CELSIUS/BLOCKFI - Exploring the Future

Current State

With Celsius working on bankruptcy process while BlockFi looks for new investment, there is a crisis of confidence in retail focused crypto asset management/lending firms. 

One way to solve this problem and set the space for long-term sustainable growth would be a structured buyout followed by implementation of time-tested Asset Management practices. 

This blog looks to explore how this process could play out.

Structured Buyout - Finding a buyer

Any prospective buyer needs to assemble a team with expertise in following areas:

• Crypto trading/lending/staking
• Asset-Liability Management (ALM) and Treasury Management
• Multi-strategy Fund Management

Such a team can get the capital needed and set up a buyout - ideally to acquire both firms using:

• PE or VC backing
• DAO - while US may not be an option, creating a DAO to buy these firms by Token sales (+ VC Backing) would be a much better option creating a retail participation on both ownership and platform usage (e.g. while unclear, nexo token is probably a big reason why it has not faced similar ‘withdrawal’ pressures). 
• SPAC - while not ideal, SPAC will allow US retail investors to participate in the buyout improving it’s chances of success

Valuation and Due Diligence

My take on valuation would be to a minimal amount wiping out existing equity holders. This will help set a precedence for moral hazard. Any positive assets should be used to fortify balance sheet.

If the team assembled does have the expertise, due diligence should not take more than a week. Based on the due diligence and resulting Asset/Liability estimates, there could be a need for institutional lenders to take a haircut. This is a significant risk which will drag out the process by weeks or months.

In some cases, there may be ‘non-core’ assets that can be disposed for value accrual - e.g. BlockFi’s launched Prime Broker platform. 

Retail investors should be last in line for potential haircut consideration. The intent for this class should be similar to FDIC liquidations - they may have to give up promised interest, but principal needs to be protected.

Post Acquisition

One of the motivations to write out this thought bubble is to highlight how these firms could operate long term - take advantage of higher returns offered in Crypto while - still maintain prudent ALM and Risk management practices. 

A firm looking to receive retail deposits offering high yields has to have a clear pricing strategy for different maturities. For example:

• Deposits allowing on-demand withdrawals will have 1-2% yield 
• Deposits with some lock-in - a week or a month - can offer 3-4% yield
• To earn high single digit yield, depositor has to lock-down for 6 months to a year.
   

Asset Management

The other side of this equation is how these firms can make sustainable returns to pay out these ‘higher than TradFi’ yields. An experienced fund manager (or fund of funds manager) would be able to come up with an allocation process that leverages all the possible venues for yield/returns while matching projected liabilities. These should include:

• Institutional staking (e.g. leverage firms like figment.io or Kraken’s Staked platform that earns rewards by running nodes/validators)
• Market Neutral Trading Strategies (e.g. leverage platforms like mltech.ai to invest in traditional arbitrage strategies successfully deployed in Crypto - Basis trades, calendar trades, cross venue arbitrage….)
• Institutional Lending (While this is the cause of current crisis, it is a reliable source of returns if managed properly)
• Other Trading Strategies (for a smaller percentage of assets that are locked for longer duration, the firm should invest in directional trading strategies (momentum/signal based) using mltech or similar platforms)
• Select DeFi protocols (DeFi remains the destination of choice for higher yields but it needs to be managed as active investments and avoid any long-term lock-ins)
   

Fund Management - Examples

When allocating to different investments, diversification across multiple exchanges/prime brokers (say max 20% on a given exchange to manage exchange related risks) and multiple cryptos (max 20% on a given coin) would be critical. 

Digging a little deeper on some of the options above, the fund manager can generate returns in variety of way using ML Tech’s non-custodial solution on supported exchanges. 

• For specific crypto deposits - say the retail customers are depositing ETH, there are strategies that will accept ETH deposits and trade ETH-margined futures (Perpetual vs Sept future or Sept vs Dec future) to generate returns
• Similar strategies are available for all major coins with liquid spot and futures markets generating consistent returns with minimal drawdown risk
• On the other hand, there are signal based strategies that can generate high double-digit returns while assuming some downside risk. 
• With baskets of market neutral and directional strategies, fund manager has wide range of discretion on how to allocate incoming funds to out-perform cost of capital while ensuring prudent risk management.