Crypto’s Carcass Will Attract Hedge Fund Vultures

by Arthur · March 10, 2023

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First Silvergate Capital Corp., now an old-fashioned operation of venture capital bank SVB Financial Group. These are tough times for the tech faithful, especially in crypto, where market turmoil has sent Bitcoin back below $20,000. In a sector where the only thing that thrives is corporate failure, it pays to be an undertaker or post-mortem rather than a true believer.

Hedge fund investors and lawyers making thousands of dollars an hour sift through the wreckage left behind by HODLers. When FTX collapsed, funds such as Baupost Group and Oaktree Capital Management chased claims held by clients with assets tied up in the exchange. One such client, Galois Capital, sold its FTX claims at an 84% discount. Crypto lender Genesis’ claims have been sold at 65% to 75% discounts; buyers include Jefferies LLC.

Expect more to come after Bitcoin’s latest slide, down more than 20% from its February peak as traders piled in despite a regulatory breach, a string of bankruptcies and the impact of rising interest rates. As investors look for a safe haven from recession fears, it remains clear that crypto is not one; it is down 75% from its 2021 high.

“There’s value in the carcass,” says Thomas Braziel, founder of 507 Capital, an investment firm named after a section of the U.S. bankruptcy code. He cut his teeth making double-digit returns on Bitcoin’s first major stock market bust, Mt. Gox — a story covered on the Bloomberg Crypto podcast — and bought its initial claim at a 62% discount. Today, he has much more choice, with FTX, Voyager Digital Ltd., Celsius Network LLC and Three Arrows Capital’s bankruptcies all working their way through the courts. One still needs at least a modicum of faith to wade into the $20 billion market for crypto claims (excluding discounts and double counting), but that remains reserved for MBA types and number crunchers, not cypher punks.

The job of Braziel and his peers sounds simple: They offer to acquire bankruptcy claims from holders at a steep discount to reflect the time, effort and expectation of getting money back (Jefferies has reportedly estimated a 10% to 35% recovery rate on FTX after fees). Sellers get the immediacy of cash; buyers get some upside from their persistence when they follow the process to the end. Braziel refutes the image of the predatory or ambulance-chasing vulture — he says he encourages claimants not to sell unless they have to. The idea is that today’s burning dumpster is tomorrow’s hotel, just as the 2008 Washington Mutual Inc failure became $3 billion in mortgages, Mr Cooper Group Inc.

The reality is somewhat riskier—as Braziel puts it, it’s like taking an 11-foot pole for an investment that no one would touch with a 10-footer. Maybe someone could look at Silvergate and see a WaMu in there. And perhaps even FTX has some valuable assets under its hood, like its stake in Robinhood Markets Inc. But the crypto bubble produced horrors beyond the knowledge of even those who worked on Enron Inc.’s demise. FTX’s assets included its own composite token, FTT, and other highly volatile ones such as Solana and Serum. Calculating the upside for penny stocks held by an exchange that used emojis in accounting is no mean feat. Even the outlook for Bitcoin is difficult to gauge when low-risk T-bills today yield around 5%.

Bridging the gaps between buyers and sellers could also become more difficult as a result of the current market turmoil surrounding Silicon Valley Bank, which has plunged after a surprise announcement on Wednesday that it issued $2.25 billion in shares to shore up capital after significant loss on the investment. portfolio, and has put itself up for sale after the capital increase failed, according to CNBC. It is likely to increase risk aversion even in areas unrelated to the lender’s own problems.

Regulatory intervention is also something to keep in mind, considering Voyager’s sale to Binance, an exchange under very high scrutiny. And there is also a risk of several voices competing for the demands in the creditors’ back pockets – sometimes with unrealistic promises. The sight of 3AC’s founders jumping on the bandwagon with a new exchange aimed at crypto creditors desperate to get back into trading is disheartening, but not surprising. Even a 12 foot pole looks too short for it.

Crypto’s growing body count and interest from bankruptcy specialists suggest we are still in the grip of an unraveling credit bubble, and not a bold new beginning of animal spirits. That’s probably just as well, given where the last round of euphoria led. With central bankers openly questioning whether crypto has any value at all, this market is truly one for the brave.