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June 21, 2022

Market Contagion; Lido; Digital Euro

Welcome to Swarm Markets’ media memo. This weekly update provides comments from Swarm Markets’ co-founders, Philipp Pieper and Timo Lehes, on key industry news that has caught our eye, plus our own developments. 

Comments available on the following news items:

  • How do you stop market contagion?
  • Lido exposure scandal highlights need for regulatory oversight
  • Circle launching digital euro

How to stop crypto market contagion – Timo Lehes

With markets badly in the rough, there’s much talk now of ‘contagion’ spreading through the system. But how you control and what that contagion actually means in practice is open to some interpretation.

It’s useful to look back to past examples when illustrating the point. Market contagion is what affected financial markets in 2008-09. It’s what led to the collapse of Lehman Brothers, for instance, and the later moves by governments to shore up the banking industry. 

Contagion, ultimately, was just amplified by investor fear and ensuing redemptions in the panic. Lehman Brothers collapsed because it didn’t have enough cash to cover its positions in the short term. Ironically enough, some of those underlying assets it held went on to be sold for considerably higher value down the line, but ultimately the firm was unable to outrun its creditors. 

So what’s the cure for this? There is no easy solution, but more robust liquidity is a good starting place for crypto institutions under stress. The US Fed is holding its latest banking stress test later this week, which is a timely reminder that this liquidity is only really organisable with some sort of oversight. 

That’s why regulators need to begin taking heed of the current situation. This might be the first time crypto has been in this position, but ultimately the core issues boil down to the same problems as before. 

The problem with Lido goes beyond market volatility – Philipp Pieper

The problems involving major institutions such as Celsius, Three Arrows Capital and others are highlighting the involvement of Lido Finance and raising questions over its involvement in ongoing redemption issues. But it is transparency, not volatility, that is at the heart of the issue here. 

Although on the face of it a big presence in the background of these providers, the size of Lido is only an issue when it comes to jeopardising the goal of distributed network infrastructure and governance. If too many nodes in Lido are operated on AWS, it makes the network more attackable. 

But in reality, the nature of non-redemption is the issue – where stEth can not be redeemed until Eth2 exists. The issues are particular to Lido’s stEth product. These issues will get even more pressing to solve after The Merge, when ETH will likely go from around 15-20% staked to around 50-60%+ of all ETH in circulation.

The bigger problem still – and where compliant structures need to be introduced – is the entire end-to-end setup of these node structures should be auditable and clear to investors. That is not a problem specific to the current market turmoil but something more fundamental in the infrastructure of DeFi. 

Circle to launch digital euro  – Timo Lehes

The issuer of USDC Circle is launching a euro stablecoin, backed by euro-denominated reserves. It certainly marks an interesting moment for a US company to launch a euro-backed stablecoin, with markets perhaps distracted by events. But it is a positive signal that important crypto projects are able to proceed in this environment. 

Stablecoins are a really important aspect of the wider crypto ecosphere and Circle has form for providing them with USDC—already a well-embedded option for the market. The addition of EUROC as it has been designated will be a welcome addition to the stable. 

The Euro area is a major player in the crypto sector so having euro-denominated stablecoin available is really important. While much focus is put on the US, the EU is a very competitive space for the sector, especially with regard to open and constructive regulatory parameters in regions such as Germany, where Swarm is regulated by BaFin. 

It is essential now for regulators to take into account developments in the stablecoin space and enable their utility and security at a trying time for valuations. Improving systemic liquidity and stability will be essential to take the sector through the difficult days ahead.