Looking at the Celsius and 3 Arrows Capital implosions

The markets have been absolutely brutal. Over the last month, we have seen a stablecoin provider, a leading lending provider, and one of the biggest crypto hedge funds implode entirely. We have discussed Terra’s implosion in the past. Today, let’s focus on Celsius and 3 Arrows Capital (3AC). The truly remarkable thing here is that we are in entirely uncharted waters as far as crypto is concerned.

We have never seen so many institutes implode at the same time. Strangely enough, I believe this could be good for the market in the long term. We will get to that later. However, first a quick intro.

What are Celsius and 3AC?

So let’s start with Celsius. Founded in 2018, Celsius was one of the biggest lending platforms in crypto. In May 2022, they had more than $8 billion lent out to clients and $12 billion in assets under management. What made them truly attractive was the incredible APR they offered on collateral. Celsius has been using client funds on various DeFi protocols like Lido, Curve, and — wait for it — Terra’s Anchor Protocol — to generate this yield. On-chain analytics platform Nansen has already identified the wallets that made these trades. When Terra imploded, Celsius CEO Alex Mashinsky quickly pointed out that they had pulled their position safely out of Terra.

On the other hand, 3AC is one of the most well-known venture capitals in the crypto space, founded by Su Zhu and Kyle Davies. 3AC is known for being one of the biggest borrowers in DeFi. During the market’s peak, 3AC had holdings worth $10 billion, including Lido, DYDX, Bitcoin, Ethereum, and….yup… Terra. 3AC borrows from every major lender out there, like — BlockFi, Genesis, Nexo, and Celsius. Inevitably, they are all going to suffer due to 3AC’s implosion.

There is one more interesting thing happening in the background that we need to look into before proceeding.

What is stETH?

As you know, you can stake your ETH in the beacon chain to be a validator. Each entity must stake at least 32 ETH to become a validator in Ethereum PoS. There are two ways that you can do this. Buy 32 ETH and stake it. Or create a pool and stake 32 ETH.

The DeFi protocol, Lido Finance did something super smart. They took ETH from their users to stake on the beacon chain. In return, they issued a new token called stETH (staked Ether), pegged 1:1 with ETH, and gave it to the user. This strategy worked very well for Lido, making it the most dominant entity in PoS Ethereum. stETH is a popular token in DeFi applications. Both Celsius and 3AC had significant exposure to stETH.

However, just a few weeks back, the stETH:ETH peg broke.

The reason this peg broke is because of stETH relative liquidity when compared to ETH. Check this out.

This chart tells us that the max addresses holding stETH never exceeded 65,000. Obviously, this is a low number when compared to addresses holding Ethereum.

As such, the daily trading volume for stETH is significantly lesser than ETH, making it a more illiquid asset. Now, if some whales decide to dump their stETH, the lack of liquidity could bring the asset’s price down. This is precisely what happened when some players chose to sell off their stETH. For example, Alameda — a major trading firm with close ties to FTX and SBF — dumped $88 million worth of stETH.

Celsius and stETH

Celsius held almost half-a-billion dollars worth of stETH.

Now… this is where I must tell you the flipside of stETH. While you can trade-off your stETH for ETH in the open market, you can only redeem them for ETH until 6–12 months after the actual mainnet merge.

Alright, so let’s quickly summarize:

• Celsius borrowed a lot of loans.
• Users staked their ETH in Celsius. To generate their high yields, Celsius converted the ETH to stETH.
• The stETH depeg has cost them a lot of money and they can’t simply redeem for ETH As such, they simply don/t have any liquidity.
• They stop all withdrawals.

Side note: The Stakehound misfortune

In this series of unfortunate events, another episode played a part in Celsius’s demise. Celsius staked a significant amount of their ETH in Stakehound — an Ethereum staking service. In June 2021, Stakehound misplaced its private keys, and Celsius lost a staggering 35,000 ETH.

3AC and stETH

How do hedge funds like 3AC work?

They borrow funds from CeFi lenders and make bets in the market. This model works when you make good bets — which 3AC did…until they didn’t.

3AC was hit hard by the Terra crash. At one point, they held 10.9M locked LUNA for $559.6 million — it’s now worth ~$675. Do the math there. There is also some speculation that the losses suffered in LUNA forced 3AC to use more leverage to earn it back. Given the current market conditions, that’s just playing with fire. To nobody’s surprise, 3AC positions were margin called.

Now, how does 3AC pay back its debt?

Remember, 3AC has made some great investments, but all those tokens are locked for years. So, what do they do?

They dump stETH — ferociously.

A wallet attributed to 3AC withdrew 80,000 stETH from Aave and converted 38,900 stETH (some $45 million) in two transactions to ETH.

As per reporter Colin Wu (aka Wu Blockchain), 3AC lost >$30 million trading on Bitfinex in May 2022, further killing their coffers.

The 3AC collapse has seriously taken everyone by surprise, given how well-regarded they were in the community.

My Thoughts — Is this the “Lehman Brothers” moment for crypto?

Well, maybe not individually, but the fact that we had 3 multi-billion dollar implosions in such a short time is pretty unprecedented. So it’s normal to be scared about the market right now.

However, in the long-term, it is necessary for businesses with poor business practices and ethics to be flushed out for the space to grow.

When the 2008 crisis happened, an unknown developer named Satoshi Nakamoto made Bitcoin. A decentralized, peer-to-peer alternative to centralized finance. It is ironic that 12 years on, Bitcoin and crypto have suffered because of the same issue we had back then — centralized bodies making stupid financial decisions.

This is why I remain more convinced than ever that regulations are the way to go for crypto. We are all hurting right now. But let’s hunker down and go back to building great products. There is so much sheer potential in this space. We haven’t even scratched the tip of this incredible iceberg,