BitMEX founder summarizes Three Arrows Capital’s failure

This article is an article by BitMEX founder Arthur Hayes summarizing why Three Arrows Capital collapsed. It was originally published on the author’s Medium blog.

The current crypto bear market is the third major one I’ve experienced. While it can feel like repetition at times, each one yields new lessons. Everyone will have an opinion on what the lessons are — but if you’re listening to the mainstream financial media, I can confidently tell you that you’ve been fed the wrong perspective. They serve the devil at TradFi and will take every opportunity to poke fun at our economic/social experiment, gleefully proclaiming, “We warned you crypto was worthless!” In the holy name of Satoshi Nakamoto, I will attempt to correct the invective that oozes from these malicious harpies.

In this post, I will use the Three Arrows Capital (3AC) saga as a lens through which we can better understand the real insights that should be learned from the current bear market. Please note that while I personally know Su Zhu and Kyle Davies (the principals of 3AC), I have no idea what happened other than what has been publicly reported. I intend to use my knowledge of crypto, financial services, and common sense to tease out the story that I believe led to its collapse, starting with the implosion of TerraUSD and Luna.

The collapse of 3AC itself was not remarkable. A hedge fund that had previously successfully executed a boring but steady yield arbitrage strategy decided to use leverage to accelerate returns, and paid the price. Using borrowed funds to conduct TerraUSD arbitrage trades, it was then sentenced to death.

But the reason the 3AC default was so impactful is that it blew a whale shark-sized hole in many of the largest centralized crypto lending operations. Many of these lending operations have shut down customer withdrawals and effectively become insolvent due to the losses on 3AC’s loans. The withdrawal of credit from the crypto ecosystem led to a general market crash in Bitcoin, Ethereum, and altcoins across the board. No coin was spared.

However, what many media outlets fail to mention is that both centralized and decentralized lending companies/platforms touched 3AC — and only one of the participants went bankrupt. Centralized lenders failed en masse, while decentralized lenders liquidated collateral and had no problems. I will use the story of 3AC as an example of why Satoshi and Vitalik’s work has stood the test of time, and what it means for the future of cryptocurrency.

Hongkong

Before we dive in, though, let's take a quick trip down memory lane to get a better understanding of how 3AC principals Su Zhu and Kyle Davies became celebrities.

Su and Kyle graduated from college the same year as me in 2008 and subsequently moved to the Asia Pacific region as employees of the TradFi bank/market maker.

Investment banking in Hong Kong, Singapore, and Tokyo is very closely connected. While I didn’t know Su or Kyle directly until years later (when we both entered the crypto space), we passed in adjacent friend circles, at most 1 degree apart at the time. The first time I met Kyle at a tempura restaurant in Singapore, I could have sworn I’d seen him at a party in Hong Kong before.

I never did any business with Kyle who worked for a while at Credit Suisse, but I did trade with him when Su was a market maker at FlowTraders. As the lead market maker for Deutsche Bank’s ETF business in Asia Pacific, I posted buy/sell quotes for a large suite of ETF products on the Hong Kong and Singapore stock exchanges. I made mistakes regularly and learned many lessons at the hands of FlowTraders. No excuses – I just lost money to them regularly. Su was one of the pros at FlowTraders who kept me on my toes every day. After his time at FlowTraders, Su worked for a while at Deutsche Bank and on the desk at Killah, who I wrote about in a previous post.

The point of this story is that Su and Kyle are arbitrage guys. In their banking careers, they were trained to profit from tiny differences in prices. Do it over and over again, and the money adds up. They brought that same approach and mentality into the creation of Three Arrows, which started by arbitraging the very inefficient OTC Non-Deliverable Forward (NDF) market.

Same as my job at Citibank...

While I was Citi’s lead ETF trader, I also dabbled in equity index forwards, including NDFs. Our desk traded primarily equity index forwards for the Hong Kong, Taiwan, India, and South Korea indices. I also ran the entire China A-share ETF book and traded a lot of equity-linked derivatives.

