Crypto trading firm Cumberland weighed in on the ongoing trend of centralized digital asset firms collapsing amid a deep liquidity crisis in the industry. It suggests that the immediate recovery of the overall market depends partly on whether distressed assets can be transferred from insolvent firms to solvent ones.
the crisis is not over yet
When a prolonged bear market hits the cryptocurrency industry, over-leveraged companies run into deep trouble as their collaterals decline in value, leading to quick liquidations. As a result, a ripple effect spreads throughout the industry, bringing down one firm after another. When all users rush to withdraw funds, the liquidity problem increases, so some firms may have to take extreme measures such as suspending withdrawals and transactions.
Given the context of a series of companies already withholding withdrawals, reducing headcount and looking to restructure, Cumberland argued that deteriorating market conditions lead to a state of uncertainty as more troubled companies will soon lose their dues of liabilities. May collapse due to huge size. More badly managed firms need to liquidate their assets “to partially offset their outstanding liabilities”, the report said.
As more crypto assets are liquidated, the prices will continue to fall, meaning there will be more pain for the industry. Cumberland saw The ongoing crisis was largely similar to traditional markets in that “the underlying economics is indistinguishable from textbook examples.”
Additionally, the firm believes that the recovery of the badly beaten crypto market depends on how these bankrupt firms manage their “distressed assets”.
This is hardly a new phenomenon; Finance companies with excessive leverage have been punished in bear markets for hundreds of years. While this current cycle raises eyebrows as assets are digital, the underlying economics is no different from the examples in textbooks.
— Cumberland (@CumberlandSays) 5 July 2022
For example, FTX sent a revolving credit line of $250M to BlockFi weeks ago to finance its operations and pay off existing debt. Later, the exchange giant raised the amount to $400M, with the privilege of acquiring the failed lending firm at a future discount of $240M.
DeFi vs CEFI
When investors are hesitant to pump capital into the crypto space, as evidenced by the decline in off-chain inflows, volatility increases as the asset’s liquidity decreases. Unlike CeFi, which involves complex human-controlled processes for capital deployment, DeFi has demonstrated relative strength with respect to transparency regarding liquidation levels as well as its distance from the spot market, Cumberland said.
Known for its algorithmic-driven mechanism that force-executes smart contracts regardless of market conditions, the DeFi protocol will automatically liquidate collateral whenever the threshold is touched. This partly explains why they have outperformed centralized firms that offered similar services during a mass market crash.
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