Month: November 2022

Last week may mark the worst week in history to date in the crypto industry. The downfall of FTX, which was considered as one of the biggest and most reputable players in the market, has stunned all crypto owners.

What was discovered?

Concerns for FTX’s liquidity spurred after the release of CoinDesk’s investigation on the close ties and blurred financials between FTX and Sam Bankman-Fried’s (SBF) trading firm, Alameda Research. It was revealed that Alameda Research held a position worth over $5 billion in FTT, the native token of FTX. It owned $3.66 billion of “unlocked FTT” and $2.16 billion of FTT collateral, combined making the biggest single asset held on its balance sheet. The report revealed that Alameda’s investment foundation was also in FTT, rather than an independent asset like a fiat currency or another crypto token.

An excel file FTX shared with prospective investors before the bankruptcy, providing a detailed picture of the financial hole in the FTX crypto empire.Source: Financial Times

On Nov 6, Binance, the world’s biggest crypto exchange, announced that it would sell its entire position in FTT tokens, worth over $500 million at the time. Unsurprisingly, FTX experienced a bank run following the announcement with customers demanding $6 billion of withdrawals. The value of FTT fell by 80% in two days.

Binance gave a short-lived promise of rescue on Nov 8 after corporate due diligence prompted concerns about the mishandling of customer funds. Having lent more than half of its customer funds to Alameda, it is reported that FTX has a shortfall of US$8 billion on its balance sheet.

A major failed experiment?

Some may say that this fallout has destroyed all confidence and set the industry back again in the eyes of regulators and institutional investors. To us, the cause of the meltdown is simple, those who have been in the financial industry will know, asset-liability mismatch, period.

The clear lack of corporate governance has contributed to the non-existence of risk management at FTX. As reported by the Wall Street Journal, Ryan Salame, co-chief executive of FTX Digital Markets, and Ryne Miller, general counsel of FTX’s U.S. arm, alongside other FTX employees, had no knowledge of FTX’s problems until exposed by the media, despite worked closely with SBF. The lack of transparency and seemingly concentrated control in the founders’ hands are disconcerting.Source: The Information

World frustrated

FTX suffered a $400 million hack which occurred on the same day the firm filed for Chapter 11 bankruptcy protection in the U.S. The internet was flooded with speculations that the hack could have been coordinated by insiders. The attacker appears to have “had access to all the cold wallet storages which he exploited,” Dyma Budorin, co-founder and chief executive of blockchain security auditing firm Hacken, said on Monday in an interview with CoinDesk TV.

Some of the wallets are labeled “fucksbf” and “fuckftxandsbf.eth”, which could be a reverse optics to appear as if it is a hack.

More pain to come

Similar to the Luna fiasco, we would expect a domino effect from the fall of FTX given the number of businesses in the ecosystem that are linked to the exchange. Genesis Global Capital has become the latest fallout from the FTX meltdown, reflecting a sign of contagion outside of BlockcFi, which is reportedly preparing for a potential bankruptcy filing.

Credit: Kyle Kim/Bloomberg

What to trust going forward?

Although it’s an extremely painful lesson to learn, individuals will now understand the importance of being their only owner of one’s digital assets. Crypto users are rushing to take control of their digital assets in the wake of the exchange’s collapse.  This will be better off for the market as a whole in the long run, to achieve the holy grail of decentralization, rather than being dependent on the notoriously centralized exchanges.

Indeed, there is evidence that crypto owners are increasingly moving to hardware crypto wallets. A major hardware wallet provider, Trezor, has recorded a major uptick in wallet sales in the aftermath of the FTX contagion. According to Josef Tetek, the firms’s brand ambassador Josef Tetek told Cointelegraph on 15 Nov, Trezor saw its sales revenue surged 300% week-on-week and it’s still growing.

And despite sell-offs, decentralized exchanges (DEXs) and decentralized finance (DeFi) platforms have been functioning smoothly and experiencing a double digit increase in the number of users in the past week. According to data share by Nansen to The Defiant, MakerDao, DeFi’s largest protocol with $6.5 billion of total value locked, has increased addresses by a third in the last week. And other top 10 protocols have also attracted huge jumps in users, with Aave notching a 70% increase, and a 63% spike for Curve.

Regulations are clearly needed for CeFi

The crypto community continues to learn the lesson of decentralization the hard way in the previous months. From Celsius Network to BlockFi, Voyager Digital, and now FTX, and probably more casualties to come, these are all centralized exchanges and financial platforms (CeFi). Similar to the situation of the 2008 falls of some of the largest American banks, we witnessed the consequence when market players under-collateralize and take risks with consumer funds. The only difference this time is that there is no government backing in the CeFi world, the CeFi companies are left to play out by themselves.