An NDF is a currency bet, but instead of exchanging domestic and foreign currency cash flows at the beginning and end of the swap, the difference between the incoming and outgoing exchange rates is paid or received in U.S. dollars.

Let's take the USDKRW (Korean won) exchange rate as an example. Korea does not allow free convertibility of the won. Assuming I want to sell won in the next 30 days instead of buying USD, I want to lock in today's exchange rate. I would trade on the right hand side (RHS) of the USDKRW NDF. If I enter the 30-day NDF at an exchange rate of 1,000 won and the spot rate settles at 1,200 won, I will receive [200 won * USD notional / USD won spot rate]. If my trade size is $1,000,000, this equates to a profit of approximately $166,666.

Understanding why NDFs are a necessary component of stock index forward trading is not important to this story, so I will spare you the gory details.

The OTC NDF market is so large that all major investment banks have desks dedicated to these derivatives. Back in the 2010s, trading was conducted via Bloomberg chats. This meant that while traders had a general idea of ​​how a particular NDF should be priced, they could not see a consolidated market like they could with spot currencies. As a result, it was easy to arbitrage across different NDF trading desks.

Every day I will choose a currency and try to "arbitrage" two counters. Let's say I want a notional 30-day Korean won NDF for $20,000,000. Bank A will quote me 1,000/1,001; Bank B will quote me 1,002/1,003. Do you see a trading opportunity?

I buy Bank A at 1,001 and sell Bank B at 1,002. After 30 days, I will have made a profit of 1 won per dollar. Assuming the spot rate is 1,000 won and the notional value is $20,000,000, the total profit is $20,000. For a bank trading desk, this is not much, but if you do this enough times, it will add up to several million dollars of risk-free PNL per year.

As bankers, Su and Kyle saw this inefficient market and used their own money to start a fund whose trading strategy centered on profiting from these mispricings. It’s worth noting that it’s almost impossible to trade in the NDF market unless you’re a trader at a bank or a very large hedge fund. You have to have ISDA, and the senior management of the bank you’re trading with has to allow you to trade with them. But somehow, 3AC managed to open accounts at several investment banks and arbitrage against each other in the Asian NDF market. When Su and Kyle told me how they got started, I was impressed by their haste to get into this lucrative market.

This is how 3AC made money for years. Then, at some point, the company discovered cryptocurrencies and ran their trades as cash-and-carry. This is the basis of any crypto arbitrage fund. Perpetual contracts have historically been net paid short - meaning if you sell USD, buy BTC, and then sell the BTC/USD perpetual contract, you will net money over time.

These currency arbitrage and margin trades are very lucrative, but they are capital intensive. You have to post margin to trade each NDF derivative, and you don't get credit for having an equal and opposite position at another bank. For crypto perpetual contract arbitrage trades, you can't use any leverage. This means that your hedge fund's AUM grows slowly and predictably; but you won't be starring in Big Pimpin' anytime soon.

The only way to improve hedge fund performance is to be a pure short or pure long trader and/or use borrowed funds. 3AC did both.

According to reliable sources:

“We’ve been in crypto for a long time,” he said. “We weren’t always long Ethereum, in fact we were short for a while. What’s the best way to beat Bitcoin right now? Own Ethereum. The ultimate goal of my book is to outperform Bitcoin.”

Davies said Ethereum is currently the firm’s largest cryptocurrency asset. It is up 245% this year against the dollar, while Bitcoin is up 29%.

Source: Bloomberg

TerraUSD/Luna

The carry trade of the century this week was brought by Do Kwon and TerraUSD.

TerraUSD (UST) is a DeFi algorithmic stablecoin. The goal of the code that supports UST is to attempt to maintain a 1:1 peg with the US dollar. I discussed how this peg works in my post “Luna Brothers, Inc.” .

The hardest part for any currency that doesn’t derive its value from government violence is generating intrinsic demand. When 10,000 Bitcoins were exchanged for Papa John’s pizzas in 2010, it marked the first known transaction of Bitcoins in the real world. This was significant because it meant that the holder of the real pizza believed that some Bitcoins were enough to compensate him in the transaction.

