‘Cappuccino basket’: How Wall Street escaped the crypto meltdown

Unlike their fates in the financial crisis, when the souring of subprime mortgages backed by complex securities took down both banks and regular people, leading to a recession, the fortunes of Wall Street and Main Street have diverged more fully this time. (Bailouts eventually saved the banks last time.) Collapsing digital asset prices and struggling crypto startups did not contribute much to the recent convulsions in financial markets, and the risk of contagion is low.

But if the crypto meltdown has been a footnote on Wall Street, it is a bruising event for many individual investors who poured their cash into the cryptocurrency market.

“I really do worry about the retail investors who had very little funds to invest,” Aggarwal said. “They are getting clobbered.”

Lured by the promise of quick returns, astronomical wealth and an industry that is not controlled by the financial establishment, many retail investors bought newly created digital currencies or stakes in funds that held these assets. Many were first-time traders who, stuck at home during the pandemic, also dived into meme stocks like GameStop and AMC Entertainment.

They were bombarded by ads from cryptocurrency startups, such as apps that promised investors outsized returns on their crypto holdings or funds that gave them exposure to Bitcoin. Sometimes, these investors made investment decisions that were not tied to value, egging on one another using online discussion platforms such as Reddit.

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Spurred partly by the frenzy, the cryptocurrency industry blossomed quickly. At its height, the market for digital assets reached $US3 trillion — a large number, although no bigger than JPMorgan Chase’s balance sheet. It sat outside the traditional financial system, an alternative space with little regulation and an anything-goes mentality.

The meltdown began in May when TerraUSD, a cryptocurrency that was supposed to be pegged to the dollar, began to sink, dragged down by the collapse of another currency, Luna, to which it was algorithmically linked. The death spiral of the two coins tanked the broader digital asset market.

Bitcoin, worth over $US47,000 in March, fell to $US19,000 on June 18. Five days earlier, a cryptocurrency lender called Celsius Networks that offered high-yield crypto savings accounts halted withdrawals.

The fortunes of many small investors also began tanking.

On the day that Celsius froze withdrawals, Martin Robert, a day trader in Henderson, Nevada, was preparing to celebrate his 31st birthday. He had promised his wife that he would take some time off from watching the markets. Then he saw the news.

“I couldn’t take my coins out fast enough,” Robert said. “We’re being held hostage.”

Robert has two Bitcoins stuck on the Celsius network and is afraid he will never see them again. Before their price plunged, he intended to cash the Bitcoins out to pay down around $US30,000 in credit card debt. He still believes that digital assets are the future, but he said some regulation was necessary to protect investors.

“Pandora’s box is opened — you can’t close it,” Robert said.

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Beth Wheatcraft, 35, a mother of three in Saginaw, Michigan, who uses astrology to guide her investing decisions, said trading in crypto required a “stomach of steel.” Her digital assets are mostly in Bitcoin, Ether and Litecoin — as well as some Dogecoins that she cannot recover because they are stored on a computer with a corrupted hard drive.

Wheatcraft stayed away from Celsius and other firms offering similar interest-bearing accounts, saying she saw red flags.

When the crypto market was rollicking, Wall Street banks sought ways to participate, but regulators would not allow it. Last year, the Basel Committee on Banking Supervision, which helps set capital requirements for big banks around the world, proposed giving digital tokens such as Bitcoin and Ether the highest possible risk weighting. So if banks wanted to put those coins on their balance sheets, they would have to hold at least the equivalent value in cash to offset the risk.

US bank regulators have also warned banks to stay away from activities that would land cryptocurrencies on their balance sheets. That meant no loans collateralised by Bitcoin or other digital tokens; no market making services where banks took on the risk of ensuring that a particular market remained liquid enough for trading; and no prime brokerage services, where banks help the trading of hedge funds and other large investors, which also involves taking on risk for every trade.

Banks thus ended up offering clients limited products related to crypto, allowing them an entrée into this emerging world without running afoul of regulators.

“Pandora’s box is opened — you can’t close it,”

Day trader Martin Robert

Goldman Sachs put Bitcoin prices on its client portals so clients could see the prices move even though they could not use the bank’s services to trade them. Both Goldman and Morgan Stanley began offering some of their wealthiest individual clients the chance to buy shares of funds linked to digital assets rather than giving them ways to buy tokens directly.

Only a small subset of Goldman’s clients qualified to buy investments linked to crypto through the bank, said Mary Athridge, a Goldman Sachs spokeswoman. Clients had to go through a “live training” session and attest to having received warnings from Goldman about the riskiness of the assets. Only then were they allowed to put money into “third party funds” that the bank had examined first.

Morgan Stanley clients could not put more than 2.5 per cent of their total net worth into such investments, and investors could invest in only two crypto funds — including the Galaxy Bitcoin Fund — run by outside managers with traditional banking backgrounds.

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Still, those managers may not have escaped the crypto crash. Mike Novogratz, CEO of Galaxy Digital and a former Goldman banker and investor, told New York magazine last month that he had taken on too much risk. Galaxy Digital Asset Management’s total assets under management, which peaked at nearly $US3.5 billion in November, fell to around $US2 billion by the end of May, according to a recent disclosure by the firm. Had Galaxy not sold a major chunk of Luna three months before it collapsed, Novogratz would have been in worse shape.

But while Novogratz, a billionaire, and the wealthy bank clients can easily survive their losses or were saved by strict regulations, retail investors had no such safeguards.

Jacob Willette, a 40-year-old man in Mesa, Arizona, who works as a DoorDash delivery driver, stored his entire life savings in an account with Celsius that promised high returns. At its peak, the stored value was $US120,000, Willette said.

He planned to use the money to buy a house. When crypto prices started to slide, Willette looked for reassurance from Celsius executives that his money was safe. But all he found online were evasive answers from company executives as the platform struggled, eventually freezing more than $US8 billion in deposits.

Celsius representatives did not respond to requests for comment.

“I trusted these people,” Willette said. “I just don’t see how what they did is not illegal.”

This article originally appeared in The New York Times.

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