Six months before the cryptocurrency crisis-triggered FTX crash in November, another cataclysm occurred: the stablecoin Terra imploded, wiping out an estimated $1 trillion in value and setting off a chain of cryptocurrency business failures. The collapse of the Earth came as a shock to most people, but not to everyone.
A hedge fund called Galois Capital was one of the few that smelled rotten in Terra and took a short position, betting that the price of the crypto-paired Terra would fall. The gamble paid off, and Galois reaped the rewards, earning praise for making a shrewd move at a time when the rest of the world thought Earth prices were over the moon.
Galoa's decision to short Tira was the same counterintuitive gamble that has been mythologized in past financial disasters. The most famous and celebrated example is in the book and film The Big Short , which tells the story of a few courageous investors who predicted the collapse of the US mortgage industry in 2008 and made their fortunes betting on it.
Now, in the wake of FTX's disastrous $32 billion blowout, it's worth asking why no one is "betting big" against a company that has shown signs in the face of brokers, from bad accounting to board absence. and managing director. Which gave important encounters playing League of Legends .
You think it will end badly.
Chris Drews, founder of Bleecker Street Research, made a name for himself by not only shorting shares in a healthcare giant called American Addiction Centers, but has since published talks on everything from air taxis to the sports arena. city. Trading in the penny stock zone. Drews says he and other Wall Street short sellers have been closely watching the cryptocurrency market for years.
"[From] the point of view of someone who cares about fraud and wants to fight fraud, you're outside the best party in the world, you look in and think, 'It's going to end badly,'" he notes. "But I think they know that if they let you in , will end." It's faster.
This year, Drose sold Coinbase shares, but not FTX, Terra or any other major blockchain project. While FTX did not have publicly traded shares, the common currency for short sellers, it did have a large inventory of its own internal liquid token, called FTT. Anyone short FTT in early November will look like a bandit. So why isn't FTT abbreviated?
Drews admits he did not foresee the collapse of FTX, but says that even if he did, he would have lacked the financial infrastructure to sell his money on the cryptocurrency.
Here's how shorting works in traditional finance: If you're a fund manager looking to sell Apple stock, for example, you can call a major broker like Goldman Sachs or JP Morgan and ask. They ask you to borrow Apple shares. The exact price in that time period that you agree to return, preferably at a lower cost after the price has dropped, allowing you as a short seller to keep the difference as a profit.
It's different in coding. While there are some big crypto brokers like Genesis that can make short bets, there are no big financial outlets like JP Morgan in the space, which begs the question: is anyone's unique set of risks. Drews says he's managing someone else's money.
"If I shorted the stock and came back six months later when I went to cover it and my prime broker was insolvent, I'd be in trouble," he says. “Especially for a hedge fund manager who handles other people's money, you really have to trust your prime broker to handle your clients' money.”
Drews' concerns seem well founded. Earlier this month, Genesis, which has long been considered a respected name in cryptocurrencies, revealed that it is having financial problems, preventing customers from withdrawing funds.
Another challenge for retail investors looking to sell cryptocurrencies is access. Large cryptocurrency brokers generally cater to large investors, which are inaccessible to many, unlike trading platforms like Fidelity or Schwab, which allow retail investors to take short positions.
There is another way for retail investors to sell cryptocurrency, says Tom Dunleavy, principal analyst at Messari: They can go to a futures exchange like Binance (or until recently, FTX) to arrange a deal where the short seller takes part of the trade. . While the uptrend (or "long" in financial terms) goes the other way. But this is not a particularly convenient option, as it is quite expensive.
“Most short bets are made using perpetual futures contracts, which is a unique mechanism for cryptocurrency markets since there is no robust crypto options market,” Dunleavy explained. Perpetual futures contracts allow players to go long or short, with one party paying the other a small commission for the privilege of holding a position. Bullish sentiment in the cryptocurrency market often makes it expensive to hold bearish bets for extended periods.
The short seller also has to pay an additional fee to the exchange, and of course there is the risk that the future exchange will default and gobble up your money.
Can short sellers help prevent cryptocurrency crashes in the future?
Short sellers are controversial figures in the financial world, unpopular with those who see them as vultures preying on struggling companies. Others, however, believe they are doing an important service by highlighting companies that mislead the markets or misrepresent their financial performance, and they are often right, as was the case with the heroes of The Big Pants .
Siamak Moalami, a professor of business analytics at Columbia Business School, believes short sellers play an important role. “The general academic view is that shorting is a net positive,” Moalimi told Fortune . "Without short selling, there is no mechanism in the market to draw attention to [bad actors]."
Al-Mouallimi believes this applies to cryptocurrency markets in the same way it does capital markets and suggests that a broader and better regulated shorting infrastructure could be attractive to investors in the future. Beware of fraudulent companies.
While there are ways to sell cryptocurrency, the teacher noted that there is also an additional risk for potential short sellers: losing profits in the event of a complete exchange crash, as is the case with FTX. “The concern is that if you make a big profit, you can't exit the platform,” he says.
Your concern seems justified. Just ask Galois Capital, the company that profited from the Terra collapse. You now have half of your capital locked up on a failed FTX platform.
This story originally appeared on Fortune.com
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