Crisis in crypto lending shines light on industry vulnerabilities

The crypto market has entered a bearish phase as prices of major cryptocurrencies have fallen to a four-year low. The current downturn in the crypto market has driven several crypto firms to go out of business, while many have made severe job cuts to remain afloat.

The crypto market crisis began with the Terra debacle that saw $40 billion in investors’ money vanish from the market. At the time, the crypto market showed good resistance against such a massive collapse. However, the after-effects of the collapse had a greater impact on the crypto market, especially crypto lending firms, which many believe are responsible for the current bearish phase.

The lending crisis began in the second week of June when top lending firms started to move their funds to avoid liquidations on overleveraged positions, but the heavy selling that put bearish pressure on prices led to a further downfall.

Ryan Shea, a crypto economist at the institutional digital asset service provider Trekx, said that the lending model makes it vulnerable to volatile markets like crypto. He told Cointelegraph:

“Asset price reversals are particularly challenging to crypto lenders because their business model is very much like that of a regular bank, namely, it is based on liquidity transformation and leverage, which makes them vulnerable to bank runs.”

“During such episodes, customers spooked into thinking they may not get their money back rush to the bank and seek to withdraw their deposits. However, banks do not keep their clients’ money in liquid form, they lend out a large portion of those deposits to borrowers (illiquid) in return for a higher yield — the difference being their revenue source,” he added.

He said that only those customers who act quickly are able to withdraw their money which is what makes liquidity crises such dramatic affairs, “which the collapse of Lehman Brothers and more recently Terra — the crypto equivalent — aptly demonstrates.”

Drawbacks of unchecked leverages

Celsius Network, a crypto lending firm that has been under regulatory scrutiny over its crypto-interest offering accounts, became the first major victim of the market crisis as it froze withdrawals on the platform June 12 in an effort to remain solvent.

The liquidity crisis for Celsius began with a massive drop in Ether (ETH) prices and by the first week of June, the platform had only 27% of its ETH liquid. Reports from different media outlets in the last week also suggested the Celsius Network has lost major backers and onboarded new attorneys amid a volatile crypto market.

Securities regulators from five United States 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 had recently completed a financing round with a $2 billion valuation, said it is facing liquidity pressure and paused withdrawals.

According to previous data from Babel, as of the end of last year, the loan balance reached more than 3 billion US dollars, the average monthly derivatives transaction volume was 800 million, and the issuance of option structured products reached more than 20 billion US dollars.

— Wu Blockchain (@WuBlockchain) June 17, 2022

Later, Babel Finance has eased some of its immediate liquidity troubles by reaching debt repayments 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 worth of assets under management, is facing an insolvency crisis as well.

people think Celsius is the biggest stETH dumper but its 3AC and it isnt relatively close, they are dumping on every account and seed round address they have, most looks like its going to payback debts and outstanding borrows they have pic.twitter.com/9bZnmTXQzj

— moon (@MoonOverlord) June 14, 2022

Online chatter about 3AC being unable to meet a margin call began after it started…