Leading crypto lending firms and hedge funds have run into trouble due to market turmoil, but mostly because of their runaway, reckless decision-making process.
The cryptocurrency market has entered a bearish phase as the prices of major cryptocurrencies have fallen to a four-year low. The current downturn in the cryptocurrency market has caused several crypto companies to go out of business, while many of them have severely cut jobs to stay afloat.
The crisis in the cryptocurrency market began with the Terra fiasco, as a result of which $40 billion in investor funds disappeared from the market. At that time, the cryptocurrency market showed good resistance to such a big collapse. However, the fallout from the crash had a larger impact on the cryptocurrency market, particularly the cryptocurrency lending companies, which many believe are to blame for the current bearish phase.
The credit crunch began in the second week of June as leading lenders began reallocating funds to avoid liquidating overleveraged positions, but heavy selling, which put bearish pressure on prices, led to further falls.
Ryan Shih, a crypto economist at institutional digital asset services provider Trekx, said the lending model makes it vulnerable to volatile markets like cryptocurrencies. He told Cointelegraph:
“Asset price reversals are particularly difficult for crypto lenders as their business model is very similar to that of a traditional bank, being based on liquidity transformation and leverage, making them vulnerable to banking.”
“During episodes like this, customers, afraid of not getting their money, rush to the bank and try to withdraw their deposits. However, banks don’t keep their customers’ money in liquid form, they lend most of those deposits to (illiquid) borrowers for higher yields – the difference is their source of income,” he added.
He said that only those customers who act quickly can withdraw their funds, making liquidity crises such dramatic events “as vividly demonstrated by the collapse of Lehman Brothers and more recently Terra, the cryptocurrency equivalent.”
Disadvantages of uncontrolled leverage
Celsius Network, a crypto lending company under regulatory scrutiny for its accounts offering cryptocurrency interest rates, was the first major victim of the market crisis when it froze withdrawals on the platform on June 12 to stay solvent.
The liquidity crisis for Celsius began with a sharp drop in Ether (ETH) prices, and in the first week of June, the platform had just 27% ETH liquidity. Various media reports last week also suggested that the Celsius network was losing key supporters and hiring new advocates amid cryptocurrency market volatility.
Securities regulators from five U.S. states have reportedly launched an investigation into crypto lending platform Celsius over its decision to suspend user withdrawals.
Similarly, Babel Finance, Asia’s leading lending platform, which recently closed a $2 billion appraisal funding round, said it was facing a liquidity squeeze and putting payouts on hold.
Babel Finance later resolved some of its immediate liquidity problems by entering into debt repayment agreements with some of its counterparties.
Three Arrow Capital, also known as 3AC, a leading cryptocurrency hedge fund founded in 2012 with over $18 billion in assets under management, is also facing a bankruptcy crisis.
Online chatter about 3AC being unable to meet a margin requirement began after it began moving assets to fund funds on decentralized finance (DeFi) platforms like Aave to anticipate potential liquidations amid the to avoid the price of ether falling. There are unconfirmed reports that 3AC has faced hundreds of millions in liquidation at multiple positions. 3AC was reportedly unable to meet creditors’ claims, leaving it at risk of insolvency.
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In addition to leading lending firms, the series of liquidations also negatively impacted several other smaller lending platforms. For example, Vauld, a crypto lending startup, recently reduced its headcount by 30% while maintaining nearly 36 employees