Smith gave a summary on how his company and others have reacted to the Bitfinex hack. Market participants took collateral not required to fund existing hedge positions and put it in cold storage. Rates on BTC have since improved, but they are still lower than loaning U.S. dollars. Smith thinks this will improve.
Investors Using More Exchanges
A bigger change has been investors’ spreading their bitcoin among more exchanges and doing more due diligence on the exchanges. Smith thinks risk is being priced more realistically, and he thinks the industry overall is healthy.
Smith stressed that the experiences forming his views are based on his companies’ experiences and those of his customers.
The immediate reaction to the Bitfinex hack was for companies to pull money not needed to fund existing position hedges. This helped drive a decline in bitcoin’s price. While Smith did not believe there was a contagion risk, the best course of action was to act and watch how the situation developed.
Markets have since returned to normal. The spread between USD and BTC deposit rates has changed. Prior to the Bitfinex hack, one could get a 15 to 20% return on USD rates to finance margin positions. After Bitfinex, bitcoin deposits dropped by 1.5% to 2%.
A 20% premium on USD deposits indicated a big credit risk existed, and the risk-adjusted return that was available on BTC deposits was negative.
Rates have since increased to 9% to 10%, which is less than the rate for loaning USD, but the spread has become narrower.
The rate is becoming more sustainable, reflecting a more realistic level of counterparty risk. There are now opportunities to structure yield products that should draw interest.
Implied spreads in the bitcoin futures market have not adjusted to reflect the new norm, as they still indicate a 15% to 20% USD/BTC rate spread.
More Scrutiny On Exchanges
There has also been more acknowledgment of the risk involved in placing assets on an exchange, particularly an exchange with a questionable ownership structure or being based offshore.
Smith’s organization has always assessed the counterparties it does business with based on location and transparency. He favors counterparties based in well-documented jurisdictions with certain levels of legal protection. He sees similar due diligence from exchange customers.
Market participants that are reputable conduct anti-money laundering and know-your-customer checks on customers. Smith is also seeing customers requesting similar disclosures from their partners.
In addition, customers have begun to spread risk more proactively among numerous exchanges.
Because of this, Smith’s company has acquired more customers who have noted they are splitting their capital among multiple opportunities and companies. In the past, these customers went with one exchange. They have since realized that it is not enough to rely on an exchange that is large since that factor does not provide protection.
Customers Want More Options
Spreading deposits among exchanges also assures customers they will have available funds to take advantage of opportunities that arise. Otherwise, they could be excluded should an exchange goes offline.
Smith believes the industry has handled Bitfinex well and is currently healthy. Six months ago, had an exchange failed, there would have been headlines proclaiming the death of bitcoin. Now, due to the industry’s educating the media, the headlines are more measured.
The discussion has been about Bitfinex’s survival, not bitcoin’s.
The market has absorbed the shock well, and its functioning has improved in some ways. There is a more realistic risk pricing. While liquidity has decreased, there is evidence of recovery.
Bitcoin Price Recovers
Bitcoin’s price has recovered most of the loss it suffered. The capital market is performing well, in some ways better than prior to the hack, by pricing risk more realistically.
The current environment prepares bitcoin for the next major growth spurt – smart contracts. These promise to reduce or eliminate counterparty risk.
While the DAO hack undermined the technology’s adoption temporarily, such setbacks are part of the industry’s progression.
Long-term, it is not acceptable to expose customers to full counterparty risk of all their assets. Smith’s company is working with customers to address this concern in the interest of offering a more secure way to trade.