Crypto Crash: What Contagious Risks Could Celsius, Three Arrows Pose?  Here’s what to watch

Crypto Crash: What Contagious Risks Could Celsius, Three Arrows Pose? Here’s what to watch

The latest crisis began Sunday with Celsius, one of the largest crypto lending platforms, pausing all withdrawals, exchanges, and inter-account transfers. The company has reportedly hired restructuring lawyers to advise on possible solutions to its mounting financial woes, according to a report in Tuesday’s Wall Street Journal.

Meanwhile, rumors of potential stress at influential hedge fund Three Arrows Capital swirled after a vague one tweet late Tuesday by its founder Zhu Su, who wrote that “we are in the process of communicating with relevant parties and are fully committed to working this out.”

On Wednesday, the Block reported that Three Arrows “is in the process of figuring out how to repay lenders and other counterparties after being liquidated by top-tier lending firms in the space.”

A major player and one of the most well-known hedge funds in the crypto space, Three Arrows was valued at around $10 billion in March, citing data from Nansen, according to Bloomberg. The company also held more than 6% of Grayscale Bitcoin Trust GBTC, -2.09%, the world’s largest Bitcoin fund, as of December 2020, according to a regulatory filing.

Read: As the crypto crash deepens, here are 4 signs the worst may be yet to come

The uneasiness has added pressure on Bitcoin, the most popular cryptocurrency, which is trading nearly 70% below its all-time high in November, although it staged a modest rebound on Wednesday after the Fed announced it would raise its benchmark interest rate, its biggest rate hike since 1994. Bitcoin BTCUSD, +0.14%, recently traded around $22,487, up 1.2% in the last 24 hours.

And all of this comes a month after the Blockchain Terra meltdown, which shook some investors’ confidence in the burgeoning crypto industry.

Some market participants are now concerned about the contagious risks Celsius and Three Arrows Capital could pose to the entire crypto market should the firms default in the worst-case scenario.

Su and Celsius officials did not respond to requests for comment.

Other lending platforms tested for risk management

Investors are closely watching the situation of Celsius’s competitors, such as crypto lending platforms BlockFi and Nexo.

Such platforms allow investors to deposit their cryptocurrencies and earn extremely high returns. Celsius consumers could reportedly earn up to 18.6% APR, according to its website, while most “high-yield” US dollar savings accounts offer annual percentage returns of just under 1% or less, according to Bankrate.

Crypto lending platforms have “fought in a battle to get the best retail deals possible to get them on board quickly,” Wave Financial chief executive David Siemer said in an interview. As companies struggled to offer higher returns to retail customers, “unless you’re just getting off venture capital money, the only way to do that was to make bets that got riskier and riskier,” Siemer said.

“A lot of the people who have been championing these types of institutional lenders could go and redeem now,” Michael Safai, founding partner of Dexterity Capital, said in an interview.

According to Bill Barhydt, chief executive of crypto financial services platform Abra, a competitor to Celsius, crypto lending companies will be tested for their ability to manage risk.

“If you’re holding withdrawals, it’s usually because as a lender, there’s a duration mismatch,” Barhydt said, referring to the possible causes of Celsius’s situation. “A discrepancy between the average life of your loan and the time it takes to process a payout for your customers. And if the two don’t match, you have to stop the withdrawals because you’ll end up with a problem,” he said.

After Celsius announced its account freeze on Sunday, Zac Prince, chief executive of rival crypto lender BlockFi, said tweeted to assure customers that “all products and services @BlockFi continue to function normally”.

But on Monday, BlockFi said it would cut about 20% of its workforce as the rapidly changing macro environment weighs on the company’s growth rate.

In response to the market’s attention, BlockFi’s institutional operations division tweeted on Wednesday that “We can confirm that we have a rigorous, prudent and proactive approach to risk management throughout our business. This also includes the management of risks that can emanate from each individual customer.”

“Our customer experience is unchanged and customer funds are protected,” it added.

Another crypto lender, Nexo, tweeted Wednesday that it has “$0 exposure to Three Arrows Capital. Nexo has always distinguished itself as a very conservative lender with strict risk management and strict over-collateralization requirements, regardless of the borrower’s reputation.”

“Systemic exposure” driving the market

When investors repay funds to the crypto lenders, “then the lenders have to reclaim the loans from the people they lent the funds to,” said Dexterity’s Safai. “In the long term, this means less volume on exchanges because there will be less credit and fewer assets to trade. And that’s generally bad news.”

Some retail exchanges that offer high-yield products could be particularly at risk if they’ve lent their funds to firms like Three Arrows, Siemer said.

Meanwhile, there could also be some crypto hedge funds “who are now mired in all this because they are lending their assets to Celsius or depositing assets there,” Siemer said.

“It’s a systemic engagement and that’s what’s driving the market right now. It just feels like no one knows who a counterparty is anymore. So take back all assets,” Siemer said.

Bitcoin, Ether sell-offs

According to Safai, the panic has also weighed on the price of bitcoin and ether. “We have already seen significant outflows from bitcoin and ether because they are the most liquid. And when people try to exit their position, they want to get into the most liquid market to get the best prices,” Safai said.

Bitcoin and Ether ETHUSD, -1.21% on Wednesday, underperformed several smaller-cap coins such as XRP XRPUSD, -0.88%, Solana SOLUSD, +2.62% and Polkadot DOTUSD, -2.44%.

institutional interests

The collapse of Terra and recent speculation surrounding Celsius and Three Arrows could hurt institutional investor confidence in the crypto space, according to Wave Financial’s Siemer. “I definitely think it pushes everything back at least a year,” he said.

David D. Tawil, President and Co-Founder of ProChain Capital, disagrees. The crypto crash could attract distressed investors from the traditional finance industry, he said.

For an institutional investor, “crypto is going through this horrible time, assuming it’s more of a technical sell-off I could go ahead and invest at good prices,” Tawil said.

Also read: Bitcoin bull Michael Saylor says recent downturn is “absolutely” a buying opportunity

imminent regulation

Some participants in the crypto industry expect stricter regulations.

Lawmakers and regulators “were already generally buzzing about crypto,” Tawil said. “What should they do with depositors at Celsius? Should they mistakenly comfort themselves like depositing money in banks? Or what kind of disclosures should there be for these companies?” Tawil said.

More: SEC Chief Gensler Says Crypto Crash “Highlighted” Need for Regulation

According to Celsius’s website, it has 1.7 million customers. While there is no other evidence to support such a number, it means the platform is pausing customer withdrawals.[Gary] Gensler’s dream, according to Siemer. Now the head of the US Securities and Exchange Commission has “this perfect case study of a million retail investors being ripped off by this black box, quasi-institution that wasn’t tightly regulated and acted as a bank,” Siemer said.