That’s what’s different this time: Stuff blows up because of leverage and cascades through the crypto space because everything’s interconnected.
By Wolf Richter. This is the transcript of my podcast recorded last Sunday, THE WOLF STREET REPORT.
Crypto lender and broker Voyager Digital, which also took deposits and offered yield products with huge interest rates of up to 12%, said in a series of tweets today that it is, “actively pursuing a series of strategic alternatives” and that it is “focused on protecting assets and maximizing value for all customers as quickly as possible.” That’s horrifying language for people who have their cryptos on deposit at Voyager and now cannot get their cryptos or anything else out.
What’s different this time about the collapse of cryptos, compared to last time in 2018, are two huge factors that were barely in their infancy back then: massive leverage and interconnectedness.
All these crypto firms lent to each other and borrowed from each other in cryptos, to speculate in cryptos with borrowed cryptos, and they lent out borrowed cryptos, and they posted cryptos as collateral with each other for more leverage, which is now triggering margin calls, forced selling, and wipeouts cascading through the space. This interconnectedness created huge systemic risks within the crypto space that are now coming home to roost.
On Friday, Voyager Digital had suspended trading and withdrawals. In other words, depositors cannot get their cryptos and collateral out. And they cannot 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 got taken down by the crypto hedge fund, Three Arrows Capital, which blew up amid huge leverage when cryptos plunged.
Three Arrows Capital, which was said to have managed about $10 billion of cryptos as of March, was ordered into liquidation by a court in the British Virgin Islands, where it’s legally headquartered. On Friday, it filed for Chapter 15 bankruptcy in the US.
Voyager had lent 15,250 bitcoins and 350 million USD Coins, a stablecoin, to the hedge fund. Combined, that loan amounts to about $650 million at current prices. And Three Arrows had defaulted on that loan.
Three Arrows ran into trouble when cryptos dropped below a certain level and when Luna, in which it was heavily invested, collapsed by 100%, at which point it received margin calls that demanded more collateral, and when that wasn’t forthcoming, its leveraged positions were liquidated by crypto exchanges including BitMEX and Deribit.
Voyager said in the series of tweets today, Sunday, that it has $1.3 billion worth of cryptos left on its platform – presumably put there by depositors – who are now locked out, and that it has $650 billion in claims against Three Arrows Capital, which Three Arrows has defaulted on.
Voyager trades on the Toronto stock exchange. On Friday, July 1st, when it announced that it had locked out its depositors, the Toronto Stock Exchange was closed in observance of Canada Day. In the US, where Voyager trades over the counter, its shares plunged 31% on Friday, to 30 cents.
Voyager was founded in 2018 and had started trading in Canada in September 2021 at around 16 Canadian dollars a share, and amid immense crypto hype and hoopla rose to over $21 by peak crypto mania in November 2021. The stock has now collapsed by nearly 100% in 10 months. So that wipeout was fast.
Companies like Voyager are in the space called Decentralized Finance. DeFi is doing what the hated and despised fiat banks are doing, except they’re doing it in cryptos 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 protections for depositors. In addition, they lured customers into depositing their cryptos there by promising to pay huge interest rates of up to 20% a year. Which is totally nuts.
And now the two concepts of leverage and interconnectedness are tearing up the cryptos, crypto exchanges, the DeFi outfits, crypto stocks, and crypto hedge funds.
The leverage is mostly hidden and tangled up with other crypto firms, and parts of it surfaces only when something blows up. And the interconnectedness causes the blow-ups to cascade through the crypto space.
So now this is an entirely different game of margin calls, forced selling, bankruptcies and liquidations, and preparations for potential future bankruptcies, the total annihilation of some cryptos, including TerraUSD and Luna, and leaving customers with deposits at 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 over-collateralized when bitcoin was at $65,000, triggered margin calls as bitcoin plunged to $19,000, and the lenders can seize the collateral, namely the crypto. But since the lenders also traded in their own accounts, with their customers’ deposits, they too got wiped out when cryptos plunged, and it’s just the beginning.
DeFi platforms are like banks, but they take deposits and make loans all in crypto. They’re highly leveraged. They’re using their customers deposits to trade cryptos in their own accounts, and they lured customer deposits with the promise of huge interest rates. And customers borrowed against their cryptos, using their crypto deposits as collateral, to gamble with more cryptos. Everything was leveraged to the hilt and interconnected. And the whole thing collapsed when crypto prices began to collapse.
