Crisis in crypto lending shines light on industry vulnerabilities


The cryptocurrency market has entered a bearish phase as the prices of the major cryptocurrencies fell to their lowest level in four years. The current slump in the cryptocurrency market has prompted many crypto companies to go out of business, while many are taking sharp job cuts to stay afloat.

The cryptocurrency market crisis began with the Terra disaster that saw $40 billion in investor funds disappear from the market. At the time, the cryptocurrency market showed good resistance to such a massive crash. However, the aftermath of the crash had a greater impact on the cryptocurrency market, especially the crypto lenders, which many believe are responsible for the current bearish phase.

The lending crunch began in the second week of June when major lenders began moving their funds to avoid liquidations in highly leveraged positions, but the massive sell-off that put downward pressure on prices led to a further decline.

The lending model makes it vulnerable to volatile markets such as cryptocurrencies, said Ryan Shea, a cryptocurrency economist at institutional digital asset services firm Trix. He told Cointelegraph:

“Asset price repercussions present a particular challenge to crypto lenders because their business model is very similar to that of a regular bank, i.e. it relies on liquidity and leverage shifts, leaving them vulnerable to banking influence.”
“During such episodes, customers were afraid to think that they might not get their money back rushing to the bank and seeking to withdraw their deposits. However, the banks do not keep their customers’ money in liquid form, rather they lend a large part of these deposits to (non-liquid) borrowers ) for a higher return — the difference being their revenue source.”

Only clients who act fast are able to withdraw their money, he said, which makes liquidity crises such dramatic, “which the collapse of Lehman Brothers and more recently Terra – the crypto equivalent – aptly demonstrates.”

Disadvantages of uncontrolled leverage
Celsius Network, a crypto lender that is subject to regulatory scrutiny of its crypto interest offering accounts, became the first major victim of the market crisis as it froze withdrawals on the platform on June 12 in an effort to stay solvent.

Celsius’ liquidity crunch started with a massive drop in the price of Ether (ETH) and by the first week of June, the platform only had 27% of its ETH liquid. Reports from various media outlets in the past week have also indicated that Celsius Network has lost major backers and added new lawyers amid a volatile crypto market.

Securities regulators from five US states have reportedly opened an investigation into crypto-lending platform Celsius over its decision to suspend user withdrawals.

Similarly, Babel Finance, a leading Asian lending platform that recently completed a $2 billion funding round, said it was facing liquidity pressures and halted withdrawals.

Later, Babel Finance alleviated some of its immediate liquidity problems by reaching debt repayment agreements with some of its counterparties.

Three Arrow Capital, also known as 3AC, one of the leading crypto hedge funds founded in 2012 with over $18 billion in assets under management, is also facing a bankruptcy crisis.

Online chatter about 3AC’s inability to meet the margin call started after it began moving assets to mobilize funds on decentralized finance (DeFi) platforms like Aave to avoid potential liquidations amid the drop in Ether’s price. There are unconfirmed reports that 3AC faced hundreds of millions of liquidations from multiple centers. 3AC has reportedly failed to meet margin requests from its lenders, raising the specter of insolvency.

Related Topics: Celsius Crisis Reveals Low Liquidity Problems in Bear Markets

Apart from the major lenders, many microlending platforms have been negatively affected by the series of liquidations as well. For example, Vauld – a crypto-lending startup – recently cut its staff by 30%, firing nearly 36 employees in the process.

BlockFi admitted that they were exposed to 3AC, and could not have come at a worse time, as they struggled to raise a new round even when they were at 80% off the previous round. BlockFi recently secured a $250 million revolving credit line from FTX.



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