Banking on a market turnaround: Cumberland believes liquidating nonviability assets is key
Cumberland believes that the market will only turn around when banks liquidate more nonviability assets.
Cumberland, a crypto trading company, commented on the trend of centralized digital asset firms collapsing amid a deepening liquidity crisis in the industry. It said that the market’s immediate recovery partly depends on whether distressed assets can be transferred from insolvent companies to solvent ones.
The crisis has not yet ended.
When a bear market in the crypto industry lasts for a long time, over-leveraged companies tend to be in deep trouble because their collateral loses value quickly, triggering liquidation. A ripple effect spreads across the industry as one firm after another is toppled down. When users withdraw funds en masse, increasing liquidity issues, some firms may have to take drastic measures like suspending withdrawals and transactions.
Cumberland warned that the market could be in for more trouble as more companies collapse due to their massive liabilities. The report said that firms with badly managed operations will have to liquidate their assets, which is "partially offsetting" their liabilities.
Since more crypto assets are getting sold off, prices will continue to fall, meaning more pain for the industry. Cumberland believes that the ongoing crisis is quite similar to what happened in the traditional markets since "the underlying economics are no different than those found in textbooks."
The firm believes that the recovery of the beaten crypto market depends on how insolvent firms manage their "distressed assets."
This is hardly a novel phenomenon; excessively levered finance companies have been punished in bear markets for hundreds of years. While this current cycle raises eyebrows because the assets are digital, the underlying economics are no different than the examples in textbooks.
— Cumberland (@CumberlandSays) July 5, 2022
For example, FTX extended a $250M revolving credit line to BlockFi weeks ago for covering its expenses and repaying existing loans. Later, the exchange giant increased the amount to $400M, with the right of acquiring the failing lending company at a discount of $240M in future.
DeFi and CeFi are two competing models for the future of finance.
When investors are reluctant to invest in the crypto market, as shown by the fall of off-chain inflows, volatility tends to increase as asset liquidity decreases. Unlike CeFi, which involves complicated human-controlled processes for capital deployment, DeFi has shown strength when it comes to transparency about liquidation levels and its distance from the spot market, Cumberland pointed out.
In stark contrast to traditional financial institutions, DeFi protocols are able to execute smart contracts without any external input. This is because their system automatically liquidates collateral when a certain threshold is reached.