So how did TerraUSD convince people to use UST? Simple… Another Terra ecosystem project called Anchor offers a 20% fixed yield on staked UST. If you stake your UST to the Anchor protocol, you will receive an ongoing interest rate of 20% per annum.

How did Anchor generate such impressive returns? My trusted research analyst solved the mystery for readers:

Borrowers pay around 10–12% APY on their agreement. Borrowers are incentivized by ANC allocations as a reward for borrowing, typically around 7%.

Anchor will also stake its collateral funds to earn staking rewards.

These are not enough to get rid of the incredible imbalance of demand between borrowers and lenders.

Anchor also has a reserve fund, funded primarily by the Luna Foundation, which will help make up the difference between about 10-12% and 20%.

The idea is that the Terra ecosystem will grow enough to eventually support a high APY. But the reality is that Terra continues to burn through its reserves and will (eventually) run out of funds.

Terra is essentially paying for Anchor’s growth and adoption. Hopefully, when the subsidy expires in 2024, the Anchor protocol will have a vibrant savings and lending ecosystem.

When billions of dollars are pouring in to earn an advertised 20% APY, a 10% yield deficit is a big hole to fill. Neither Anchor nor Terra have survived long enough to determine if the ecosystem can support removing subsidies.

Few fund managers will stop to engage the critical thinking part of their brains and think about how this messed up Anchor is generating these returns. But that’s okay because until UST and LUNA crashed, it paid out 20%. This is the mother of all crypto carry trades.

Excuse me, but I have to beat this particular draft horse to death. I did some analysis on about 3 million bonds indexed by Bloomberg. I specifically screened for bonds with a maturity of less than one year and a yield to worst of at least 20%. Of the 3 million bonds, only 159 met these criteria. For those of you who like math, that's less than 0.01%. Included in this list of ultra-high yield instruments are bonds from countries like Sri Lanka, Ukraine, Argentina, and Turkey. It should be obvious that lending to these sovereign governments has been a path to ruin for investors for centuries. If these are the entities paying 20% ​​yields, what does it mean for Anchor to be able to do the same thing and ensure that the principal is repaid?

Any so-called institutional money manager who invested his or his clients’ money in TerraUSD arbitrage trading and was surprised when he lost all his money should find a new job.

Back to 3AC.

The reason I rambled on about HK history earlier is because I wanted to give you some insight into how these guys originally developed their fund. Arbitrage trades like UST can’t be ignored — especially for people like Su and Kyle, who have been big supporters of DeFi and have made a lot of money directly from correctly betting on the price growth of many other protocols. We know 3AC holds a lot of LUNA — but we don’t know how deep they are in the UST arbitrage trade.

Davies said 3AC invested more than $200 million in LUNA tokens as part of a $1 billion Luna Foundation fundraiser in February, an amount that is now essentially worthless since the Terra ecosystem collapsed in mid-May. “The Terra-Luna situation caught us very unprepared,” Davies told the Wall Street Journal.

UST arbitrage trading is very simple.

1. Borrow USD at an interest rate below 20%

2. Convert USD to UST

3. Deposit UST into Anchor and earn 20%

4. Annualized unrealized profit = 20% — borrowing cost

To realize a profit, they will do the opposite.

1. Withdraw UST + UST interest from Anchor

2. Convert UST to USD

3. Repayment of US dollar loans

4. The remainder is profit

Using your own capital as a hedge fund severely limits your profit potential. A true master of the universe, faced with such a lucrative carry trade, would increase leverage by borrowing money.

Imagine you could borrow $1 billion at 10% annual interest, using your already owned shitcoin portfolio (or even none at all) as collateral. Then, convert $1 billion into $1 billion and earn 20%. You would be making $100 million per year, and it would take zero effort to manage the position. Again, I don’t know how big 3AC’s UST position is, but if we believe they had nearly $18 billion in AUM at some point earlier this year, it makes perfect sense for them to borrow billions to deploy this carry trade.

The ability to borrow money depends on your collateral and reputation. The goal is to borrow money with as little collateral as possible. The less collateral you ask for, the more the borrower will trust you.

