The cryptocurrency market has entered a bearish phase as the prices of major cryptocurrencies fell to a four-year low. The current downturn in the cryptocurrency market has seen several crypto firms go out of business, while many of them have severely cut jobs to stay afloat.

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The crisis of the cryptocurrency market began with the Terra fiasco, as a result of which $40 billion of investor money disappeared from the market. At that time, the cryptocurrency market showed good resistance to such a large-scale collapse. However, the effects of the crash have had a greater impact on the cryptocurrency market, especially on the cryptocurrency lending companies that many believe are responsible for the current bearish phase.

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The credit crunch began in the second week of June when major credit firms began moving their funds to avoid liquidating overleveraged positions, but strong selling, which put bearish pressure on prices, pushed prices further down.

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Ryan Shih, a crypto-economist at institutional digital asset services provider Trekx, said the lending model makes it vulnerable to volatile markets like cryptocurrencies. He told Cryptooshala:

“Asset price reversals are particularly difficult for crypto lenders because their business model is very similar to that of a conventional bank, namely, it is based on liquidity transformation and leverage, which makes them vulnerable to banking transactions.”

“During episodes like this, customers, terrified at the thought that they might not get their money, rush to the bank and try to withdraw their deposits. However, banks do not hold their clients’ money in liquid form, they lend out most of these deposits to (illiquid) borrowers in exchange for higher returns – the difference is their source of income,” he added.

He said that only those clients who act quickly can withdraw their money, making liquidity crises such dramatic events “as the collapse of Lehman Brothers and, more recently, Terra, the cryptocurrency equivalent, vividly demonstrates.”

Disadvantages of Uncontrolled Leverage

Celsius Network, a crypto lending firm that was under regulatory scrutiny for its accounts offering crypto-currency interest, was the first major victim of the market crisis as it froze withdrawals on the platform on June 12 to remain solvent.

The liquidity crisis for Celsius began with a sharp drop in Ether (ETH) prices, and by the first week of June, the platform had just 27% ETH liquidity. Various media reports last week also suggested that the Celsius Network has lost major supporters and hired new lawyers amid the volatility of the cryptocurrency market.

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

Similarly, Babel Finance, Asia’s leading lending platform, which recently completed a $2 billion valuation funding round, said it faced a liquidity squeeze and put withdrawals on hold.

Later, Babel Finance eased some of its immediate liquidity problems by entering into debt repayment agreements with some of its counterparties.

Three Arrow Capital, also known as 3AC, a leading cryptocurrency hedge fund founded in 2012 with over $18 billion in assets under management, is also facing an insolvency crisis.

The online chatter about 3AC being unable to complete a margin call began after it began moving assets to replenish funds on decentralized finance (DeFi) platforms such as Aave to avoid potential liquidations amid the fall in the price of Ether. There are unconfirmed reports that 3AC has faced liquidation totaling hundreds of millions across multiple positions. 3AC was reportedly unable to meet creditors’ claims, causing a threat of insolvency.

Celsius crisis exposes low liquidity problems in bear markets

In addition to leading lending firms, the series of liquidations also negatively impacted several other smaller lending platforms. For example, Vauld, a crypto lending startup, recently cut its staff by 30% while laying off almost 36 employees.

BlockFi admitted that they had contact with 3AC and it couldn’t have happened at a worse time as it struggled to raise a new round even when it has an 80% discount from the previous round. BlockFi recently secured a $250 million revolving line of credit from FTX.

David Smook, founder and CEO of Hackernoon, told Cryptooshala:

“In order for the cryptocurrency to reach trillions, it was necessary and expected that traditional institutions would buy and hold. A young industry often follows old business models, and in the case of cryptocurrency lending companies, this has all too often meant that companies have become loan sharks. Companies that promise unacceptably high returns for simply holding reserves will do just that—not support.”

Are market conditions to blame?

While from a distance it may seem that market conditions were the main cause of the crisis for most of these lending firms, upon closer inspection, the problems seem more to do with the day-to-day running of the company and the spiraling impact of the crisis. poor decision making.

Celsius’s insolvency crisis exposed several of its misdeeds from the past, when Swan Bitcoin founder Corey Clippsten and bitcoin influencer Dan Held warned about questionable business practices on the lending platform. In a Twitter discussion on June 18, they listed a number of issues with Celsius from the start that had gone unnoticed until now.

Held emphasized that Celsius was using misleading marketing tactics and stated that he was insured while the founders backing the project had a dubious past. The firm also covered up the fact that its chief financial officer, Yaron Shalem, had been arrested. Held said: “They had too much leverage, a margin call, a liquidation, which resulted in some losses for creditors.”

Similarly, 3AC invested heavily in the Terra ecosystem – the firm amassed a $559.6 million asset now known as Luna Classic (LUNC) – now forked Terra (LUNA) – before its eventual collapse. The value of 3AC’s half billion dollar investment is currently in the hundreds of dollars.

Dan Endelbeck, co-founder of Tier 1 blockchain platform Sei Network, spoke to Cryptooshala about the key issues with 3AC and why it is facing insolvency:

“Three Arrows Capital is a trading firm that is very opaque about their balance sheet and where they borrow and allocate capital. We believe the lack of transparency affected their lenders’ risk assessment and led to a market decline. These circumstances can create extreme risk, especially during market volatility. What happened here is a strong signal that DeFi will continue to grow and bring more transparency and accountability to this space.”

Market rumors indicate that 3AC used large loans to make up for LUNC’s losses, which did not go as planned.

Dion Guillaume, head of communications at crypto trading platform Gate.io, told Cryptooshala:

“Both Celsius and 3AC suffered because of their irresponsibility. Celsius escaped the LUNA crash, but they were hit hard by stETH depeg. It looks like they used their users’ ETH funds in stETH pools to generate income. This led to insolvency. In the case of 3AC, they lost about nine figures due to the LUNA fiasco. To make up for their losses, they traded with a lot of leverage. Unfortunately, the bear market rendered their margin worthless and they were unable to meet numerous margin calls.”

Simon Jones, CEO of decentralized finance protocol Voltz Labs, believes that the current crisis caused by crypto lending projects is very similar to the 2008 recession. When lenders held extremely high risk assets as collateral on their balance sheets and these high risk assets were overvalued or exposed to sudden (major) changes in value.

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The revaluation of these assets meant that lenders thought they had sufficiently capitalized loan books. As asset prices corrected, lenders suddenly faced the risk of undercollateralized positions. To try to maintain solvency, the pledge had to be sold. However, with huge quantities trying to sell at the same time, this contributed to a downward spiral in asset values, meaning that lenders could only sell for pennies per dollar. Jones told Cryptooshala:

“We must create an open source financial services sector that is trustless and antifragile. Not one that is closed source and makes high leverage bets on retail deposits. This is not the future of finance and we should be ashamed that we allowed this to happen to retail users at Celsius. Three Arrows Capital is a hedge fund so they will never be open source, but lending companies should have applied better risk management, in particular systematic risk.”

Yves Longchamp, head of research at SEBA Bank, believes regulation is the key to saving the crypto market. He told Cryptooshala:

“The recent operating decisions of unregulated crypto service providers in the industry reflect the need for more transparency and regulation in the industry. In this way, we can ensure that businesses and users can operate in this sector with confidence. While regulation is being applied in more jurisdictions, as both the US and the EU are in advanced stages of developing digital asset frameworks, regulators should view this as an urgent matter.”