How Did So Many Crypto Lenders Go Bankrupt?
“The issues here were foreseeable and actually credit-specific, not crypto-specific in nature,”
- Coinbase.
This is crypto’s Lehman Brother’s moment. At least crypto lenders believe it is. One, two, three major crypto lenders have declared bankruptcy recently, foretelling a crash in cryptocurrency, just as the Lehman Brother bankruptcy case foretold the fall of the housing market in 2008.
So, what happened? Here’s a case-by-case analysis:
Celsius froze withdrawals on June 12 — the first indication that a crypto lender was facing liquidity issues. On June 27, Three Arrows Capital (3AC) defaulted on a $670 million loan from Voyager. As a result of 3AC’s default, Voyager declared bankruptcy in early July.
Three Arrows Capital
3AC owes approximately $3.5 billion to over 27 different companies, according to court documents. Genesis Global Trading was the largest lender of the 27 companies, offering a $2.36 billion under-collateralized loan with a margin requirement of 80%.
Troubles began with the collapse of Terra, their cryptocurrency (LUNA) and stablecoin (UST). Losing practically 100% of its value, LUNA and UST, almost overnight, became worthless tokens. The result of failed governance, many investors with large Terra holdings have lost hundreds of millions of dollars. Terraform Labs, the company behind these cryptocurrencies, is currently being investigated by South Korean Authorities and the U.S. Securities and Exchange Commission.
3AC lost $200 million when UST destabilized from its $1 peg. Su Zhu, Co-Founder of 3AC, described the Terra downturn, stating:
“What we failed to realize was that LUNA was capable of falling to effective zero in a matter of days and that this would catalyze a credit squeeze across the industry that would put significant pressure on all of our illiquid positions… We had different types of trades that we all thought were good, and other people also had these trades. And then they kind of all got super marked down, super fast.”
Voyager
Voyager was a crypto investment firm, with the façade of a traditional bank. Voyager promised up to 12% interest on your deposits, offered a debit card, and had a mobile app. They even convinced customers that they were FDIC insured. The company encouraged customers to deposit their checks into their Voyager accounts.
But Voyager, despite claiming that its business model was working, was experiencing significant year-over-year losses. The Q3 2022 release announced that revenue was up — $102 million — but the fine print read that Voyager was accruing an operating loss of $43 million per year. When Terraform’s Anchor platform failed, Voyager did not believe it had any exposure.
Unfortunately for Voyager, it was extremely exposed to Terra losses through its largest debtor — Three Arrows Capital. 3AC knew it was in deep, but didn’t tell Voyager.
On July 1, Voyager announced it was “temporarily suspending trading, deposits, withdrawals and loyalty rewards.” Financials released that day showed the massive hole 3AC had put Voyager in, leading to its bankruptcy filing shortly thereafter
Celsius
Celsius has a similar story to Voyager. It operated much like a bank, promised double-digit returns to customers, but in reality was robbing Peter to pay Paul. According to Castle Island Venture’s Nic Carter, “They [Celsius] were subsidizing it and taking losses to get clients in the door. The yields on the other end were fake and subsidized. Basically, they were pulling through returns from [Ponzi schemes].”
Celsius has a similar story to 3AC. Celsius held over $500 million in Terra, which promise 20% returns to those with UST holdings. The UST token dropped almost 100%.
On June 12, Celsius announced that it would be halting customer withdrawals due to “extreme market conditions.” Over the span of 10 months, Celsius went from managing $25 billion in assets, to $11.8 billion three months ago, to now only $167 million “case on hand.” The firm also had approximately $8 billion in client loans. Celsius owes $4.7 billion to users and has a hole around $1.2 large in its balance sheet.
Offering nearly 20% APY to customers was unrealistic. One lawsuit has already accused Celsius of running a Ponzi Scheme, alleging that it paid early depositors with money it gained from attracting new users. “They always have to source yield, so they move the assets around into risky instruments that are impossible to hedge,” said Nik Bhatia, founder of The Bitcoin Layer. “They probably lost customer deposits in UST,” Bhatia added. “When the assets go down in price, that’s how you get a ‘hole.’ The liability remains, so again, poor risk models.”
Lessons Learned
Double-digit returns are a thing of the past. Crypto lending firms with overzealous APY’s and other “great perks” will likely disappear after this crash too.
Many are blaming the overall cryptocurrency market for the downfall of these three firms, and other DeFi organizations. Cryptocurrency is an incredibly volatile asset and when organizations like Celsius, 3AC, and Voyager take undue risks, they expose themselves to real vulnerability if the crypto market does collapse. They hedged their bets, and lost.
High risk though can be high reward. If someone offers 20% return on an asset, that is a really great value. But the translation is that there is a one in five chance it goes to zero in a year, as much as the chance to double your investment in four years. Bonds with big yields are called “junk bonds” for a reason: investors understand that those dividend yields imply high levels of risk. But when high returns are offered in other markets, many seem to forget this very simple fact of investing.
As cryptocurrency investing becomes more accessible, especially to those who don’t know much about the market, it will be important to remember foundational rules of investing — rules that apply to every asset, not just crypto. This will protect investors from the siren song of high-returns without acknowledging equal levels of risk.
About Centuries Analytics
Investing in cryptocurrency doesn’t have to be risky — not anymore. We let data speak; not investors, “experts”, pundits, or tv show commentators. Centuries uses social media, financial, and macro-economic data to determine and predict cryptocurrency markets.
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