What the hell did Voyager do with all your money?
The recent turmoil in the crypto market has been led by a series of sweeping events, including the collapse of Terra UST and the failure of the famous hedge fund Three Arrows Capital (3AC). Particularly notable and perhaps most impactful is the wipeout of distressed centralized crypto-lending platforms, which have disproportionately hurt retail investors.
These investors have been blindsided by the withdrawal freeze imposed by troubled firms such as BlockFi, Celsius, Voyager and many more. The headlines paint a story that is stranger than fiction with rumors of CEOs fleeing the country and the rise of a latter-day John Pierpont Morgan to save the industry. Blockchain scouts trace the digital trail to reveal hidden wallets and hidden transactions like scenes from a Hollywood movie.
When the dust settles, questions will undoubtedly demand answers. How did crypto lenders fail? What happened to customer money? How can investors be protected going forward? Bits of public information, such as the Voyager bankruptcy filing, can help piece together some preliminary answers.
A veneer of competence and security
On the surface, Voyager Digital has many attributes of a qualified business institution. Voyager is a publicly traded company trading under the ticker VOYG on the Toronto Stock Exchange. The company’s CEO, Stephen Ehrlich, had extensive experience in traditional finance (TradFi), and previously served as CEO of E*TRADE, an online platform for retail investors.
Voyager’s website goes on to tout its status as “Publicly traded, licensed and regulated. Honesty and transparency are our top priorities.” In reality, the extensive regulatory frameworks applied to TradFi simply do not yet exist for the crypto industry. Even Voyager’s own risk disclosure will tell you that “Cryptocurrencies are not regulated or are lightly regulated in most countries, including the US.”
What may be the most controversial of Voyager’s marketing tactics is their message about Federal Deposit Insurance Corporation (FDIC) insurance, which states: “Your USD is held by our banking partner, Metropolitan Commercial Bank, which is FDIC insured, so the cash you have with Voyager is protected.” Voyager fails to finish what should have been a longer sentence explaining that the cash is protected against the failure of MC Bank, not Voyager itself.As reported by Forbes, the FDIC is now investigating Voyager for potential false advertising and misrepresentation.
Retail investors have been gutted
The Voyager bankruptcy filing reveals that Three Arrows Capital defaulted on loans totaling 15,250 BTC and 350 million USDC as of June 2022. These loans accounted for over 50% of Voyager’s loan book as of its Q1 2022 public filing. Not only were the loans unsecured, but they also represented a highly concentrated exposure to a single counterparty.
Voyager’s bankruptcy filing also reveals that the vast majority of the top 50 unsecured claims are represented by customers ranging from $9,771,026.39 down to $955,417.27. Most of these customers are not quite large enough to be institutions, and there is a high probability that they are private investors.
As with the previous collapse of Terra UST, a stream of harrowing stories from angry and distraught customers flooded the internet. Journalist Laura Shin described the experience of Jess Archer, a Voyager customer who was attracted by the advertised 9% reward for USDC deposits and the perceived safety of stablecoins over more volatile cryptocurrencies. Archer is one of Voyager’s many unsecured creditors with more than $70,000 — money she intended as a down payment on a home for herself and two children — now tied up in bankruptcy court.
Deposits are not all the same
It is now abundantly clear that a cryptocurrency deposit on a centralized crypto platform is nothing at all like a fiat deposit in an FDIC insured bank. The murky treatment of cryptocurrency deposits during insolvency became a hot topic in May, when Coinbase disclosed in its quarterly 10-Q filing that crypto assets held on behalf of customers could be subject to bankruptcy proceedings and those customers could become unsecured creditors. In truth, Voyager also made similar statements in its user agreement:
“Customer expressly understands and acknowledges that the treatment of Customer’s cryptocurrency in the event of a Customer, Voyager or Custodian insolvency proceeding is undecided, not guaranteed and may result in a variety of outcomes that are impossible to predict, including but not limited to Customer being treated as a unsecured creditor and/or total loss of all the Customer’s Cryptocurrency.”
Moreover, Voyager telegraphed its risky lending business, such as its unsecured loans to 3AC, in the same User Agreement under “Agreement to Rehypothecate” in Section 5(D):
“Customer grants Voyager the right, subject to applicable law, without further notice to Customer, to hold cryptocurrency held in Customer’s account in Voyager’s name or in another name, and to pledge, pledge, hypothecate, remortgage, sell, lend, wager, arrange for wagering, or otherwise transfer or use any amount of such cryptocurrency, separately or together with other property, with all related property rights, and for any period of time and without retaining a corresponding amount of cryptocurrency; and to use or invest such cryptocurrency at the customer’s own risk.”
Customers deposited cryptocurrency into Voyager and a balance is displayed in the beautifully designed mobile app. What may be lost on the customer is that the platform now has broad rights to use these funds, including lending them to hedge funds. Due to the mixed nature of customers’ crypto assets, it is difficult to even distinguish what portion of a customer’s assets are mortgaged, loaned, or spent. In the wake of the bankruptcy, Voyager suggests the following: “Customers with crypto in account(s) will receive a combination of crypto in account(s), proceeds from the 3AC recovery, common shares in the newly reorganized Company, and Voyager tokens,” far from the the original balances shown in the customer’s mobile apps.
Hard lessons
Is it especially heartbreaking to see risk-aware retail investors like Jess Archer face uncertainty about their savings when they may have thought their crypto deposits were secured as bank deposits. Bank deposits are not without risk, and Circle (issuer of the USDC stablecoin) noted that “holding any significant amount of cash in any bank entails exposure to the counterparty and credit risk of that bank.”
However, banks operate under mature laws and a robust regulatory framework. The procedures are clear in the event of bank failure and there is never any doubt as to where depositors lie within the payment priority. According to the FDIC, “No depositor has ever lost a penny of insured deposits since the FDIC was created in 1933.”
The point is, as Voyager’s experience shows, crypto deposits on a crypto lending platform are not similar to traditional bank deposits. The key differentiation is that one operates largely without regulation and the other is heavily regulated. Retail customers need a reliable environment that doesn’t put them at risk if they missed the fine print on remortgaging. Regulatory oversight can help establish a baseline for the safe and sound operation and proper governance and management of a centralized crypto platform. Furthermore, regulation will help clients better understand how their funds are stored and protected and what legal claims they have on those funds under normal and exceptional circumstances.
The bar must be raised for centralized operators in the crypto industry. Purists will revert to the saying of “not your keys, not your coins.” To adopt a more moderate point of view, perhaps ownership is not only assigned by self-storage of private keys, but can also be assigned in a more transparent and strict manner protected by law and regulation. For the centralized operators, the mantra might be “not your keys, but still your coins, under all plausible and foreseeable scenarios, even during bankruptcy.”
