Utilization and interconnection blow up crypto and defi

That’s what’s different this time: Things inflate due to influence and waterfalls through the crypto space because everything is interconnected.

By Wolf Richter. This is the transcript of my podcast that was recorded last Sunday, THE WOLF STREET REPORT.

Crypto lender and broker Voyager Digital, which also took deposits and offered return products with huge interest rates of up to 12%, said in a series of tweets today that it is “actively pursuing a number of strategic options” and that it is “focused on protecting assets and maximize value for all customers as quickly as possible. ” It’s a scary language for people who have their cryptocurrencies on deposit with Voyager and now can not get their cryptocurrencies or anything else.

What is different this time around with the collapse of cryptocurrencies, compared to the previous time in 2018, are two huge factors that were hardly in their infancy at the time: massive influence and coherence.

All these crypto firms lent to each other and borrowed from each other in crypto, to speculate in cryptos with borrowed cryptos, and they lent borrowed cryptos, and they put out cryptos as collateral with each other for more influence, which now triggers margin calls, forced sales and wipeouts cascading through the room. This interconnection created enormous systemic risks within the crypto area that are now coming home to rest.

On Friday, Voyager Digital had suspended trading and withdrawals. In other words, depositors cannot get their cryptocurrencies and securities out. And they can not get any fiat out either.

These people are unsecured creditors if Voyager files for bankruptcy. Voyager has already hired restructuring and bankruptcy lawyers and consultants.

Voyager was taken down by the crypto hedge fund Three Arrows Capital, which exploded in the midst of enormous influence when the cryptos plunged.

Three Arrows Capital, which was said to have managed around $ 10 billion in crypto as of March, was ordered for liquidation by a court in the British Virgin Islands, where it has its legal headquarters. On Friday, it filed for Chapter 15 bankruptcy in the United States.

Voyager had lent 15,250 bitcoins and $ 350 million Coins, a stable currency, to the hedge fund. In total, this loan amounts to around 650 million dollars at current prices. And Three Arrows had defaulted on that loan.

Three Arrows got into trouble when cryptocurrencies fell below a certain level and when Luna, in which it was heavily invested, collapsed by 100%, at which point it received margin calls that required more security, and when it did not come, positions were exploited. liquidated by crypto exchanges including BitMEX and Deribit.

Voyager said in a series of tweets today, Sunday, that they have $ 1.3 billion left of the crypto on the platform – presumably placed there by depositors – which is now banned, and that they have $ 650 billion in claims against Three Arrows Capital, which Three Arrows has turned on by default.

Voyager trades on the Toronto Stock Exchange. Friday 1. July, when it announced that it had shut down its depositors, the Toronto Stock Exchange was closed on the occasion of Canada Day. In the US, where Voyager trades over the counter, shares plunged 31% on Friday, to 30 cents.

Voyager was founded in 2018 and had started trading in Canada in September 2021 to around 16 Canadian dollars per share, and in the midst of huge crypto hype and mood rose to over 21 dollars at peak cryptomania in November 2021. The stock has now collapsed by almost 100% in 10 months. So the wipeout went fast.

Companies like Voyager are in the area called Decentralized Finance. DeFi does what the hated and despised fiat banks do, except that they do it in crypto instead of fiat, and there is no deposit insurance, and there is no regulation, and everything goes, and there is no central bank for them, and no protection for depositors. In addition, they enticed customers to deposit their cryptocurrencies there by promising to pay huge interest rates of up to 20% a year. Which is completely crazy.

And now the two concepts of influence and interconnection are tearing up the cryptos, the crypto exchanges, the DeFi outfits, the crypto shares and the crypto hedge funds.

The influence is mostly hidden and entangled with other crypto companies, and parts of it only appear when something blows up. And the interconnection causes the explosions to flow through the crypto space.

So now this is a completely different game with margin calls, forced sales, bankruptcies and liquidations, and preparations for potential future bankruptcies, total annihilation of some cryptocurrencies, including TerraUSD and Luna, and leaving customers with deposits on crypto exchanges and crypto-lending platforms twisting in the wind.

There is no regulation and no deposit insurance, and these customers are just unsecured creditors when these highly leveraged platforms collapse. And the loans that were overdrawn when bitcoin was at 65,000 dollars, triggered margin calls when bitcoin plunged to 19,000 dollars, and lenders can seize the security, namely the crypto. But since lenders also traded on their own accounts, with customers’ deposits, they too were wiped out when the cryptocurrencies plunged, and that’s just the beginning.

