Houston, We have a Problem
Market Recap
After weeks of consolidation between $9,000 ~ $9400, Bitcoin broke up higher, first to $9,600 level fueled by news that OCC is allowing U.S. banks to hold digital assets. Furthermore, on Sunday evening 6:00PM HKT, Bitcoin pierced through $10,000 for the first time since 1-Jun. $348M worth of short contracts were liquidated across major exchanges. [Figure 1] Ethereum posted an even more impressive gain of 32% over the week, breaking $300 barrier. The strong outperformance is attributed to profit taking on DeFi tokens, which rallied significantly over the last few weeks.
U.S. equities pushed higher early in the week over positive development on vaccines and continuous government economic stimulus. However, with rising U.S.-China tension and investors worrying about stalls in economic recovery following unexpected increasing number of U.S. initial jobless claims, the gains evaporated quickly. The week ended with a modest decline. Across the other side of world, China Shanghai Composite Index and HK Hang Seng Index were down 0.54% and 1.53% respectively. Amid the sharp deterioration in U.S.-China relationship, gold surmounted $1,900 for the first time in 9 years and silver surged approximately 10%.
What is Happening?
On Tuesday (21-Jul), United States government ordered China to “cease all operations and events” at its Houston consulate “in order to protect American intellectual property and Americans’ private information”. The consulate was given 72 hours to vacate due by 4:00PM EST on Friday, right after which a group of American officials were seen forcing open a back door of the consulate. Houston consulate was the first consulate to be established in 1979 after the US and China established diplomatic relations. The move was seen as a declaration of cold war between the world’s two largest economies. In retaliation, Beijing revoked the U.S. Consulate’s license to operate in Chengdu on Friday. The U.S. and China diplomatic tension has been building up since last year following clashes over trade, coronavirus pandemic and Hong Kong’s national security law. The Houston consulate shutdown is seen as not only to provoke China but also to turn around Trump’s polling decline for the coming presidential election. With four more months ahead of the election, many analysts believe that Trump will continue to play the China card and worsen the relationship.
As noted in our Satori Research Letter last week (20-Jul-2020), yield farming is gaining traction over the last few months. Yield farming is a subsection of DeFi that allows one to earn yield using DeFi apps, wallets and protocols for idle assets which often involves providing liquidity. The yield could come in many forms including interests, liquidity provider (“LP”) fees and incentives/rewards from DeFi protocols.
Compound, an autonomous borrow/lend platform, issued its governance token COMP in Jun-2020, which aims to provide governance rights over the Compound protocol to its users by distributing pro-rata number of COMP tokens according to how much they use the protocol. The COMP tokens been distributed to users of the protocol is seen as free yield being farmed. When COMP token listed, the price surged over 3 folds, which brought in significantly high return to Compound users with the additional yield earned in COMP. Such yield farming drove a flood of capital into Compound, pushing total value locked (“TVL”) in the Compound protocol from $100M to over $1.7B at the peak. [Figure 2]
Following this extraordinary success from Compound, many other DeFi protocols also started releasing their own yield farming schemes. The most popular yield farming platforms are listed below. [Table 1] However, as high yield usually implies high risks, even though loans are usually overcollateralized(>100%), there are still various aspects that could go wrong in a yield farming process, including smart contract risk, system design risk, liquidation risk and bubble risk of the price of both the underlying asset being locked in the protocol as well as the reward tokens.
Conclusion
The accusation of hackers stealing vaccine information and visa fraud has clearly demonstrated that the Houston consulate closure is not a one-off incident but just the beginning. China has been responding in an eye-for-an-eye manner.
This tit-for-tat retaliation between U.S. and China has escalated the situation. The jury is still out whether this would result in a hot war, but we are certain that “Houston, we have a problem”.
