investor and founder and CEO of industry data provider Messari, wrote in a research note on Wednesday. “No one knows how to unwind their leveraged positions and are left with Schroedinger’s bitcoin collateral: if you look at the GBTC shares, the position and its borrower are dead.”

Grayscale — as well its investors — have argued that those problems could be solved if the trust were allowed to convert into an ETF. That would lift certain trading restrictions and make it easier for GBTC shares to realign with the value of the vehicle’s Bitcoin holdings. The firm had deployed an aggressive lobbying and public relations strategy to make that case with both the SEC and Congress.

“The 28 to 30 percent discount that GBTC is trading at; that represents billions of dollars of unrealized shareholder value,” Grayscale CEO Michael Sonnenshein said in an interview on Thursday. “In that context, this is a very, very much missed opportunity on [the SEC’s] part.”

The agency, however, has repeatedly rejected other Bitcoin ETF proposals on the grounds that the vehicles couldn’t adequately protect investors from fraud or manipulation. Its 86-page decision letter on Grayscale’s fund makes the same case.

“SEC staff likes products to fit into well-defined slots like kids toys; crypto doesn’t easily fit,” Justin Slaughter, a former SEC and CFTC staffer who’s now policy director at the crypto investment firm Paradigm, wrote in a series of tweets on Thursday. “We’re at an impasse.”

To that end, the SEC’s decision on Grayscale wasn’t unexpected. Earlier this month, the firm tapped the former U.S. Solicitor General Don Verrilli to lead its legal strategy in the event of a denial. Grayscale has already filed a petition challenging the SEC’s decision in federal court.

It will take months, possibly more than a year, for Grayscale’s case to reach any sort of resolution. In the meantime, troubled crypto lending businesses and investment funds who had locked up their balance sheets with GBTC shares will have little recourse for generating much liquidity to pay off any of their outstanding loans.

Given the amount of leverage and risk-taking that fueled some of the industry’s excesses over the last two years – often in the absence of meaningful investor and customer protections – crypto skeptics aren’t clamoring for those groups to get thrown a life raft.

“The SEC’s overriding mission is to protect investors and that could not be more important than now after more than $2 trillion have been lost in crypto investments during just the last several months,” Better Markets President and CEO Dennis Kelleher said in a statement. “While the current crypto-crash, carnage, and seeming death spiral may not kill the product, investors are nonetheless suffering enormous losses and the SEC must act very, very cautiously before unleashing yet another vehicle for investors to lose money.”

IT’S FRIDAY! — Kate Davidson will be back on Tuesday, after the July 4 holiday. Send tips to [email protected] or @KateDavidson, or [email protected] or @aubreeeweaver.

KEY INFLATION GAUGE REMAINS HIGH“,”link”:{“target”:”NEW”,”attributes”:[],”url”:”https://apnews.com/article/inflation-biden-prices-government-and-politics-dcd05b4a21aaebcc200b233a6b3aaee4″,”_id”:”00000181-c5bd-d066-a3bb-dfbd10070001″,”_type”:”33ac701a-72c1-316a-a3a5-13918cf384df”},”_id”:”00000181-c5bd-d066-a3bb-dfbd10070002″,”_type”:”02ec1f82-5e56-3b8c-af6e-6fc7c8772266″}”KEY INFLATION GAUGE REMAINS HIGH — AP’s Paul Wiseman: “A measure of inflation that is closely tracked by the Federal Reserve jumped 6.3 percent in May from a year earlier, unchanged from its level in April. Thursday’s report from the Commerce Department provided the latest evidence that painfully high inflation is pressuring American households and inflicting particular harm on low-income families and people of color.

“The report also said that consumer spending rose at a sluggish 0.2 percent rate from April to May. Consumer spending is beginning to weaken in the face of high inflation. But it’s still helping fuel inflation itself, especially as demand grows for services ranging from airline tickets and hotel rooms to restaurant meals and new and used autos.”

POLITICO’s Garrett Downs has more on how food is one of the biggest drivers“,”link”:{“target”:”NEW”,”attributes”:[],”url”:”https://www.politico.com/news/2022/06/30/biden-inflation-00043397″,”_id”:”00000181-c5bd-d066-a3bb-dfbd10070003″,”_type”:”33ac701a-72c1-316a-a3a5-13918cf384df”},”_id”:”00000181-c5bd-d066-a3bb-dfbd10070004″,”_type”:”02ec1f82-5e56-3b8c-af6e-6fc7c8772266″}” food is one of the biggest drivers of spiking prices: “The cost of meat, eggs and other edible items at the grocery store has been a big driver of the historic inflation and rose by 11 percent in the last year, surpassed only by increases in energy expenditures…A July Fourth cookout is expected to be 17 percent more expensive than last year, according to a recent survey.”

FORMER TREASURY SECRETARY GEITHNER: FED’S RATE PIVOT HIGHLIGHTS NEED FOR TREASURY MARKET FIXES“,”link”:{“target”:”NEW”,”attributes”:[],”url”:”https://www.wsj.com/articles/geithner-says-feds-rate-pivot-highlights-need-for-treasury-market-fixes-11656595800″,”_id”:”00000181-c5bd-d066-a3bb-dfbd10070007″,”_type”:”33ac701a-72c1-316a-a3a5-13918cf384df”},”_id”:”00000181-c5bd-d066-a3bb-dfbd10070008″,”_type”:”02ec1f82-5e56-3b8c-af6e-6fc7c8772266″}”FORMER TREASURY SECRETARY GEITHNER: FED’S RATE PIVOT HIGHLIGHTS NEED FOR TREASURY MARKET FIXES — WSJ’s Nick Timiraos: “The Federal Reserve’s sprint to withdraw stimulus in the midst of concern that high inflation could be more persistent is underscoring the need to improve the resilience of the U.S. Treasury market, according to a report prepared by former senior policy makers. The Group of 30, an independent group of central bankers, financiers and current and past regulators, released the report to highlight the status of recommended overhauls to the $23 trillion market for U.S. government debt. The report followed an initial set of recommendations released last year to reduce the risk of a crackup in the Treasury market.”

A WORD WITH MFA’S BRIAN CORBETT — From Kate: MM sat down with Bryan Corbett, president and CEO of the Managed Funds Association, which has strongly objected to SEC Chair Gary Gensler’s aggressive regulatory agenda, including rules that would impose new reporting requirements for fund managers. A few takeaways from the conversation:

Why now? One of the group’s main arguments is that the current wave of proposals hasn’t been driven by a crisis or major legislation, like the 2010 Dodd-Frank Act. “In our mind, it’s hard to figure out what the problem is that he’s trying to solve with this voluminous rulemaking that’s coming at such a frenetic pace that it’s almost impossible for market participants – and the industry who have to deal with these rules – to thoughtfully respond to him and help provide thoughtful feedback.”

Market volatility: Corbett said some of the proposals are especially unwise at a time of heightened market volatility, warning they could reduce choices for investors. “The SEC proposal on dealers will actually push people out of the Treasury market and result in more concentration, less liquidity, and potentially more dislocations like we saw back in March 2020.”

Full steam ahead: The sense is that Gensler is racing to get as much done as he can before January, when Republicans could regain control of the House or Senate, Corbett said. “But he still has the votes, he still has the three-to-two majority, he still has an administration that will stand behind him. … Will there be more (congressional) oversight? Without a doubt. But does that stop…