3AC has cleverly created an aura of invincibility. It’s a combination of correctly calling the market in the past, and actively telling everyone how they’re trading on social media. 3AC was one of the largest pools of dedicated crypto capital in the world at its peak. This reputation for superior trading, combined with the sheer size of assets they controlled, allowed 3AC to borrow on very generous terms. For example, publicly traded company Voyager loaned 3AC hundreds of millions of dollars without any collateral. 15,250BTC and $350 million, to be exact, leaving them bare-handed, shirtless, and completely defenseless against the bullets sent through their vault by 3AC’s default settings.

game over

My thoughts (purely speculative) on how 3AC began its slide into bankruptcy.

As I said above, I suspect 3AC used not only its own funds, but also borrowed USD from individuals and funds to conduct UST arbitrage trades. For loan collateral, 3AC took a combination of Bitcoin, Ethereum, and most importantly, various other less liquid and more volatile shitcoins as collateral. On paper, 3AC's crypto asset portfolio was impressive. However, when UST broke the peg and the entire $40 billion Terra ecosystem collapsed in a week, the once lucrative arbitrage trade quickly turned into a nightmare - 3AC's demise became a matter of when, not if.

When the market goes down, it goes down in a correlated way. This simple fact spelled doom for 3AC, whose inflated valuation was largely derived from the market value of the many illiquid shitcoins they held. When the market began to fall, the liquidity of these shitcoins evaporated, leaving only orders. As 3AC continued to sell through rapidly depleting demand, the price reflexively fell in a non-linear fashion, ultimately resulting in an inability to recover enough dollars to repay the loan.

3AC suddenly owed a lot of dollars that it did not and could not collect because the remaining assets it could liquidate to repay these loans had fallen by 50% to 75%. If the broader crypto market had not fallen, 3AC might have been able to salvage the capital losses tied up in UST and LUNA. Instead, the market sniffed out a wounded lion and set about eviscerating it.

Then the problems started.

Who lends money to 3AC?

How much money is loaned to 3AC? How much is the collateral worth?

What is collateral?

Does 3AC pledge the same collateral multiple times?

Wow...Soooo Danga!!!

As time went on, various large centralized crypto lenders came under pressure. Some of the big players declared bankruptcy and partnered with a handful of crypto OGs with enough capital to restore their solvency.

“But how did the default of one fund turn into the near-destruction of an entire industry?” you might be wondering. Good question — let’s take a closer look at how 3AC’s losses beat many of the largest and most well-known centralized crypto lending companies.

Centralized Crypto Lenders

First, let’s familiarize ourselves with the major players in the centralized lending space. Some of the big companies currently feeling the pinch of 3AC’s collapse include Voyager, Celsius, BlockFi, and Babel Finance.

Reminder: I have no non-public information about these companies. I only have inferences and public statements.

The lending business is very simple: a lender accepts deposits and pays interest to depositors in exchange for the ability to lend the funds out. The lender then makes a profit by lending the funds out at a higher rate than it paid to depositors.

The simplicity of this model also brings some pitfalls - one of which is that in any kind of financial crisis, the lending business will inevitably come under stress. Unless you work for the company, depositors have no way of knowing whether the company is using their money in a prudent way. So at the first sign of stress, you will rush to exit, and if the lender takes on any maturity mismatch risk, they will quickly become insolvent.

With that in mind, let me describe the safest way to run a loan business.

Suppose you have 3 clients: Mark Karpeles aka MagicalTux, Do Kwon aka The King, and Su Zhu aka The Sultan of Singapore. Each of them has 1ETH and wants to get a return on their assets. Each has a time preference.

Mark = 1 month; Do = 3 months; Su = 1 year

Let's call the lending position Long-Term Crypto Management (LTCM).

LTCM could be a safe lender or a risky lender.

If LTCM is conservative, it will match everyone's time preference at maturity. Therefore, LTCM lends 1 ETH for 1 month, 1 ETH for 3 months; 1 ETH for 1 year. There is no risk when Mark, Do, or Su asks for their money back.

