CRYPTO CREDIT CRUNCH: Shadow Debt Market is frozen & the spillover effects are impacting market liquidity
Crypto Shadow Debt Market Credit Crunch
In recent months, the crypto industry has gone through some of the most difficult moments, since its birth in 2009. Behind the scenes, the secretive crypto Shadow Debt Market was severely shaken up as some of the largest crypto players have woken up to the counter-party risk - a situation where nobody trusts anyone. Once celebrated hedge fund 3AC, went under in a matter of days and as they were one of the biggest borrowers in the crypto Shadow Debt Market, its collapse created a profound ripple effect throughout the crypto industry. The FTX & Alameda Research collapse was a true Black Swan event that caught the whole industry off-guard.
In my discussions with numerous players in the crypto industry, I can confirm that the crypto Shadow Debt Market - which strongly fueled the rapid growth of the crypto industry - is currently completely frozen, with literally no transactions going through. Large lending & borrowing entities that are still left standing, are retreating from further exposure to debt-hungry crypto players or reducing their exposure.
Data service provider Kaiko has created a beautiful graph showing the liquidity in the +-2% price range for the BTC/USDT pair, which demonstrates a significant drop in market liquidity following the collapse of FTX & Alameda and dubbed it the “Alameda Gap”, referring to a loss in market liquidity as the market-making company Alameda Research has effectively shut down.
I would like to offer an alternative explanation, and state that the loss in liquidity shown in Kaiko’s graph, is in fact due to the spill-over effects of the crypto Shadow Debt Market being at a complete standstill, and name it the “Crypto Credit Crunch gap”, in reference to the more well-known Credit Crunch of 2008, when TradFi experienced a severe decline in lending activity by financial institutions. Crypto market-makers' balance sheets are being shrunk & unwound, as the lenders are calling-in loans, in anticipation of further contagion and uncertainty. As a result, liquidity is dropping which will spark further volatility and sharp price moves. Contagion is not over and the crypto ecosystem should prepare for more uncertainty. We can expect liquidity providers to retreat from trading and reduce the number of exchanges where they trade, be they centralized order books or AMMs.