Renewed speculation regarding the potential approval of ETFs on BTC futures by the SEC provided some optimism within the markets, with BTC gaining 4.0% in the last 24 hours after clear bearish price action over the last week. SEC chairman Gary Gensler reiterated support for Bitcoin ETFs that invest in futures contracts as an alternative to the underlying asset. Crypto ETFs could entice additional large scale institutional investors into the crypto markets, providing an important source of demand for crypto assets.
The Bitcoin lightning network channel capacity reached an all-time high of 2,955 Bitcoin, according to data from The Blocks Data Dashboard. The lightning network is the primary 2-layer solution for Bitcoin, designed and implemented to make small bitcoin transfers faster and cheaper. This means that users of the network can transfer $132 million (at the current price of BTC) and the network has grown at a daily rate of 19.4 BTC over the last 90 days. This is an indication of an always increasing adoption.
Finally, the daily transaction volume of the Bitcoin network hit an all-time high of 29 billion USD on Tuesday. Findings from researcher Kevin Rooke also outlined that this is only 1 of the 5 times the daily transaction volume of BTC has surpassed 20 million USD. This is in sharp contrast with off-chain volumes that are still very low when prices rise, still pointing towards a bear market.
Last week began with a defining moment in the future of the Chinese economy, with large real estate group Evergrande seemingly destined for collapse. The fallout from this inevitable collapse has reverberated throughout all markets, with the crypto market, in particular, seeing significant selling pressure and volatility during the periods of heightened uncertainty surrounding the fate of this real estate titan. The significant debts of Evergrande are predominantly domestic based, with Evergrande having been identified in 2018 as a company that poses a systemic risk to China’s financial system. This poses the question; how and why is the Evergrande crisis affecting the crypto markets?
Firstly, it is important to outline exactly how and why Evergrande and China find themselves in this unfavourable position. I attribute this to two significant factors: Evergrande’s overuse of leverage and the Chinese government’s obsessive drive for high GDP growth.
Evergrande Group has positioned itself firmly as the most in-debated real estate company in the world, with a reported $310 billion of outstanding debts owed to bondholders, banks, and other creditors. Evergrande’s assets make up approximately 2% of the Chinese GDP, with the real-estate sector making up a staggering 30% of all debt in China. These numbers alone indicate that Evergrande’s eventual collapse will send shockwaves through the Chinese economy, likely correcting the currently frothy real-estate market. This is certainly alarming news in a territory with the highest levels of homeownership in the world, with HSBC reporting the average urban household in China owns 1.5 residential properties.
Adding more fuel to the fire, Evergrande’s financials are not as healthy as implied by their strong balance sheet position and positive working capital ratio (current assets /current liabilities). When delving deeper, it can be seen that 66% of the current assets of Evergrande are made up of incomplete projects which are being held at face value (the value that these assets would command in current market conditions). Additionally, real estate is a wholly illiquid asset, meaning selling large or many properties in a short period of time is extremely difficult and likely forces the seller to offer the properties at below face value. Therefore, it can be assumed that a significant proportion of the current assets held by Evergrande are impaired and the sale of these assets will culminate in significant losses. This has already begun to materialise as Evergrande have reportedly been offering some of their assets to debtholders at significant discounts. This amounts to the perfect destructive storm - a company with significant short term debt obligations and a balance sheet built up of illiquid and theoretically overvalued assets.
The Chinese government’s push for high GDP has also played a significant role in the current position Evergrande and the Chinese real estate market finds themselves in. China has allowed its real-estate sector and economy participants to continually increase leverage over the prior financial periods, culminating in a property market and economy that is highly dependent on using debt for growth. This fact, in combination with the circumstance that China has supported its GDP growth with significant overbuilding of infrastructure and property, indicates that if large real-estate developers’ collapse, contagion across the Asian credit markets would be inevitable. The Chinese government certainly finds itself in a difficult situation. If they do not step in and rescue Evergrande they indirectly risk a credit crisis. This would mean the Chinese Government would be disabling the driving force behind their multi-decade growth in GDP.
Finally, it is important to note that the Chinese government identified the excessive use of leverage in their real estate sector and as a result implemented restrictions on Evergrande in August 2020, banning them from taking on additional debt. This has caused the aforementioned difficulties with Evergrande, who have no way of financing their significant short-term obligations. Although, this raises the issue, of whether Evergrande is truly ‘too big to fail’, and if so, does this mean a government bailout is inevitable. China’s recent economic policy changes would suggest the contrary, with President Xi Jinping, akin to Chairman Mao, driving a shift to a communist China. The Evergrande crisis presents a significant test to this ideology, as allowing Evergrande to go bust could have significant and longstanding economic ramifications. Whilst bailing out Evergrande would signal to the other highly leveraged real-estate market participants, they too will be extended a bailout and can continue with their current aggressive financial practices.
Whilst cryptocurrency began life as an asset class that was considered to be uncorrelated with the global macro-economic environment, this is certainly no longer the case. The ever-growing adoption of cryptocurrency has attracted retail traders and large-scale money managers alike. This means today more than ever, crypto assets are exposed to the macro-economic variables influencing the investment decisions made on many of the more traditional asset classes, such as equities. Additionally, Crypto assets are considered within the markets as a risk-on/speculative asset class, meaning in times of uncertainty investors usually reduce exposure to these assets, preferring safer and less volatile investments. This has been seen on multiple occasions in the past 18 months, with large selloffs occurring during times of heightened economic uncertainty, such as the global pandemic. A market selloff of similar characteristics occurred on 24/09/21 at 9 am, with Bitcoin’s value dropping by 10% at the exact time Evergrande missed its first debt repayment date.
Secondly, it is important to note that a study from Fidelity Digital Assets revealed that 70% of institutional investors in Asia hold digital assets, compared to 33% in the US. This is significant as the Evergrande crisis has affected many Asia based institutional asset managers and banks, who could be selling to rebalance or cover losses due to the ongoing crisis and economic uncertainty. This again would force significant volatility and selling pressure into the crypto markets, as institutions could be taking profits or converting to cash to meet any margin requirements.
Finally, we must discuss Tether, otherwise known as USDT. The stablecoin has been a widely discussed topic in recent months due to wide speculation regarding the composition of its reserves. Tether recently released an attestation report disclosing the composition of its reserves, outlining that 65.3% of its reserves are made up of ‘commercial backed paper’. This has led to speculation that Tether may hold commercial backed paper from Evergrande or other at-risk Chinese real-estate developers. Whilst this rumour was quickly quashed, this has raised additional doubts as to why Tether refuse to disclose a breakdown of its commercial paper holdings and if the assets held in reserves are appropriately diversified. Whilst the effects of this uncertainty cannot be quantified, it is important to understand that if Tether were to be holding endangered commercial paper it would be at risk of not being fully backed. This poses a significant risk to the crypto markets, as Tether plays a vital role in market liquidity and any level of uncertainty could damage the liquidity & efficiency of the crypto markets.