If LTCM was aggressive, it would have lent for longer terms than everyone's time preference. To illustrate this with an absurd extreme, LTCM could have loaned out 3 ETH for 10 years. Obviously, if any depositor demanded their money back on their preferred schedule, it wouldn't be there. That's how lenders become insolvent. But LTCM could bet that it would be able to convince every depositor to roll over their deposits multiple times so that LTCM would never become insolvent.

This analysis covers only the duration of LTCM's loan book. The second aspect of the lending business is the quality of the borrowers. A lender's value as a firm derives largely from its ability to properly assess the credit risk of its borrowers and, based on those risk assessments, require appropriate security or collateral before lending.

In cryptocurrencies, credit demand comes from three sources:

1. Carry trades and cash-and-carry basis trades. The borrower would rather not post collateral because it wants to have as much cash as possible to use these strategies most effectively.

2. Margin loans for speculation. These are for one-way long and short traders. Usually, they post some kind of collateral. But failure to realize the volatility and liquidity changes of the underlying collateral can cause losses to the lender.

3. Mining asset-backed loans. Miners either pledge hardware (such as ASIC Bitcoin miners) or cryptocurrency and receive fiat currency and/or stablecoins. These borrowers have the least risk because they have strong cryptocurrency cash flows to back their loans. However, if you repossess ASIC machines from defaulting miners, you must have the facilities to plug in the machines and start mining to fully utilize them.

The main missing use case in crypto credit is business lending. The space is so new and risky that it doesn't make sense to lend to crypto companies. Crypto companies, similar to the underlying tokens themselves, should be viewed as call options. By default, you're out of the game no matter where you are in the capital structure. Assuming that, it's better to just own equity - because at least you can participate.

Due to the inherent volatility of crypto markets and the assumed profitability of various yield farming, arbitrage, and basis trading, borrowers have been willing to pay extremely high interest rates. This means that lenders can offer extremely high rates to retail savers and still have a positive net interest margin (NIM).

I believe the major crypto lenders started out lending very sensibly but then grew too fast. Deposit rates are extremely attractive relative to fiat deposits and bonds offered by TradFi banks and sovereign governments. This is a result of the reckless money printing and zero interest rate policies of central banks. Yield hungry retail investors are not able to get enough of these high yields in crypto and fiat stablecoins.

The billions of dollars that poured into these few companies outstripped the supply of responsible borrowers. They had to deploy the money because it cost them money to get it (remember, they paid interest to everyone). The pressure to lend money forced companies to lower their lending standards, which also led them to engage in the same arbitrage trades that 3AC did.

For example, BlockFi was once one of the largest holders of GBTC, a U.S.-listed Bitcoin tracking fund. BlockFi accepted BTC deposits, created GBTC shares, and then sold the GBTC shares on the market for a premium. That was the plan, anyway — but it took six months to create GBTC shares. During that six-month period (late 2021 to early 2022), the GBTC premium turned into a discount, and when they exited the arbitrage, they had lost money. If you have Bloomberg, search for GBTC US Equity HDS <GO>. Then, look up BlockFi and you’ll see that they sold 3.6 million GBTC shares sometime in the first quarter of this year.

Above is a chart of GBTC's premium or discount to its net asset value (NAV). Given the six-month lead time and the human propensity to infinitely extrapolate short-term trends, I bet that many firms borrowed BTC to create GBTC in the hope that they would get a 40% profit six months later. As you can see, this obviously did not happen, as GBTC has been trading at a discount since the second quarter of 2021.

3AC was able to do such massive arbitrage and one-way trades in large part because it had a pool of money willing to invest. In my opinion, there is no other reason why a public company like Voyager would lend them hundreds of millions of dollars in unsecured USD and Bitcoin. 3AC said they would pay high interest rates, and Voyager kept their word - because in the minds of the people in charge of Voyager, no other institution had the pedigree of 3AC to absorb the large amounts of money that needed to be shipped out. As Chuck Prince so eloquently quipped in response to Citi's involvement in originating subprime mortgages, "When the music stops, things will get complicated in terms of liquidity. But as long as the music is playing, you have to get up and dance. We are still dancing".