It has been three weeks exactly – on June 12th – that one of the largest crypto lenders, Celsius Network, which had managed about $12 billion in cryptos as of May, told users that it is halting all withdrawals, swaps, and transfers between accounts.
It blamed extreme market conditions. It said it needed “to stabilize liquidity and operations.” Customers have not gotten their cryptos out. No one knows what’s going on, except that it isn’t good and that Celsius has hired restructuring and bankruptcy lawyers in preparation for a possible bankruptcy filing.
If Celsius files for bankruptcy, its customers with crypto deposits are unsecured creditors, and they might not be able to recover their cryptos, 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 annual percentage yields of over 18% on their crypto deposits. That this was either a scam or a super-high-risk gamble should have been clear to everyone. The only time a company is paying 18% interest on debt is if it’s near default. That’s a very high-risk debt, and bond buyers know this, but apparently, not the customers at Celsius.
At least three other crypto platforms have now blocked customers from withdrawing their crypto deposits or collateral, or have limited the amounts: Babel Finance, CoinFlex, and Finblox.
We’re not talking hated and maligned fiat dollars here, but cryptos. They’re borrowing cryptos from each other, they’re lending cryptos to each other, they’re posting collateral in cryptos with each other, they’re paying interest in cryptos, they’re trading cryptos between each other, and they’re trying to bail each other out in cryptos.
And they have to pay each other back those cryptos, and the cryptos have plunged in value and are gone because of leverage that blew up, and because of the interconnectedness that is spreading those blowups around the system.
Leverage and interconnectedness, which were just in their infancy in 2018 when cryptos blew up last time, are now the dominating factors. Back then it was just folks selling their cryptos. Now stuff is blowing up because of leverage. That’s a much more insidious process.
Leverage in the crypto world takes on other forms as well, as exemplified by MicroStrategy. That’s a dotcom darling whose shares spiked ridiculously during the dotcom boom into early 2000, and then totally collapsed. To keep the share price above the delisting limit, in 2002, the company did a 1-to-10 reverse stock split. Then it scraped by as an enterprise software maker, until 2020, when it announced with huge hype and hoopla that it would begin buying bitcoin as one of its key business strategies, and that it would fund those purchases with leverage.
Part of this leverage would come from issuing unsecured convertible bonds, which the bitcoin-crazed crowd ate up at the time. Even if bitcoin goes to zero, the holders of those unsecured bonds have no rights and cannot do anything as long as the company doesn’t default on the interest or principal payments. So this is stable funding, and the concept of margin call doesn’t apply here.
But then, to buy more crypto when the mood was souring just a tad, it issued bonds that were secured by bitcoin and other corporate assets.
Then in March, the company obtained a $205 million term loan that was collateralized by close to 20,000 bitcoins. The loan agreement required a minimum loan-to-value ratio of 50%. If bitcoin drops below $21,000, the minimum loan-to-value ratio would be violated on this $205 million term loan.
According to a filing with the SEC on Wednesday, MicroStrategy now holds about 129,700 bitcoin that it bought at an average price of about $30,700 each, for a total purchase price of nearly $4 billion.
At the current price of bitcoin of about $19,000, MicroStrategy’s gamble has lost the company $1.4 billion from the acquisition cost – all of it borrowed money.
Upon MicroStrategy’s bitcoin purchase announcements in the summer of 2020, it stares spiked from about $110 to over $1,300 by February 2021, multiplying by over 10 in just 8 months. That’s how braindead crazy the whole market had gotten. At which point the shares began to collapse. They’re now back at $164, down by 87% from the ridiculous peak in February 2021.
This enormous amount of speculation, risk-taking with these gambling tokens, and scamming was one of the more sordid parts of the Everything Bubble. It’s a hugely profitable trade if you ride it up and then sell this stuff to the greater fool, and rake in the hated and soon to be worthless fiat dollars. But unfortunately, lots of people that were gullible enough to go for this, lost lots of money, and will lose lots of money. But that’s how bubbles work, that’s just how it is if you participate in that kind of craziness and don’t get out before it vanishes – and two-thirds of it has already vanished.
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