The 2022 Crypto Debt Crisis
Market Recap
A Flat Week After The FTX Debacle
The 2022 Crypto Debt Crisis
Over the past week and a half, we witnessed the unravelling of the $32 billion empire that was FTX and the fall of its "benevolent" leader Sam Bankman-Fried, otherwise known as SBF.
This story of overleveraging and outright fraud has formed a part of the bigger crypto debt crisis of 2022. This article will explore how this debt crisis has unfolded and how all parties were closely interlinked.
A Timeline
The 2022 debt crisis started in May with the collapse of Terra Luna, a blockchain designed for the issuance of the stablecoin UST. This is where cracks in the system started showing; nevertheless, we can trace the entities involved and their relationships with one another further back.
19th of January 2022
It began when the founder of Terra Luna Do Kwon announced the launch of the Luna Foundation Guard (LFG). The purpose of this organisation was to "build reserves supporting the $UST peg amid volatile market conditions" and "allocate resources supporting the growth and development of the Terra ecosystem" through grants.
22nd of February
This was shortly followed up with an announcement that the LFG had managed to raise $1 billion through the sale of its own token, LUNA, to purchase bitcoin for the UST reserve system. This raise was led by Three Arrows Capital (3AC) and Jump Crypto.
28th of March
From the 22nd to the 28th of March, the LFG managed to purchase 27 000 BTC worth roughly $1.3 billion. With plans to continue purchases, they also see the LUNA token move towards all-time highs.
5th of April
LUNA reached its all-time high on this date, trading at $119.20. This was a 542% increase from where it had been trading a year before.
Over the rest of April, the LFG continues purchasing BTC and other tokens, such as AVAX, to bolster its treasury. Demand for UST continued increasing over this period and, towards the end of April, became the third largest stablecoin by market capitalisation. Due to the mechanics of the burn and mint system Terra Luna used to create UST, the total circulating supply of LUNA hit an all-time low of 346 million tokens.
7th of May
A Twitter bot called Curve Whale Watching that monitors and tweets about large movements of money within the Curve system picks up a swap of 85m UST for 84.5m USDC.
8th of May
Within a short time period, we started to see a significant number of sales of UST on Terra's Anchor protocol and Curve, the stablecoin exchange protocol. This resulted in the UST breaking its 1:1 peg and dropping to 0.985 per UST.
Trying to counteract this, the LFG committed to loaning $750m in BTC to market makers to defend the 1:1 peg. They also earmarked another $750m UST to be used to buy back BTC after the volatility subsided.
9th of May
The protocol continues to struggle to maintain its 1:1 peg and deposits on Anchor plunge. This also affects the protocol's native token ANC, losing 35% of its value in one day.
Over 42 530 BTC were moved out of the LFG wallet to be sold to defend the peg.
10th of May
As UST loses its peg for the second time in three days, users rush to redeem the UST token for LUNA, driving the price of UST as low as 65 cents and LUNA to $35.
People started to speculate that this was actually a Soros-style attack on the network itself.
Someone had managed to borrow over 100 000 BTC to start a convertible debt death spiral and manipulate the LUNA/UST relationship to their advantage.
11th of May
The 1:1 peg continues to strain and drops as low as 25 cents before bouncing back to over 70 cents.
CoinDesk also reports that Do Known was one of the pseudonymous co-founders behind the failed algorithmic stablecoin Basis Cash.
12th of May
With slight optimism that the peg is recovering, we see UST return to a last high of just over 80 cents early in the day on some exchanges. However, optimism is short-lived as UST starts dropping in value once more, driving down the price of LUNA by over 96% to under 10 cents.
As a response to this, the Terra blockchain is officially halted for the first time to implement a patch that would "prevent governance attacks". This was followed shortly after by a second halt that would last over nine hours as the Terra Luna team came up with a plan to solve the issues facing the network.
This concluded a $60 billion wipeout over four days catching many in the industry by surprise.
