The Great Deleveraging

The Great Deleveraging

Terra’s collapse has sent a shockwave to the whole crypto industry, and it is not over yet. However, this pain might not have been in vain, as individuals and companies learn the dangers of crypto finance.

? Last week Three Arrows Capital, a crypto hedge fund largely exposed to Terra and its now-defunct currency LUNA, filed for bankruptcy.

? Yesterday a crypto brokerage firm Voyager Digital, which had lent $670 million to 3AC, commenced its own bankruptcy proceedings.

? CeFi lender Celsius is trying to keep itself afloat, as it recently repaid a $183 million loan on Maker DAO, all while still blocking withdrawals from its platform. Most Celsius’ problems stem from its over-exposure to stETH, a token representing staked ETH, which de-pegged from ether, creating a massive liquidity crunch. A recent report from Nansen, a blockchain analytics company, implies that the main reason for this de-pegging was also Terra’s implosion, as big amounts of wrapped stETH on Terra were sent back to Ethereum DeFi protocols, creating imbalance in stETH/ETH pools.

? Babel Finance, Coinflex, Hodlnot and Maple Finance are some of the other CeFi players who are dealing with serious liquidity problems, all more or less involved with Terra and with each other.

Centralized crypto Finance, or CeFi, as well as individual investors, rely on human decision making, and its main disadvantage is that it is, well… human – susceptible to emotions, more or less friendly relationships with other industry players, miscalculations etc. Among the most dangerous, perhaps, is the desire to take uncalculated risk, for example by leveraging one’s position beyond reasonable level.

The current market situation has done a great job of showing how bad such risks could turn, and it looks like the industry has understood. According to DappRadar’s recent report, Total Value Locked in DeFi protocols has dropped from $215 billion in Q1 2022 to just $67 billion in Q2. People and companies deleverage their positions and withdraw their crypto from DeFi protocols.

Also, the old adage “Not your keys, not your money” has made a dazzling return, with so many CeFi platforms halting withdrawals. Users are massively retrieving their coins from centralized platforms, with Bitcoin monthly outflow from exchanges reaching the highest level ever: a whopping 151k BTC left exchanges’ wallets in June (Glassnode).

This crisis, albeit dramatic for many, has shown its tough love by educating people on the importance of risk management and the mechanics of finance in general. Hopefully, this knowledge is put to a good use in the next growth cycle.