The collapse of FTX will spur more calls and urgency for crypto regulations. Both CFTC and SEC are experts in regulating the financial markets. What the regulators have essentially been trying to do is to replicate the regulatory framework for the traditional financial (TradFi) market to the crypto market, at least for CeFi, which would be challenging. The Federal Reserve took six years to create after the 1907 Wall Street panic, so it will not be surprising if it takes few years to come up with the regulations for CeFi.

The flaw in CeFi is that the reliance on trust that Satoshi Nakamoto was trying to avoid has been reintroduced. The collapse of FTX once again reminds us of the importance of decentralization. DeFi platforms are designed to preserve transparency and self-sovereign custody of assets. Regulations that do not overprotect those with an upper hand could be beneficial for the industry. Although unclear with the approach yet, we believe the crux of regulating decentralized projects would be to regulate on a protocol level rather than on an entity level. Nonetheless, the ultimate solution remains to leave governance in the hands of consensus mechanisms.

The meltdown of FTX was a failure of CeFi, not DeFi. If there is a silver lining for the FTX meltdown, it would be to redraw the ecosystem’s focus on its original purpose of decentralization, reaching consensus on who owns what cryptographically across nodes rather than relying on a central source of trust.

 

 

 

Reference

Divisions in Sam Bankman-Fried’s Crypto Empire Blur on His Trading Titan Alameda’s Balance Sheet. CoinDesk.

CZ Strives to Show Binance is Different From FTX. The Defiant.

FTX Tapped Into Customer Accounts to Fund Risky Bets, Setting Up Its Downfall. The Wall Street Journal.

FTX’s Collapse Leaves Employees Sick With Anger. The Wall Street Journal

Trezor reports 300% surge in sales revenue due to FTX contagion. Cointelegraph

FTX balance sheet, revealed. Financial Times

FTX Hack or Inside Job? Blockchain Experts Examine Clues and a ‘Stupid Mistake’. CoinDesk

FTX’s New Boss Reveals Chaos Left Behind by Bankman-Fried. Bloomberg

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The disturbing almanack

In the past, that is not too distant was a decade of abundance, peace, and order. Food, energy, resources, and capital were plenty and affordable if not cheap by today’s standards. Today, we have the exact reverse.

Six months ago, we wrote about the rising food security risk globally (link). Since then, food prices have cooled down in the wake of recessionary fears driven by the global central bank tightening cycle. The FAO food price index has fallen by 14.7% in USD terms from its peak in April 2022.

The question: is the food security risk now no longer a concern?

Anecdotal evidence of the rising popularity of food-protectionism measures would suggest the contrary. In 2H2022, Malaysia banned chicken export, India restricted the export of rice, and recently Mexico halted 24 key food exports.

Furthermore, the recent surge of the US dollar actually has worsened the food security risk for many countries. At the same time whereby the FAO food price index fell by 14.7 percent from its March 2022 peak, the dollar index rose by 21.5 percent. This means that most countries experienced a 3.65 percent higher food prices. It was no relief.

Furthermore, we still identify three major supply-side overhangs for food security: (1) the high possibility of a third consecutive La Nina; (2) escalation of political risk in Europe; (3) gas-crisis-driven fertiliser cost.

While the almanack that we provide might feel disturbing if not stomach-churning, we think that the mounting pressures of food security could signify the value of food technology. A vertical that has perhaps been taken for granted in the decades of plenty. Ironically, it is also the sector that allows humanity to thrive and defy the infamous Malthusian catastrophic prophecy.

Malthusian prophecy and its 180-degree reality

Students of economics would have been familiar with the Malthusian Trap. The 18^th-century British philosopher and economist Thomas Malthus was well-known by the history book for his grim prediction in 1798. Malthus argued that food production will not be able to keep up with the growth of human populations. As a result, disease, famine, war, and calamity are seen as humanity’s inescapable fate.

Proponents of this school of thought might resort to an extreme solution to this problem like extreme population control. This reminds us of Thanos, the villain of the Marvel Universe, and his conquest to wipe out one-half of the universe’s population to maintain prosperity and peace in the galaxy.

Fortunately, the reality has fared better than the doomsday prediction. Humanity has prevailed and continued to expand the frontiers of welfare. For instance, Our World in Data showed that life expectancy has more than doubled from 29 years old in the 1800s to 71 years old in 2015. At the same time, the global population went up sevenfold from about 1 billion to 8 billion in 2022.

Moreover, data from the 1820s to 2015 suggests that the poverty eradication curve is getting steeper rather than flatten. The share of the global population that lives in poverty plunged from over 94 percent in 1820 to 9.6% percent in 2015.

