From Celsius to Three Arrows: The Domino-level Epic Liquidity Drain of Crypto Billionaires

Since May this year, the crypto market has never been peaceful. In just one month, we have witnessed the collapse of Luna's $40 billion financial empire, the depegging of Lido derivatives, the largest decentralized node in the world for ETH 2.0, the suspension of withdrawals by Celsius, the largest crypto bank in the United States, and the liquidation of Three Arrows Capital, which was said to have once held $18 billion in crypto assets. When we connect these events in series, from Luna to stETH, from Celsius to Three Arrows, we can find the subtle relationship between them and the development clues interspersed in between.

Two Martyrs: Celsius and Three Arrows Capital

After the collapse of Luna, institutions in the crypto space were in a state of panic, and visible operations on the chain became more frequent. After the recent depegging of stETH, Celsius was the first to have problems. This CeFi lending platform, which is well-known in Europe and the United States, has 1.7 million users and manages over $30 billion in assets, was eventually forced to suspend all withdrawals due to a liquidity crisis, becoming another "martyr" crypto institution after LFG.

Prior to this, Celsius had lost a large amount of user assets in various accidents: first, it lost about 35,000 ETH, worth more than 70 million US dollars, in the loss of private keys of Eth2.0 staking company Stakehound, and then lost about 2,100 BTC and 151 ETH, worth more than 50 million US dollars, in the BadgerDAO theft incident. What's more serious is that Celsius has always deliberately concealed the truth, and even did not admit it after the news was exposed, which directly hit users' confidence in the platform.

As one of the largest holders of stETH, Celsius was hit hard by the stETH depegging incident. As the value of stETH fell and the platform's liquidity problems intensified, the platform encountered a severe run due to panic and was forced to sell stETH to meet users' demand for redemption of assets. Eventually, it had to turn on "HODL mode" and suspend withdrawals and transfers from all accounts. (BlockBeats note: How serious is the risk of stETH as institutions withdraw from Lido? ) The stETH and Celsius crisis are described in detail.

What’s more serious is that as the market continues to fall, Celsius’ hundreds of millions of dollars in DAI loans on the MakerDAO platform are also facing the risk of liquidation. In the past two days, Celsius has been adding wBTC collateral to Maker and repaid nearly 50 million DAI, bringing the collateral ratio to 219%, which has barely escaped the risk of liquidation.

Faced with Celsius being besieged on all sides, Nexo, also a CeFi lending platform, extended an olive branch to Celsius, expressing its willingness to acquire its "remaining eligible assets", but the Celsius team did not respond. This advocate of the blockchain revolution who once shouted "the bank is bankrupt" can only rely on suspending withdrawals and restructuring lawyers to survive.

And the day after Celsius exploded, there were comments on Twitter about Three Arrows Capital facing liquidation. People found that its usually flamboyant founder Zhu Su not only did not post for several days, but also deleted his Instagram account and modified his Twitter Bio.

Soon after, Zhu Su broke his silence and wrote: "We are communicating with the relevant parties and working hard to resolve the problem." The community immediately went wild. Three Arrows Capital, which once had tens of billions of assets and was one of the most active and influential investment institutions in the industry, has now taken the spotlight from Celsius and become the object of public attention. All of its previous assets and behaviors have been dug up.

According to The Block, the total liquidation amount between Three Arrows and the top lending companies in the market is at least $400 million, and it still needs to repay loans from other lenders after this liquidation. As the main endorsement institution of Luna, Three Arrows suffered huge losses during the collapse of UST, and in the past month, Three Arrows has been on the list of Bitfinex's loss rankings. In this stETH de-anchoring and selling, Three Arrows' "activity" far exceeded Celsius, and it sold a large amount of stETH to repay its debts.

Like Celsius, Zhu Su, who previously shouted about the super cycle and advocated the new L1 public chain ecosystem, has now become unusually silent. He deleted the Token tag in his Twitter Bio and admitted his misjudgment of the market.

But what is more noteworthy is that there seems to be a connection between Celsius’ liquidity crisis and the liquidation of Three Arrows Capital. In addition to the “top lending platforms” mentioned in The Block’s report, KOL trader Degentrading also pointed out on Twitter that Three Arrows is Celsius’ largest lender and also has lending positions on mainstream CeFi lending platforms such as Genesis and BlockFi.

Although the liquidation of Three Arrows is of no benefit to borrowers and lenders, judging from the problems exposed by Celsius, these "crypto banks" urgently need to solve the liquidity needs of users to redeem deposits. In the event of a liquidity crisis, liquidating their own borrowers in exchange for liquidity seems to be a reasonable choice.