16th of May
The general crypto market had struggled over this period; one reason was the forced selling of tokens. The LFG confirmed that it had been forced to sell over 80 000 BTC and the majority of its other assets trying to maintain the peg.
The collapse of Terra Luna also helped further propel crypto into a bear market. This had significant effects down the line, especially on those who were intimately involved with Terra Luna and the projects in its ecosystem or those reliant on its lending facility. It also seriously affected those sensitive to declining market prices, especially lending platforms, as decreased confidence in the industry spurred a "bank run" on many lending companies.
12th of June
Almost a month to the day, the first lending platform, Celsius, halted withdrawals as it cited "extreme market conditions".
Celsius was one of the largest lending platforms in the industry, owing clients and creditors over $5.5 billion.
This move fuelled rumours that the platform had become insolvent, and the team provided no timeline as to when they may open up withdrawals again. This move resulted in the platform's native token, CEL, losing over 70% of its value within the hour.
Market conditions in crypto continued to decline over the next few days, posting double digital losses taking the total market capitalisation under $1 trillion, where it was in February 2021.
15th of June
Rumours started swirling as Three Arrows Capital, the company that led the $1b raise for Terra Luna (it is estimated they lost between $200m-$560m with their collapse), began selling off assets to avoid the liquidation of loans it owed to DeFi platforms Aave ($264m) and Compound ($35m).
This included selling $40m worth of stETH (Lido Staked Ethereum).
At this point, they were one of crypto's biggest trading desks with over $18 billion under management (it has been estimated that only $2.7 billion was liquid). They owed over $3.5 billion to 27 separate companies, including Voyager Digital, FTX, BlockFi, Deribit and Celsius, yet the most significant was $2.36 billion to Genesis, a Digital Currency Group company.
17th of June
Voyager Digital, who had $661 million in exposure to 3AC, signed a non-binding term sheet with Alameda Research to secure a revolving line of credit providing Voyager with access to further capital. The first credit facility was cash/USDC with an aggregate amount of $200 million, with a second revolving credit facility for 15 000 BTC. Interestingly, Alameda Research owed loans to the value of $337 million to Voyager Digital already and owned 9.5% of its publically listed shares.
19th of June
As the liquidity crisis starts spreading and affecting several industry participants, SBF states in an interview that: "I do feel like we have a responsibility to seriously consider stepping in, even if it is at a loss to ourselves, to stem contagion." He added, "even if we weren't the ones who caused it, or weren't involved in it. I think that's what's healthy for the ecosystem, and I want to do what can help it grow and thrive."
21st of June
As more firms are affected, SBF makes good on his statement and extends a $250 million revolving credit facility to BlockFi, another big lender in the space.
As per the agreement, the loan proceeds are "intended to be contractually subordinate to all client balances across all account types (BIA, BPY & loan collateral) and will be used as needed".
22nd of June
Voyager Digital announced that it will reduce its withdrawal limits by over 50% from $25k to $10k and may issue a "notice of default" to 3AC as the firm still owes Voyager 15 250 BTC and $350 million USDC.
27th of June
After 3AC fails to repay the loan to Voyager Digital, the latter follows through with its earlier threat and issues a notice of default to 3AC.
Voyager also started to realise that they may not get back the total amount owed and are "unable to assess at this point the amount it will be able to recover from 3AC".
29th of June
At this point, 3AC was ordered by a British Virgin Islands court to liquidate. Liquidation is the formal shuttering of a business when it cannot pay off its financial obligations, and any leftover assets are sold off to try to recoup the losses.
They were officially done, and one of their founders, Kyle Davies, directly attributed it to the Terra Luna collapse, saying that "the Terra Luna situation caught us very much off guard".
1st of July
Following the reduction in its withdrawal limit, Voyager announces that it has temporarily suspended all withdrawals, deposits, and trading on its platform.
