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An unprecedented crisis of confidence has affected the crypto industry for several months.
To measure this, simply consider the prices of cryptocurrencies, which are often tied to a platform or project. According to CoinGecko, the cryptocurrency market has lost $2 trillion since hitting an all-time high of $3 trillion in early November. The price of bitcoin, the king of cryptocurrencies, has fallen by more than two-thirds since hitting an all-time high of $69,044.77 on November 10.
The severity of the crisis intensified earlier this spring in a seemingly contained event. In early May, sister coins Luna and UST or TerraUSD collapsed. The fall of the two digital currencies was caused by the fact that many investors wanted to liquidate their positions at the same time. As a result of this disaster, at least 55 billion dollars were destroyed.
The collapse of the moon
What might have seemed like an isolated event ended up being an octopus with multiple branches. A month later, crypto lender Celsius Network, which operates like a bank, announced that it was suspending withdrawals, thereby depriving its customers of access to their money. A few days later, Three Arrows Capital, or 3AC, a Singapore-based hedge fund, said it was stunned by the debacle of Luna, a digital currency in which the firm had invested more than $200 million.
Voyager Digital, another crypto lender, has announced that 3AC has defaulted on a loan of at least $630 million it provided to it. Babel Finance, CoinLoan, CoinFlex and other crypto lenders have also suspended withdrawals. BlockFi, one of the biggest names in the sector, was forced to turn to young crypto billionaire Sam Bankman-Fried, the founder of the FTX.com platform, for help. The liquidity crisis has spread to other small lenders such as Wold. Cryptocurrency exchange Blockchain.com has warned its shareholders that it could lose $270 million due to 3AC.
Domino’s began to fall: 3AC was forced into liquidation, Voyager Digital and Celsius Network filed for Chapter 11 bankruptcy. BlockFi was saved, and the future of the rest remains uncertain. As for their clients, they don’t know if they will ever be able to get even a small part of their money back.
The link between all these companies and platforms is the 3AC hedge fund. It appears from company statements and white papers that a large number of crypto lenders have lent money to the company. But what they didn’t seem to know was that they were all often hedge fund lenders.
3AC is “an old-fashioned Madoff-style pyramid scheme”
Three Arrows Capital was operating as a Bernie Madoff Ponzi scheme in disguise, according to a recent report from research firm FSInsight, an independent research firm. The firm was an “old-fashioned Madoff-style Ponzi scheme” that occupied positions similar to those that sank Long Term Capital Management (LTCM), according to FSInsight.
Long Term Capital was a well-known hedge fund run by prominent Wall Street traders and Nobel Prize winners in economics. The firm went bankrupt in 1998, forcing the government to intervene to prevent the markets from collapsing.
In the case of Three Arrows, Kyle Davis, 35, and Su Zhu, 35, the founders, acted like Bernie Madoff, according to a research note on the hedge fund crash. Davis and Zhu “used their reputation to recklessly borrow money from virtually every institutional lender in the business,” writes FSInsight.
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Zhu and Davis likely “used borrowed funds to pay off interest on loans made by lenders while ‘forging their books’ to show huge returns on capital,” the note says.
This finding raises questions about whether 3AC’s financial disclosures were truthful. At its peak, the hedge fund claimed to have over $18 billion under management. But given the degree of exposure that crypto lenders have to the hedge fund, it’s likely that most of its assets were bought with debt and its collateral ratio was quite low, according to Sean Farrell, head of digital assets at FSInsight.
A Ponzi Scheme is a fraudulent financial scheme that pays existing investors large returns from the capital invested by new investors. This fraud feeds on the gullibility of the deceived. Often this is only disclosed when the funds raised by new investors are no longer sufficient to cover payments to previous investors. This scam was used by former Nasdaq Chairman Bernard Madoff for the largest Ponzi scheme in history.
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“People may call us stupid”
“The Terra-Luna situation took us by surprise,” Davis tried to explain in June.
Since then, two former Credit Suisse traders who became friends in high school have been in hiding. They recently gave a phone interview published July 22 by Bloomberg News.
“People may call us stupid. They may call us stupid or delusional. And I will accept it. Maybe,” Zhu told the publication. “But they will, you know, say that I hid the funds during the last period, when I actually put more of my personal money back. It is not true”.
“The whole situation is unfortunate,” Davis told the publication. “Many people have lost a lot of money.”
“What we didn’t understand is that Luna could drop to virtual zero in a matter of days and that this would be the catalyst for an industry credit crunch, putting significant pressure on all of our illiquid positions,” Zhu added.
Looking back, two former Credit Suisse traders say their fiasco is similar to the LTCM fiasco.
“For us, it was very similar to the moment of LTCM, the moment of Long Term Capital,” Zhu said. “We had different types of deals that we all thought were good, and other people had those deals too,” Zhu said. And then they kind of all got a super markdown, very quickly.”
The firms responsible for liquidating the hedge fund have complained about the non-cooperation of the two co-founders, which the latter reject.
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