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By Doug Wolfe, Esq., Managing Director, Corporate Recovery
You’ve heard of market makers, and maybe you’ve heard of market creators. So, what’s the difference? Let’s start with the market makers; they create liquidity for a tradeable asset by setting both a buy and sell price. Market makers set their prices on an asset already established for transaction elements such as acquisition, verification, allowance (or validity), and even distribution.
But what happens when what appears to be a tradeable asset has no market?
In December 2008, when Bernie Madoff rocked the financial world with the discovery of the most significant financial fraud of our time, I’m sure there weren’t many people thinking about the future market for his customers’ losses, but, surprisingly, there were. I know because I was one of them. Speculating that the Madoff fraud would create a distressed market for investors was predictable because financial fraud cases usually go through a corporate bankruptcy proceeding, and over the years, my, then, firm had successfully invested in numerous situations like the after-effects of the Madoff collapse. Aside from the assets that were available, we knew the precedents behind fraudulent transfers or “clawbacks” and the culpability of the financial institutions involved in the scheme would govern the ability to help bring value to creditors. Just as important, we had experience with the process of buying such claims from creditors or, in the case of Madoff Investment Securities LLC (BLMIS), the firm’s customers.
The wild west of cryptocurrency is also a present example. Unlike regulated assets, the crypto holder believed in the published value of the asset without realizing that distressed investors were simultaneously looking to take advantage of the situation and the likelihood that the asset would be devalued. Today, crypto investors’ asset values are being turned upside down because of asset volatility. As with any investment that goes bad, some customers who have frozen their investments are looking to liquidate the losses. Enter the market creators.
Market creators not only set a price for assets that don’t have established rules, but often set their prices based on assumptions about the process itself.
Much like the Madoff customer claims market, the firms (“Buyers”), customers (“Sellers”), and the market makers that create the demand for crypto claims, have many unanswered questions around the market itself. These unanswered questions will directly impact crypto claims’ prices and eventual distributions received by the claimholders. The challenge is not only trying to predict the answers to the questions, but knowing which questions to ask. The first question that is usually asked in these types of cases is “who owns the assets,” or in a crypto case the “digital assets,” the bankrupt company or the individual customer that made the investment? In the recently-filed and presently ongoing Celsius case, Judge Martin Glenn has already ruled in favor of the company for purposes of whether the debtor can use deposits to fund operating expenses; however, the reasons behind that decision can be used in other cases when trying to predict the answer.
So how does anyone trade in a market that is still being created? There is no precedent or previous experience to help guide one in their quest for a trade in an illiquid asset. But even an experienced market creator knows each transaction has risks and the potential for pitfalls, which may include eventual regulatory oversight to ensure information asymmetry. In other words, larger institutions with access to broad historical knowledge are on one side with all the data and the market influence, and individuals are on the other with little or no counsel.
The risks go beyond the transaction itself. An investment in an immature, fluid and still-forming market could rest on factors outside your ability to predict, such as (i) decisions coming down from the court in a case of first impression and, (ii) at times, governmental intervention.
Tread carefully, my friends. Anything can happen when you’re writing the story as you go.