According to a disclosure on the 30th of June, Voyager had the following on its balance sheet: $685.3 million worth of crypto assets, loans worth $1.12 billion, $355.7 million worth of customers' cash, and was holding nearly $168.7 million worth of crypto collateral.
In addition to this, BlockFi announces that it has reached a new deal with FTX to increase the size of its revolving credit line from $250 million to $400 million, with the option to acquire BlockFi at a variable price of up to $240 million if performance targets are hit.
5th of July
Voyager Digital files for Chapter 11 bankruptcy, including its affiliate companies Voyager Digital LLC and Voyager Digital Holdings. According to the document, Voyager had more than 100 000 creditors and between $1 and $10 billion in assets.
Regarding the decision, CEO Stephen Ehrlich said, "we strongly believe in the future of the industry but the prolonged volatility in the crypto markets, and the default of Three Arrows Capital, require us to take this decisive action".
Voyager marked the first big lender to file for bankruptcy.
13th of July
Shortly after Voyager files for bankruptcy, Celsius follows in its place. A month after halting withdrawals and trying to solve its liquidity issues, Celsius also files for Chapter 11 bankruptcy.
According to the filings, the firm owed clients and creditors $5.5 billion and had assets worth $4.3 billion, leaving a $1.2 billion hole in its balance sheet.
This was even after it had managed to reclaim around $1 billion in collateral by paying off its loans to DeFi protocols Maker, Aave, and Compound.
According to the filing, Celius went bankrupt because "as a result, the Company made what, in hindsight, proved to be certain poor asset deployment decisions. Some of these deployment activities took time to unwind, and left the Company with disproportional liabilities when measured against the unprecedented market declines".
2nd of November
After the bankruptcy of Celsius, the industry slowly started stabilising and dealing with the repercussions of what had occurred. That was until CoinDesk released an article titled: Divisions in Sam Bankman-Fried's Crypto Empire Blur on His Trading Titan Alameda's Balance Sheet.
In it, based on a leaked balance sheet, the author details how the majority of the net equity value of Alameda Research (SBF's trading firm) is actually FTT, the native token of FTX (SBF's exchange), which FTX can print and issue as they see fit. The balance sheet also contained a significant number of illiquid tokens.
6th of November
As more revelations around FTX and Alameda were coming to light, Binance (who incubated FTX) announced that it would liquidate the entirety of its FTT holdings (worth around $584 million).
Part of the announcement is that they will do it in a way that "minimises market impact". Nevertheless, it starts to trigger fear among those who hold FTX and Alameda-related project tokens.
In response to this, Caroline Ellison, the CEO of Alameda Research, tries to quell fears stating that the balance sheet CoinDesk circulated was a "specific balance sheet for a subset of our corporate entities, we have > $10b of assets that aren't reflected there".
She then follows up and makes a public offer to the head of Binance, CZ, to purchase all the tokens from the exchange directly for $22 each.
7th of November
SBF insists that "a competitor is trying to go after us with false rumors". He also presses that "FTX is fine. Assets are fine. FTX has enough to cover all client holdings. We don't invest client assets (even in treasuries). We have been processing all withdrawals, and will continue to be."
As FTX and SBF fail to calm fears, panic continues to spread, and we see mass withdrawals from all centralised exchanges in the industry.
8th of November
Without warning, FTX freezes customer withdrawals and offers no further communication. However, people soon see that FTX is sending funds to Alameda.
When called out about it, Caroline claimed it was FTX US, the U.S. branch of FTX.
As markets start looking as if they are going into freefall, Binance announces that it has signed a non-binding Letter of Intent to purchase FTX and help alleviate some of its liquidity issues. However, this would be subject to a deep due diligence process.
9th of November
It is soon reported by CoinDesk that Binance is "strongly leaning against buying FTX" after only a few hours of having been granted access to FTX's books and loans.
It was confirmed later in the day by a Binance spokesperson that the exchange had scrapped its Letter of Intent.