Unfortunately, the lenders were all on the same side of the trade. They had the same borrowers. They held the same collateral. The borrowers were all losing money on the same carry trades. The only difference between 3AC and these lenders was how well they marketed themselves. As we have seen, none of them were doing the proper risk management to the degree that was needed to weather this particular storm.

Worse, these private companies don’t have to issue regular updates on the health of their loan books, nor do they have to set aside provisions for expected bad loans like listed banks do. We can only speculate on the scale of potential losses these lenders face without any mooring. As a result, everyone tries to extract funds at the first sign of stress – which is exactly what leads to insolvency if a lender has a maturity mismatch. This is exactly what happened as the market wondered how big a hole 3AC had dug in these lenders.

It wasn’t just retail investors that were exiting, either. These lenders were trading the same risk with each other, which meant they were also exposed to each other — and they didn’t trust each other either. A complete loss of confidence in centralized, opaque lenders was why they all went extinct at almost the same time.

Half time

A quick recap: 3AC went bankrupt because they took a boring, stable, and predictable arbitrage strategy, used massive leverage, and succumbed to the market after the TerraUSD arbitrage trade collapsed.

3AC was allowed to borrow with little to no collateral by lending firms eager to redeploy retail deposits into high-yielding crypto credit instruments, due to its investment acumen and large asset pool. These lenders, such as BlockFi, Babel Finance, Voyager, and Celsius, circumvented prudent risk management policies in order to loan as much as possible, as quickly as possible. As a result, when 3AC failed to meet margin calls, these lenders were left with Mariana Trench-sized holes in their balance sheets. Unfortunately, these once-renowned “fintech” startups, valued at over $1 billion, are now heading toward bankruptcy first, followed by second-tier companies.

There is nothing innovative about how these lenders went bankrupt. As long as there have been centralized lending operations, there have been epic failures, such as what this group of crypto lenders experienced in this case. The technology underpinning crypto and DeFi has nothing to do with why 3AC and these lenders are in trouble.

Now that it’s clear this was just a run-of-the-mill failure by a small group of financial institutions with poor risk management, let’s dig deeper into how actual crypto and DeFi applications are handling these market stresses.

TerraUSD succeeded

The core of the Terra ecosystem is DeFi. A group of engineers launched a codebase, and anyone who cared to take the time to investigate could see the lines of code that controlled how the UST algorithmic stablecoin behaved. The UST code performed 100% as designed. It worked; but investors didn’t care how it worked. So when the peg dropped, the recursive logic that controlled how LUNA and UST were minted and burned to balance the ecosystem wiped out 100% of the ecosystem’s value. It was pure math, and more or less inevitable. The fact that many people refused to read the whitepaper is not TerraUSD’s fault.

DeFi Lending Protocol

Another group of entities that have lent money to 3AC and various other addresses in the crypto ecosystem are DeFi lending protocols. The main players in this melodrama are Compound (COMP), Aave (AAVE), and MakerDAO (MKR).

When you lend or borrow in a decentralized manner, individuals do not make arbitrary decisions. This means that the protocol cannot factor any trust-related data points into its decision on whether to lend funds and how to protect them. Community-governed protocols have a set of rules that clearly spell out the type of collateral required and its amount.

If I want to borrow USDC with Bitcoin as collateral, the protocol will require the borrower to over-collateralize with Bitcoin. This is because Bitcoin is a more volatile asset compared to fiat stablecoins like USDC. Typically the initial margin is 150% of the value of the USDC borrowed. If Bitcoin is $100 and I want to borrow 100 USDC, then I must post 1.5 BTC as collateral for the 100 USDC loan.

If the price of Bitcoin drops, typically by 120% of the USDC loan value, the protocol will immediately programmatically liquidate the Bitcoin so that in most cases 100 USDC is returned to the lender. These levels are established at the protocol level and can only be changed if enough governance token holders agree to loosen or tighten lending standards.