DeFi platforms are like banks, but they take deposits and lend everything in crypto. They are very exploited. They use customers’ deposits to trade crypto in their own accounts, and they lure customer deposits with the promise of huge interest rates. And customers borrowed against their cryptocurrencies, and used the crypto deposits as collateral, to gamble with multiple cryptocurrencies. Everything was used for the booklet and connected. And it all collapsed when cryptocurrencies began to collapse.

It has been exactly three weeks – on June 12 – that one of the largest crypto lenders, Celsius Network, which had managed around $ 12 billion in crypto as of May, told users that they would stop all withdrawals, exchanges and transfers between accounts.

It blamed extreme market conditions. It said it needed to “stabilize liquidity and operations.” Customers have not received their cryptos. No one knows what is happening, except that it is not good and that Celsius has hired restructuring and bankruptcy lawyers in preparation for a possible bankruptcy report.

If Celsius files for bankruptcy, customers with crypto deposits are unsecured creditors, and they may not be able to get their cryptocurrencies back, and unlike bank customers in the despised and hated fiat banking system, there is no government deposit insurance. People are just on their own.

Celsius lured customers with an annual percentage return of over 18% on their crypto deposits. That this was either a scam or a super-high-risk game should have been clear to everyone. The only time a company pays 18% interest on debt is if it is close to default. It is a very high-risk debt, and bond buyers know this, but apparently not the customers of Celsius.

At least three other crypto platforms have now blocked customers from withdrawing crypto deposits or collateral, or have limited the amounts: Babel Finance, CoinFlex and Finblox.

We are not talking hated and insulted fiat dollars here, but crypto. They borrow crypto from each other, they lend crypto to each other, they lend crypto to each other, they pay interest in crypto, they trade crypto between each other, and they try to save each other in crypto.

And they have to pay each other back these cryptos, and the cryptos have plummeted in value and are gone because of the influence that exploded, and because of the connection that is spreading these explosions around the system.

Utilization and interconnection, which were only in their infancy in 2018 when the crypto exploded last time, are now the dominant factors. Back then, only people sold their cryptocurrencies. Now things are blowing up because of influence. It is a much more insidious process.

Utilization in the crypto world also takes other forms, as exemplified by MicroStrategy. It’s a dotcom darling whose stocks rose ridiculously during the dotcom boom into the early 2000s, and then totally collapsed. To keep the share price above the strike limit, the company made a 1-to-10 reverse share split in 2002. Then it scraped past as a software maker for businesses, until 2020, when it announced with great hype and humor that it would start buying bitcoin as one of its most important business strategies, and that it would finance these purchases with influence.

Part of this influence would come from the issuance of unsecured convertible bonds, which the bitcoin-crazy amount ate up at the time. Even if bitcoin goes to zero, the holders of these unsecured bonds have no rights and can do nothing as long as the company does not default on interest or principal payments. So this is stable financing, and the concept of margin call does not apply here.

But then, to buy more crypto when the mood just got worse, it issued bonds secured with bitcoin and other corporate funds.

So in March, the company received a $ 205 million mortgage that was secured with nearly 20,000 bitcoins. The loan agreement required a minimum loan-to-value ratio of 50%. If bitcoin falls below $ 21,000, the minimum lending ratio will be violated on this $ 205 million term loan.

According to a submission to the SEC on Wednesday, MicroStrategy now has around 129,700 bitcoins that they bought at an average price of around $ 30,700 each, for a total purchase price of almost $ 4 billion.

With the current price of bitcoin at around 19,000 dollars, MicroStrategy’s investment has lost the company 1.4 billion dollars from the acquisition cost – all borrowed money.

Following MicroStrategy’s announcements of bitcoin purchases in the summer of 2020, it rose from around $ 110 to over $ 1300 by February 2021, multiplied by over 10 in just 8 months. This is how brain dead crazy the whole market had become. Then the shares began to collapse. They are now back at $ 164, down 87% from the ridiculous peak in February 2021.

This huge amount of speculation, risk-taking with these gambling tokens and fraud was one of the worse parts of Everything Bubble. It’s a very profitable trade if you drive it up and then sell these things to the bigger fool, raking in the hated and soon worthless fiat dollars. But unfortunately, many people who were gullible enough to go for this, lost a lot of money and will lose a lot of money. But that’s how bubbles work, that’s just the way it is if you participate in that kind of madness and do not get out until it disappears – and two thirds of it has already disappeared.

You can subscribe to THE WOLF STREET REPORT on YouTube or download it where you can find your podcasts.

Do you enjoy reading WOLF STREET and would you like to support it? By using ad blockers – I understand why – but do you want to support the site? You can donate. I really appreciate that. Click on the beer and ice cream mug to find out how:

Would you like to be notified by email when WOLF STREET publishes a new article? Sign up here.