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Crypto and Blockchain Get a Gut Check on Risk and Stability

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  • (2:00) - Collapse Of TerraUSD & Luna: A Threat To the Blockchain?
  • (17:30) - Staking and Yield Farming: FinTech and DeFi Innovations
  • (23:40) - The Wild Wild West of Crypto: Whence Cometh Law and Order?
  • (28:30) - The Future of the Newest Fiat Asset Class
  • (33:15) - Will Michael Saylor Be Pushed Out of His Bitcoin Investment?
  • (38:45) - Bitcoin Bear Market Impact On Square and PayPal


Welcome back to Mind Over Money. I'm Kevin Cook, your field guide and storyteller for the fascinating arena of behavioral economics.

As if the laboratory of greed and fear that is the financial markets didn't offer enough dramas of human behavior to dissect, last week brought another cryptocurrency aberration to the headlines.

This particular episode involved the sudden implosion of a pair of related instruments: the cryptocurrency, Luna, and the TerraUSD "stablecoin," which at their bubbly peak had a market valuation near $40 billion.

Writing for Bloomberg on May 16, Olga Kharif summarized the events and their impact thus...

The Terra blockchain -- the platform supporting scores of decentralized applications that let users swap crypto coins and earn yields -- was halted and then restarted twice in recent days, as the value of its main cryptocurrency, Luna, and the related TerraUSD (UST) stablecoin collapsed following a wave of selling pressure. Along the way, incentives for various parties to support the chain evaporated, sending the ecosystem that nurtured more than 110 applications connected with more than 4 million digital wallets into disarray.

She also speculated that this "implosion may bring about something just as noteworthy: the death of a major blockchain."

Today on the podcast, I invited my colleague, professional day trader, and experienced trader of "DeFi" (decentralized finance) instruments, Jeremy Mullin, to discuss that event and its implications.

On the innovative frontiers of FinTech and DeFi, it seems that new ideas and technology platforms will outpace regulators' ability to keep up with them. Jeremy offers some important views here as well as explaining how "yield farming" works.

The Innovation of Risk Management

One place I've always looked to as a model of financial innovation that possessed built-in security, transparency, and sustainability were the futures and derivative markets which grew out of Chicago in the 19th and 20th centuries.

There, the model perfected by CME Group (CME - Free Report) over a century -- from the first wheat futures before the Civil War to the stock options, currency futures, and interest rate derivatives invented in the 1970s -- became the global standard for fungibility, risk management, and liquidity even during financial crisis.

And having watched CME Group economists and technology leaders navigate these waters for decades since I first walked on those trading floors in 1994, I can say that the other trend which will likely persist is that the exchanges will continue to lead and teach regulators what risks are important and how precisely to manage them.

I talked about the evolution of risk management since the Renaissance in my last podcast episode Get Your Money Game In Top Shape With Mark Harvey, The MoneyPlan Coach.

Bankruptcy and Devaluation, Brothers From Another Mother

What the CME Group model achieved was a sufficiently high level of security and trust, with the exchange clearinghouse standing between every buyer and seller as the guarantor of mark-to-market trading performance.

This eliminated counter-party risk and fostered increased usage of the derivative markets from a diverse array of hedgers (risk avoiders) and speculators (risk takers) who could all trust in the underlying economic purpose and stability of any standardized forward contract -- whether it was settled with actual delivery of the physical commodity, or just marked to a financial index with cash settlement.

This sophisticated architecture of checks and balances -- using "performance bonds" as partial collateral and real-time risk analysis of all positions that violate those bonds -- guaranteed that no counterparty would ever lose money because of the losses of another.

Crypto Land: Fiat As Any Banana Republic

Meanwhile, the best analogy I can think of for the "wild west" of crypto DeFi is a currency devaluation, where any country can decide to dramatically lower the exchange rate for its money on the global market.

This has been done for ages whenever the debt or trade imbalances a country suffered under became too onerous.

In essence, crypto land is no less fiat than any third-world banana republic.

