Navigating Crypto’s Liquidity Crisis: Diversification is Key

By April 6, 2023No Comments

A tumultuous March has shaken confidence in crypto markets’ liquidity; major players like BNY Mellon are rebuilding trust.

As the Fed addresses the ongoing crisis of confidence in the banking sector, the mostly unregulated cryptocurrency market is still reeling from the spillover effects of the collapse of Silicon Valley Bank and Signature Bank: both were active supporters of crypto market transactions.

  • The closure of Signature and Silvergate Bank meant the elimination of Signet and Silvergate Exchange Network—two 24/7 digital payment networks used by most in the crypto industry. Now, corporate treasuries must adapt to the new environment.
  • For treasury teams that use cryptocurrencies for payments, the events of the past few weeks have raised two concerns:
    • A lack of access to liquidity.
    • The risk of custodial overconcentration.

A liquidity squeeze. In a recent session of NeuGroup’s Digital Assets Working Group, one member discussed challenges working with crypto custody firm Anchorage Digital, which in March told him they had paused all conversion from crypto to fiat currencies. This essentially trapped the company’s crypto holdings indefinitely.

  • This member uses cryptocurrency as working capital, including to pay some employee salaries, and aims to minimize balance sheet holdings by converting any excess digital tokens into USD. Because the company keeps its crypto exposure low, it has only worked with a single custodian for crypto reserves: Anchorage.
  • While Anchorage did not provide a direct business justification for pausing conversion, the member believes it was because Anchorage banked with Signature, which is no longer servicing cryptocurrency firms after its acquisition by Flagstar.
  • “It’s been a big scare,” he said. His company’s immediate focus is to convert everything it can back to dollars but “there’s just no liquidity right now.”
  • “The lack of other conversion options is really throwing sand into the face of crypto,” he said. “It’s supposed to be open, decentralized and deregulated, but if you can’t swiftly move your money into an asset and take it back, then what’s the point?”

Unleashing trapped cash. “It’s just like what other corporates face with trapped cash in China, it’s the same thing,” the member said. “Should this have occurred? With proper risk management, I don’t think so.”

  • He is now looking for other brokerages to take the company’s crypto and do the conversion. But KYC and due diligence won’t be a quick process.
  • Over the long-term, the member’s team is working to improve forecasting to minimize its crypto exposure—a tall order.
  • “Like any new business, it’s very difficult to forecast that because we don’t know what kind of products we’ll be dropping in three to six months that are supposed to generate crypto revenue,” he said. A better forecast would allow the company to use that revenue to make future payments.
    • “But we’re not the business unit that does planning and analysis. I’m just treasury, and there’s a bit of a disconnect,” he said.

Diversification. One member who works at a crypto-native company that deals with digital assets as a regular part of its business said that having a single custodian increases liquidity risk substantially. It’s therefore crucial for treasury to have a diverse crypto-custody infrastructure.

  • “We can’t just all wait until these banks fail, we need to find more partners, and more diverse partners,” she said. “You need to put extra scrutiny on these banking partners now.”
  • But she added that there are only so many banks that are working with corporates in the crypto space. Her strategy is to open accounts with every bank that’s willing to work with her company, and then let the treasury team figure out how to divvy up its assets.
  • “Utilizing a bunch of different banks and making sure we’re sweeping excess balances and tracking credit metrics of institutions is the best we can do.”

A silver lining. The liquidity crisis is not without an upside. Major banks such as BNY Mellon are fast-tracking their engagement as custodial banks and crypto transaction enablers.

  • The member who works at a crypto-native firm said the company has been looking to open an account with a bank “only tangentially related to crypto” like BNY Mellon—though KYC may be a long road.
  • Matt Thomas, who leads NeuGroup’s Digital Assets Working Group, said, “Six months ago, BNY Mellon was kicking the can down the road because there was so much competition.” He added, “I think the silver lining of all this is it has brought BNY Mellon into the use case for real, which lends legitimacy to the crypto use case for corporates.”
Justin Jones

Author Justin Jones

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