These are signs that indicate the world’s productivity has exceeded the growth of the population. What went different from Malthus’ view?

The uncounted factors that matter: the man-made miracles

Robert Malthus’ theory of growth lacks respect for the fundamental reality of technological progress. This is implied by assuming that food production would only be growing at an arithmetic progression. In reality, innovation and technology have pushed the boundaries and changed the course of history. Especially in the front of productivity.

Three foundational food production technologies allow the humanities to dodge the Malthusian trap:

1. Fertilizers

One of the cornerstones of modern food production lies in ammonia which contains nitrogen and hydrogen. Nitrogen is one of the most important crop nutrients, a secret sauce of yield improvement. Ammonia can effectively bind nitrogen to be applied directly on crops or to be processed further for fertilisers like urea, DAP, and NPK.

The advent of haber-bosch process in 1908 allowed the synthetic production of ammonia. ­It is a game-changer and worthy to hold the title of one of the greatest inventions of the 20^th century. Erisman et al. (2012) estimated that the existence of nitrogen fertilisers have helped to feed 48 percent of the global population in 2008. In today’s number, that is equal to 3.8 billion people.

Back in March 2022 blog (link), we discussed ammonia as the main feedstock of fertiliser was caught in a perfect storm of geopolitical conflict, energy crisis, tight agricultural market, and supply chain constraint.

So far, we see a minimum disentanglement of these factors. As such, that might keep ammonia prices at elevated heights for a long time. Note that fertiliser crisis could cause a decline in the harvest that will worsen the global food stock.

2. Seeds technology

You reap what you saw. Seeds technology plays a vital role in fulfilling global food needs mainly through variants of better vigour and productivity.

In the case of the US, seed technologies have played an enormous role in jacking up the corn yield from merely 2 tons per hectare to 12 tons per hectare, a six-fold increase. This is a perfect showcase of what 160 years’ worth of long and continuous research effort could bring, defying the Malthusian trap.

In that regard of such immense research effort and multi-billion research budget, we perceive seeds technology businesses to be something secular whose profits are beyond justifiable for society. Their business enhances the economics of farming and helps feed the world in the process.

The advent of gene editing technologies (CRISPR) and super-computer could expand the frontier of seed technology in form of genetic modified organism (GMO) and genetic-edited (GE) seeds. Recent article from Financial Times (link) reported that gene-editing using CRISPR technology could cut product development cycle (variety development including regulatory approval) from 16.5 years to 5 years and research budget from $115 mn to $ 10.5 mn per product. Compared to GMO, gene editing using CRISPR is more precision in terms of adding or cutting the gene. Nevertheless, the technology mastery is still limited to a few and still in due process for more regulatory acceptance. Genetic-edited crop is the new unexplored frontier.

3. Crop protection

Besides fertilizers, the development of chemicals in crop protection has also contributed to feeding the world. For instance, pesticides could improve crop quality and increase crop yield by 30 percent on average (Bromilow, 2005). Pesticides are not something new, it has been widely used since the last 1940s.

Unfortunately, most crop protection products also require petrochemical-based feedstock. This suggests that a severe and prolonged energy crisis could adversely impact global food security by affecting the affordability and availability of fertilisers and crop protection chemicals. From that point, a vicious cycle in global food security could emerge from the subsequent decline in crop yields.

A difficult but hopeful journey ahead

It has been an adage of the investment world to invest in the pain points. Crop solution companies are essentially the direct solution to the looming food security risk. These companies range from fertilisers, seeds technology, and crop protection chemicals.

Given the R&D barrier of the business and the deeper pockets of the farmers, crop solution companies would be one of the few businesses that can thrive in this era of inflation. Crop solution companies’ pricing power is bound to rise in times like this. It is pretty obvious since crop solution products are the must-have ingredients for farmers to extract the risk premium and the cure to the crisis itself.

Although the short-term outlook might be difficult, the long story of humanity would suggest that this is a beginning of a hopeful tomorrow. Today’s market risk premium unveils the challenges and opportunities that lie ahead of us. It’s been years since capital was substantially directed toward resources, the bedrock of civilization. We believe persistent commodities’ risk premiums will redirect the capital into sectors that become the seeds of the next decade of plenty.

 

Bibliography

Bromillow. (2005). Pesticides. Encyclopedia of Soils in the Environment, Vol. 3, Elsevier, 188-195.

Ritchie, Hannah;. (2017, November 07). How many people does synthetic fertilizer feed? Retrieved from Our World in Data: https://ourworldindata.org/how-many-people-does-synthetic-fertilizer-feed

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