And adding insult to the injury of a perfect storm last week, where Bitcoin was crashing while TerraUSD and Luna were racing to zero -- creating a vicious feedback spiral for all three -- Coinbase Global (COIN - Free Report) included a disclosure in its surprising quarterly loss of $430 million dollars that spoke of how things would go, should they go bankrupt.

Coinbase warned that "in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings, and such customers could be treated as our general unsecured creditors."

Cathie Wood's ARK Invest Still a Fan of COIN

As I wrote earlier this week, "Coinbase, the $15 billion cryptocurrency exchange that lost over two-thirds of its value in the last month, delivered a crushing reversal of fortunes last week in its Q1 report. Lower crypto prices and volatility in the quarter that ended in March, led to lower trading volumes and resulted in a drop in net revenue of 27% year-over-year to $1.2 billion."

While Cathie Wood's ARK Innovation ETF (ARKK - Free Report) continues to back COIN with total fund family purchases of over 850,000 shares last week, a persistent bear market for Bitcoin should continue to challenge that investment thesis for the entire asset class.

Jeremy described Bitcoin as the "reserve currency" of the crypto-sphere to which "alt other" coins are tethered.

Speaking of reserve status, if you want to better understand why the US dollar is not collapsing anytime soon, despite the wailing from crisis promoters, check out my vlog from two weeks ago...

Inflation Crisis and the Imploding Dollar: Panic of the Profiteers

In the podcast, I argue that the dollar is a lot like water for the planet. It might get dirty, but it's always vital for the global financial plumbing as the value exchange for the strongest, most dynamic economy.

Read and watch the presentation above to learn why I say "in FX, it's all relative" and that it's tremendously easy to clobber inflation over the long run by having an investment plan that recognizes asset growth opportunities where your dollars can multiply exponentially.

Albatross or Anchor: How Heavy Is the Asset for Michael Saylor?

In a wide-ranging 40-minute discussion with Jeremy, I closed by asking him about the outsized Bitcoin investment by MicroStrategy (MSTR - Free Report) CEO Michael Saylor, who has a significant portion of his and his company's wealth tied up therein.

MicroStrategy said it held 129,218 Bitcoins at the end of Q1 2022, after having acquired another 4,500+ "coins" at an average price of about $45,000.

Bitcoin's price trades around $30,000 this week after a crash from $35,000 to $25,000 in just a few days last week, valuing the stake at roughly $3.9 billion.

Rumors have floated about the market waters in the past few weeks that his stake is not only "under water" at a weighted-average acquisition price around $35,000, but that he could be subject to a margin call on his leveraged positions at a Bitcoin price of $21,000.

This raises serious concerns for MSTR shareholders about the impact of a Bitcoin collapse on investor confidence in the company strategy.

Even a more conservative Bitcoin "corporate investor" like PayPal (PYPL - Free Report) has seen its stock plummet 75% and take out its Corona Crash lows in the past year.

Bitcoin's Best Use Case? Payment Processing for Speculators

I think that crypto is a new asset class. And that it's better than gold. But this evolution is still in its early stages. Until financial innovations create harder connections and functionality, the faulty designs, lack of trust, and "devaluation beatings" will continue.

While PayPal has transaction use cases for holding and offering Bitcoin capabilities to customers, MicroStrategy is simply making a bet on another currency besides the US dollar to store its wealth.

And even if this bet turns out very well, it may still be seen as an inappropriate gamble for a public corporation. MSTR shares are down over 80% since their peak above $1300 early last year.

Last week, in accordance with this view of its Bitcoin-tethered volatility, shares fell 54% in 4 days from $294 to $134, before recovering back above $200.

If it has anything going over PayPal, MSTR hasn't taken out its Corona Crash lows -- yet. Maybe that's because Saylor says that Bitcoin could go all the way back down to $3,500 (near its Corona Crash lows) before the company would be materially impacted by any leveraged loans.

The whole financial world is watching this drama, that's for certain.

Be sure to check out the podcast and hear Jeremy share a unique and simple tool to view the total liquidity of the crypto market, including what has been lost and what will have to be overcome before Bitcoin sees new highs again.

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