In fact, several lending protocols have already changed their policies during the current crisis. These changes must go through a series of community-driven governance votes before they can be implemented. Wow, isn’t it amazing when stakeholders can make decisions quickly, efficiently, digitally, and programmatically? As an example, here’s a recent proposal to adjust the collateral factor on Compound.Finance, which was approved by the DAO that governs the protocol.

The only information these protocols have about lenders and borrowers is their Ethereum wallet addresses. To them, 3AC is just an address with an asset balance. It is not a group of people with a certain pedigree that indicates they can and should be trusted to pay back what they owe, even without requiring collateral beforehand. I will repeat: these lending protocols are designed with the explicit goal of removing the need for trust from the lending equation.

These protocols control multi-billion dollar loan books. Their lending criteria, borrower/lender addresses, and liquidation levels are fully transparent as they are all publicly posted to the blockchain. We can assess the health of their loan books in real-time. Depositors in these protocols can process all relevant information about the health of these protocols before depositing their funds. This is in stark contrast to the opaque nature of centralized lenders, where depositors only have to consider clever marketing campaigns.

Both 3AC and a cabal of centralized lending company package holders are heavily involved in these DeFi lending protocols. We know this because using blockchain analysis tools, market participants were able to determine where certain companies would liquidate their large outstanding loans on these protocols. The market is brutal and it systematically looks for levels that would force protocols to sell indiscriminately to keep their lenders intact. Fortunately, all of these major DeFi lending protocols have survived due to conservative margin requirements set by the community.

The protocol does not have to stop any withdrawals.

The agreement continues to extend loans.

The protocol did not suffer any downtime.

Rekt'um Damn Near Killed 'Em

When you remove trust from the equation and rely solely on transparent lending standards enforced by unbiased computer code, you get much better results. That’s the lesson to be learned. Don’t let the media claim that the failure of these centralized companies is evidence of Satoshi’s shortcomings. Because he saved those who deserved to be saved.

The question now is who will lend money when hundreds of thousands or millions of people lose money due to the contraction of centralized crypto credit? These DeFi lending protocols will solve this problem as the bear market develops.

At some point, the price-to-book multiples of these DeFi lending protocols will become attractive again. Currently, they are still trading too expensive given the near-term outlook for lending demand. There is not a ton of organic lending demand due to speculators, large trading firms, and centralized lenders. Maybe I'm just greedy, but I hope the market will give me a chance to hold COMP, AAVE, and MKR at much lower levels before we exit this bear market.

Thirst Trap

Water, water, everywhere,

All the boards were shrunk;

Water, water, everywhere,

Not a drop to drink.

——The Rime of The Ancient Mariner, Coleridge

Centralized crypto lenders are desperate! However, should these harried zoomers be offered a sweet bailout of capital?

For crypto hedge funds like 3AC, their intrinsic value depends only on the ability of their portfolio managers (PMs) to take risks wisely and consistently make money over time. If a bunch of PMs go bankrupt because they use leverage inappropriately, what value is left in the funds they control? I suspect 3AC made frantic calls to CZ and SBF, but what on earth were they buying? A mess, that’s for sure. And I suspect 3AC and funds in similar positions will not find a savior.

For crypto lending companies, their only value lies in their customer lists and a small percentage of quality loans. If these customers can be retained and sold for additional crypto financial products, it may make sense to buy the paralyzed centralized crypto lenders and assume their liability. Their radioactive loan books may contain a few properly underwritten loans that can be purchased at attractive prices. The problem is that the longer these lenders remain without life, the less likely they are to reopen and allow their retail depositors to exit. The time pressure to conduct due diligence on these opaque entities makes it more difficult to accurately assess whether crypto tycoons will abandon their capital and save these sinners.

Sure, the Fed or other central banks can bail out these hedge funds and companies, but these entities trade in cryptocurrencies. These entities are not part of the TBTF club of financial institutions and should die an honorable death. But let us not shed too many tears, because we have learned through these trials and tribulations that the promise of a new decentralized financial system has withstood yet another test.