"As a result of corporate due diligence, as well as the latest news reports regarding mishandled customer funds and alleged U.S. agency investigations, we have decided that we will not pursue the potential acquisition of FTX.com"
"In the beginning, our hope was to be able to support FTX's customers to provide liquidity, but the issues are beyond our control or ability to help. Every time a major player in an industry fails, retail consumers will suffer. We have seen over the last several years that the crypto ecosystem is becoming more resilient and we believe in time that outliers that misuse user funds will be weeded out by the free market."
10th of November
Everything beings to unravel rapidly for Alameda and FTX. SBF makes an announcement that they are going to be shutting down operations at Alameda Research.
In a series of tweets, SBF also explains how due to "poor internal labeling of bank-related accounts meant that I was substantially off on my sense of users' margin". The previous Sunday, users had tried to withdraw $5 billion, but they only had liquidity to support 80% of it.
To top the day off, the Wall Street Journal released an article that alleges FTX lent around $10 billion of customer assets to Alameda Research. These loans were sanctioned by SBF without informing other top executives at the company.
11th of November
Reports start to emerge that some funds are being withdrawn from FTX under a directive by the "Bahamian regulators" to allow their citizens to withdraw funds.
This loophole was soon exploited, and there were independent confirmations that some people who weren't Bahamian or based in the Bahamas could withdraw their assets.
Many speculate that this was FTX employees exiting with their crypto.
On the same day, SBF announced on Twitter that FTX, FTX US and Alameda Research was filing for Chapter 11 bankruptcy.
To add fuel to the fire, FTX gets "hacked" in the evening, and more than $600 million is drained from their wallets.
14th of November
A Twitter user Mario Nawfal who claims that they know an FTX insider insists that the hack was only made possible because SBF had instructed his CTO to build a backdoor to allow him to move funds when he wanted.
This is apparently how he moved funds from FTX to Alameda without any of the executives knowing.
There are still stories coming out regarding FTX and what they were actually doing behind the scenes.
From the Collapse Till Now
The FTX collapse has rippled across many other companies in the industry, and over the past week, the extent of its impact has been emerging.
Genesis Trading
Genesis Trading is one of the largest crypto investment banks and market-makers in the industry, owned by the Digital Currency Group (DCG). It revealed that its derivatives arm had $175 million in locked funds on the FTX exchange. They more recently announced a temporary suspension of withdrawals and new loans.
It has also recently been reported that they are seeking an emergency loan of $1 billion as it needs liquidity to fulfil immediate redemption requests.
Gemini
Gemini, a Winkelvoss twins company, announced a pause in the withdrawals from the Gemini Earn program as their primary counterparty was Genesis Trading.
BlockFi
BlockFi also announced a temporary pause in the withdrawal of funds from their platform as they attempt to deal with the fallout of FTX, who had also provided them with the $250 million revolving credit earlier in the year.
While we have only mentioned three firms, many more have been affected, and as time goes on, we will better understand who else is involved.
Where to From Here?
This year has been a real stress test for crypto. Not only have prices been subdued, but companies in the space have been acting irresponsibly and irrationally.
One thing that this whole debacle has taught us is that human intervention can have serious consequences, especially in an opaque world.
It also significantly strengthens the case for Decentralised Finance and how one should rather place trust in mathematics and computer science over human discretion. This is also supported by the ability to verify transactions yourself on an open, transparent, public blockchain.
This may be a watershed moment for crypto as people begin to realise that these networks, if designed correctly, are safer than their traditional counterparts. Decentralised economic infrastructure is the way forward. The only question that remains is how long it will take before it becomes the standard.
Whilst we all have the option to look, to seek to understand, it’s often easier not to. Bitcoin, Ethereum, and distributed ledger technology are complex systems that require significant due diligence. At Etherbridge, we aim to lower the barriers to understanding this fast-growing digital economy.
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This is not financial advice. All opinions expressed here are our own. We encourage investors to do their own research before making any investments.