Perhaps for this reason, Celsius offered Margin Call to Sanjian, turning it into a "sacrifice" to solve the crisis. In order to avoid getting into trouble, other lending platforms such as Genesis and Nexo quickly released news to reassure users.

The liquidation of Three Arrows has also forced more institutions to become "collateral victims." Yesterday morning, a trading institution under the Three Arrows account posted a message saying that Three Arrows had taken $1 million from its trading account, apparently to fill the funding gap elsewhere. And this morning, DeFiance, a capital that has a close relationship with Three Arrows, also seemed to have problems, and its founder Arthur typed a tearful emoji on Twitter.

In fact, it is not difficult to see from the decline of Celsius and Three Arrows that the two events of Luna collapse and stETH decoupling had a great impact. Taking the Luna incident as a watershed, the situation of crypto institutions has also changed greatly before and after.

Two Wrong Things: Luna and stETH

After this round of market cycle began, words such as "faith", "fundamentalism" and "All In" appeared more frequently than ever before. When people talked about investing, they talked more about narratives rather than facts. For a time, the meme "Irresponsibly Long" even became a condition for visionary investors to show off.

This atmosphere is particularly evident among institutions, and everyone has established an "unshakable" consensus on hot narratives. The Lunatic army led by Delphi Digital and Galaxy Digital can be seen everywhere on Twitter, and Anchor's 20% APY has become the recognized "best safe haven in a bear market"; OG communities such as Bankless often post articles to recharge their faith in Ethereum 2.0, and liquidity staking has become a perfect solution for Ethereum 2.0 node verification.

But it is precisely these strong consensuses that have caused institutions to make fatal mistakes on Luna and Lido. Just like the subprime mortgage crisis in 2008, the problem stems from excessive optimism and confidence. Before the Lehman Brothers explosion, the market was too optimistic about "rising housing prices" and no one was willing to believe that almost "risk-free" mortgage securities would have problems. Perhaps convinced by their own rhetoric, the institutions did it themselves and really achieved "Irresponsibly Long". Before the collapse of Luna and the decoupling of stETH, no one believed that these DeFi leaders with brand effects would still have fatal risks.

For Luna, UST's success has made institutions forget basic economics. The sustained and stable APY has brought a strong enough Lindy effect to UST, making people forget Anchor's terrible lock-up ratio and Luna's amazing market value. More and more funds continue to enter the market, and even a protocol dedicated to UST Looping leverage services has emerged, so that in the end, most of UST's market value is used to stack leverage in Anchor.

Celsius is also a major holder of UST, using the high APY provided by UST to achieve yield arbitrage. The platform first offered an APY of about 10% for stablecoins such as USDT and USDC to absorb users' assets, and then exchanged them for UST and deposited them in Anchor to achieve a 10% yield arbitrage, but users were unaware of this. It was not until the run on UST that people discovered that Celsius was the "big dumper" of UST and lost a large amount of user assets during the collapse of UST.

VCs and market makers such as Three Arrows, Galaxy Digital, and Jump Trading selectively ignored Luna’s strong financial attributes, and put the Terra ecosystem, which was dominated by Anchor, into the public chain narrative, keeping pace with the ecosystems such as Solana and Avalanche, and constantly advocating "Solunavax". According to FatMan, a member of the Terra Research Forum, Three Arrows once purchased 10.9 million LUNA at a price of US$559.6 million. Now, they are only worth US$670.45.

After a $40 billion financial empire evaporated overnight, the collapse of UST had a significant ripple effect, and many small stablecoins were decoupled. Panic continued to rise, and even USDT experienced a short-term run. This crypto asset with the highest liquidity was temporarily decoupled due to liquidity.

To a certain extent, USDT's short-term depegging is already a strong signal from the market: after tens of billions of dollars evaporated, liquidity is shrinking rapidly. Many stablecoin projects and ecosystems have also responded to this. The stable USN and USDD launched by NEAR and TRON have adopted a full or even over-collateralized model. But the impact of the UST incident is far more than that: since UST has developed into a cross-chain asset, its collapse will trigger liquidations to varying degrees in each ecosystem. In other words, Luna's collapse ignited the fuse of liquidity contraction.

However, institutions are too optimistic about the liquidity and demand of stETH. No one would have thought that the liquidity fuse would burn stETH, which has nothing to do with stablecoins. Since the "collateral" of stETH is ETH 2.0, it cannot be taken out before the Ethereum merger is completed. Therefore, unlike other liquidity pledge certificates, stETH is a futures certificate of ETH 2.0, which does not necessarily maintain a 1:1 anchor with ETH, and its price is completely determined by market demand.

