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The meltdown at Celsius and Three Arrows Capital

Tokenised is your weekly read to navigate and mine the rich vein of crypto developments that flow through India and Southeast Asia. Someone sent you this? Sign up here

Good Evening [%first_name |Dear Reader%],

Welcome to this week’s edition of Tokenised.

Borrowing money to lend money is a practice as old as finance. But in the crypto world, there’s little to do with all that leverage except maybe… speculate? While that goes pretty well when prices are going up, when they turn down, a lot of people lose money. Sometimes, even those who depended on it for their pensions. 

Leverage has pushed a crypto lender (Celsius) and a hedge fund (Three Arrows Capital) into bankruptcy. With billions of dollars worth of balance sheet holes to fill, climbing out will be a herculean task. 

Let’s jump right in.

A tale of two bankruptcies

Last week, crypto lender Celsius filed for bankruptcy. 

The move wasn’t a surprise. There has been plenty of speculation about Celsius being insolvent ever since it halted customer withdrawals in June. But its bankruptcy filings show that it has a US$1.1 billion hole in its books. 

A few days earlier, crypto hedge fund Three Arrows Capital—popularly known as 3AC—had been ordered into liquidation by a court in the British Virgin Islands. A couple of days after that, 3AC also filed for bankruptcy in New York. 

A partial list of the firm’s creditors compiled by Bloomberg (which includes the who’s who of crypto land) shows that it owes about US$2.1 billion to them. 

At its peak, 3AC had about US$18 billion under management, according to an estimate from FInsight. All of that has unraveled quickly, though, and buckled under the pressure of leverage.

The crypto industry was “brought to its knees” in recent weeks by an “old-fashioned Madoff-style Ponzi scheme” … Madoff in this scenario would be the founders of 3AC, Su Zhu and Kyle Davies, who used their reputation to “recklessly borrow from just about every institutional lender in the business,” resulting in pain for some high-profile firms in the industry, including Voyager Digital, Babel Finance and BlockFi

And when the word Ponzi is evoked in crypto, how can Terra-Luna be far behind? 3AC’s bankruptcy filings showed that the hedge fund held about US$600 million worth of TerraUSD and Luna in May 2021. Following the collapse of Luna in May this year, 3AC has failed to meet margin calls and its founders have ghosted their creditors—and they seem to have bought a yacht using borrowed money (!). 

“Su Zhu and Kyle Davies [3AC founders] had also reportedly made a downpayment on a US$50 million yacht, with the yacht to be delivered sometime in the next two months in Italy,” a liquidation filing linked to 3AC noted. While Terra was a reason for 3AC’s collapse, CoinDesk’s David Morris writes that it was only one of the three arrows that slayed the hedge fund. 

In a bit of striking poetry, though, LUNA was just one of three mortal wounds that took out 3AC. The other two were not frauds, but illiquid bonds the fund couldn’t sell when it needed cash to cover its loans: stETH (Lido staked ETH) and GBTC, the Grayscale Bitcoin Trust.

Parallels between 2008 and crypto’s current collapse are quite striking, but also not so much if you zoom out and look at financial history. Sure, trouble in both instances started brewing in seemingly ‘safe’ assets: mortgage bonds and a stablecoin, respectively, and then flooded over to all the interconnected shops on the street. 

But from a wider angle, trouble really started when Wall Street (and its cousins across the world) took a decent idea—an algorithmically-managed money market fund—and got greedy with it. And that’s been a sure-shot recipe for disaster through all of financial history. But in crypto, ‘hedge’ funds have been comically good at failing to ‘hedge’ their bets, using the money instead for yachts (like I mentioned above) or buying a multi-million dollar mansion that was registered under a 3-year-old’s trust. 

Celsius, for its part, was very adamant about marketing itself as safer than banks, but seems to have done little to back up its words. According to a recent lawsuit filed against the firm, Celsius failed to hedge its bets, faltered on accounting practices, and plugged its native token in a Ponzi-like fashion. But when the market turned and customers started withdrawing tokens, it all broke down. 

As customers sought to withdraw either deposits, Celsius was forced to buy more ether in the open market at high prices (around January 2021) and suffered heavy losses, the lawsuit claims. Stone [the plaintiff] alleges that Celsius then began to offer double-digit interest rates in order to lure in new depositors whose funds were used to repay earlier depositors and creditors.
“Thus, while Celsius continued to market itself as a transparent and well capitalized business, in reality, it had become a Ponzi scheme,” the lawsuit claims.

What is perhaps the most frustrating part of it all was that Celsius was backed by Canada’s second-largest pension fund. So it wasn’t just a matter of high-on-their-own-supply financiers playing with VC money. Also on the hook were people who just wanted a comfortable retirement.  

Now, it’s hard to say how exactly things will go from here. Both Celsius and 3AC are bankrupt and lawsuits might even lead to hefty fines and jail time for some. But the larger questions will linger. Is crypto just a plaything for lovers of leverage or will it ever deliver some real utility? 

I posed this question a couple of editions earlier and some readers actually took the time to write in with what they see could be real-world use cases. While all of them were interesting ideas, that’s all they are right now. Ideas.

With that, let’s turn to some other things that happened in crypto over the last few days:

Crispy bytes

  • Singapore plans to broaden its crypto regulations. [Bloomberg]
  • The Dutch central bank has fined crypto exchange Binance. [Financial Times]
  • NFT marketplace OpenSea has cut 20% of its jobs. [Reuters]
  • Hong Kong-based metaverse company Animoca Brands has raised US$75 million in a funding round. [Nikkei Asia]
  • Crypto miners moved US$300 million of bitcoin in one day and some are dropping out of the business altogether. [CNBC]
  • The crypto industry has a lot of non-compliance issues, according to the head of the US markets regulator. [CoinDesk]

What caught my this eye this week

Life seems to be coming full-circle for crypto in India. In a written response to questions raised about crypto in the Indian parliament this week, the country’s finance minister Nirmala Sitharaman said that the Reserve Bank of India (RBI) wants to ban crypto. 

“The RBI has recommended framing of legislation on this sector. The RBI is of the view that cryptocurrencies should be prohibited,” the minister noted. Sitharaman qualified her statement by adding that the government feels that international collaboration on crypto regulation would be key if such legislation is to be effective at all. 

While international link-ups on regulating crypto might be miles away, given how some states have warmed up to it due to its ability to attract capital, the finance minister’s statement does make it pretty clear how the government feels about the sector. Reading between the lines, it might even be fair to infer that if a ban was feasible and enforceable, they might have gone for it already. 


[Bonus: For today’s dose of crypto-evangelists having a skewed idea of reality, here’s Balaji Srinivasan talking about how he feels crypto can solve racism. I am just gonna leave this here for you to take in. 

That’s all for this week’s edition. If you have any overarching thoughts (or even nitpicky ones) about this newsletter, please do write to me at [email protected].

I’ll see you again next week. Take care!

Regards,

Jaspreet Kalra

This newsletter has been discontinued. But you can read The Stack which includes our newsletters around cleantech, fintech, personal finance and e-commerce in India!