How a Stablecoin’s $48B Collapse Rippled Across Crypto

A Citi analyst said on July 21 that the contagion from a depegged stablecoin spreading eight- and nine-figure losses through the crypto lending and exchange community appears to have run its course.

Which will be cold comfort to the roughly 150 people crypto exchange Blockchain.com laid off that Thursday in the wake of the firm’s $270 million loss to Three Arrows Capital, a crypto hedge fund that had an estimated $10 billion in assets and made a number of very risky investments in decentralized finance (DeFi) projects including the Terra/LUNA algorithmic stablecoin project.

TerraUSD shot from nowhere to the No. 3 position in stablecoins last year, with a market capitalization of $18 billion worth of dollar-pegged UST. But it maintained that peg through a complex arbitrage system with its free-floating sister token, LUNA, which was managed by self-executing smart contracts.

On May 7, it lost its peg briefly — first by fractions of a penny and then by nearly 2 cents by May 9. Attempts to reassure investors failed and a run ensued. On May 10, it collapsed to $0.80, then on May 13 to $0.40. By the end of the month, it was under $0.03, and its market cap had fallen from $18 billion to $220 million.

Three Arrows had invested heavily in LUNA, which at the beginning of May had a $29.5 billion market cap. At the end of the month that was $750 million.

The hedge fund couldn’t repay its loans, leaving a number of crypto lending firms, which offered extremely high interest rates — some over 20% — to people who locked in cryptocurrency, in the lurch. They then leant it out to both small retail borrowers in overcollateralized loans and in large sums to institutional investors like Three Arrows — known as 3AC — seeking aggressive returns to cover the interest rates they were paying.

“3AC was supposed to be the adult in the room,” said Nik Bhatia, a finance economics professor at the University of Southern California, told CNBC. “Not only were they not hedging anything, but they also evaporated billions in creditors’ funds.”

Bhatia, author of the 2021 book on digital currencies “Layered Money,” said that “the terraUSD and LUNA collapse is ground zero … [in a] long, nightmarish chain of leverage and fraud.”

Three Smaller Waves

While much of the damage flowed through Three Arrows, two other waves rippled out from terra/LUNA’s collapse — wiping out many small investors. It’s unlikely that the only bankruptcies of the $48 billion collapse were corporate.

Separate from the Three Arrows debacle was crypto lender Celsius, which had invested heavily in a DeFi project that was indirectly but badly damaged by the terra/LUNA collapse.

Read more: Stablecoin Collapse Sent Voyager Digital and Celsius on Different Paths to Bankruptcy

It was the first to freeze customer funds but after a long struggle, it entered bankruptcy on July 13. It’s out $1.2 billion, with $5.5 billion in liabilities and $4.3 billion in assets, Bloomberg said.

Read also: Bankrupt Crypto Lender Celsius: We Own Customers’ Funds

That said, Celsius does appear in the Three Arrows bankruptcy filing for $40 million, according to Bloomberg.

The second is Babel Finance, which froze withdrawals on June 17 citing, like others “unusual liquidity pressures.”

Beyond that, one other ripple isn’t financial but political. In the wake of the collapse and contagion, moves are afoot in Congress to pass a stablecoin regulation bill this year that would, among other things, mandate 100% backing reserves held in dollars or U.S. Treasuries.

Read more: Reports: House Committee Close to Vote on ‘Payments Stablecoin’ Bill

That’s despite acknowledgment that a broad crypto regulation act will not happen before 2023.

The Three Arrows’ Ripple

In dribs and drabs, seven big lenders emerged over the next month, although Three Arrow’s bankruptcy liquidator named two dozen creditors, The Wall Street Journal said.

All in all, about $2.8 billion is owed by Three Arrows, Bloomberg reported.

By far the largest was Genesis Global Trading, owned by Digital Currency Group, which lost $2.4 billion. It owns several other prominent crypto companies, including news site CoinDesk and Grayscale Bitcoin Trust.

Next was crypto lender Voyager Digital, with $687 million and BlockFi, which lost about $250 million. The former is in bankruptcy and the latter cut a deal that could see it acquired for a song by the FTX exchange. That could make FTX a long-term winner, even though it lost a relatively small sum to Three Arrows — as did derivatives exchange BitMEX.

See also: Another Firm Cuts Withdrawals, Highlighting Crypto Lending’s Dangers

Voyager has said that customers will likely not get all of their funds back but rather a grab bag including its own VGX tokens.

Aside from Blockchain.com’s $270 million — and its cuts well beyond layoffs to include expansion projects and pulling out of Argentina — its derivatives exchange Derebit was also hit for $80 million. Exchange CoinList lost $35 million to Three Arrows, as did DeFinance Capital and lender Finblox limited withdrawals on June 17, CryptoSlate reported.

Ripples on Ripples

There have been other dominos. The Thai exchange Zipmex halted withdrawals on July 21, after losses to Celsius and Babel Finance. Lender Vauld froze withdrawals on July 4, not after losses directly related to Three Arrows or Terra/LUNA, but due to nearly $200 million since June 12 — in effect, a run.

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