A few months ago, there was no liquidity problem in the market, and the stETH-ETH pool prepared by Lido on Curve was fully able to cope with the demand, so people simply understood stETH as an asset pegged to ETH. At this time, one of the most popular strategies among institutions was to borrow ETH at a low interest rate of about 2%, and pledge it on Lido to obtain a yield of about 4% from stETH production, and then use stETH as collateral to loan out ETH on Aave in a circular manner, increasing leverage in this seemingly low-risk way.

As one of the largest holders of stETH, Celsius exchanged a large amount of user assets for stETH, which cannot be easily entered and exited through the liquidity pool. As can be seen in the figure below, Celsius had nearly 450,000 stETH at its peak. The platform will deposit these stETH into Aave as collateral and lend stablecoins or ETH to meet users' redemption needs. Once the liquidity problem is triggered, the consequences will be serious, because any decline in stETH will strictly put Celsius in a situation where its assets are not enough to cover its liabilities.

But when Celsius realized this problem, it found that the liquidity on Curve could not meet the needs of the platform at all. Selling would cause panic and bank runs, and not selling would not be able to meet the redemption needs of users, which put it in a dilemma. San Arrows was no exception. At the beginning of this year, it built a large-scale position in ETH and pledged stETH on Lido. Under the liquidation pressure of Celsius, San Arrows exchanged multiple stETH for wETH at a discount, and then sold them all for DAI to repay the debt.

Of course, the mistakes that ruined Celsius and Three Arrows Capital also happened to countless retail investors, and the problems exposed by Luna and stETH also reflect two clues that have been surrounding the crypto market in the past few months.

Two clues: high leverage crisis and liquidity exhaustion

Yesterday afternoon, Paidun released news about the liquidation of Three Arrows Capital’s ETH assets. According to the Aave platform, the wallet address suspected to be Three Arrows Capital (starting with 0x7160) has nearly 200 million US dollars in loans that are facing liquidation at any time. In order to avoid large-scale liquidation, this address has been constantly repaying debts on the chain.

At that time, rumors of the liquidation of Three Arrows were hot, and everyone regarded it as a "self-defense counterattack" by Three Arrows. However, according to the disclosure of KOL on Twitter, the address may actually be the wallet address of Longling Capital. This market liquidation can be regarded as a "spectacular scene" of whales diving collectively.

In addition to stETH, San Arrows itself has a large amount of loans used to purchase GBTC positions. Since last year, the spread of GBTC has continued to deteriorate and is currently -30%. This has also caused San Arrows' assets in this part to shrink significantly and is also facing liquidation risks.

We can't help but ask, how much leverage was there in the second round of crazy rising cycle last year? From the overall TVL of DeFi in the figure below, we can get a slight sense. The red box on the left is the collapse of Luna in early May, during which the TVL of the entire DeFi fell from US$200 billion to around US$120 billion, losing US$80 billion; the red box on the right is the liquidation of institutions such as Celsius and Three Arrows caused by stETH this time, and TVL lost another US$45 billion.

It is not difficult to see that the liquidation of mainstream ecosystems and institutions has caused the overall credit scale of the market to shrink rapidly, and may lead to continued deleveraging. Just like Celsius withdrawing capital, many other lending platforms will also protect themselves by withdrawing credit from the market, further reducing the capital flowing in the market and further drying up liquidity. For example, TRON ecological stablecoin USDD, despite the support of hundreds of millions of dollars from the Federal Reserve, could not escape the fate of decoupling, and fell to around $0.96 yesterday.

There is no doubt that the crypto market is experiencing its own Lehman moment. In order to prevent further deterioration of liquidation, external funds are often needed to save the situation. Unfortunately, we have caught up with a rare wave of interest rate hikes in history: at the FOMC meeting last night, the Federal Reserve once again raised the benchmark interest rate by 75 basis points to a range of 1.50% to 1.75%; in Europe, Italian government bond yields continued to rise, and the European Central Bank held an emergency special meeting yesterday to discuss response strategies and early interest rate hikes.

Recently, the U.S. Treasury yields have also been rising, and the U.S. stock market has continued to decline, which has clearly gone out of the "Correlation of One" situation: when the economy as a whole is facing severe liquidity reduction, people tend to be in a state of "selling what they can sell" rather than "selling what they want to sell". As a market with high volatility, crypto will undoubtedly be one of the areas where liquidity tightens the fastest. Raoul Pal, a famous macroeconomist and founder of Real Vision, also pointed out that when important collateral such as U.S. Treasury bonds are experiencing unprecedented volatility, margin calls will be everywhere.

Today’s crypto market is facing the dilemma of double tightening of internal and external liquidity, and the bloodshed may continue. Celsius and Three Arrows Capital are not the first institutions to fall, nor will they be the last.