The nightmare of the subprime mortgage storm in 2007 reappears, and the collapse of the currency circle is being staged according to the script of the year

Looking back at the financial history of mankind, crises are always strikingly similar, and history keeps repeating itself. And this time,The cryptocurrency industry, which holds high the banner of the decentralized financial revolution, is no exception. Even the speed and scale of the crisis are even more staggering.

About a month ago, Luna-UST, the world’s fourth-largest stablecoin system with a market value of over $40 billion, suddenly collapsed, shocking the entire financial market.

But many people may not have imagined that this seemingly independent event will have a devastating impact on the entire encryption industry in the next month or so.

A butterfly flapping its wings will soon cause a hurricane on the other side of the world. In 2008, the global financial crisis caused by the bankruptcy of Lehman Brothers was like this. Now, the butterfly effect caused by the return of Luna to zero is also sweeping the entire currency circle little by little.

Investing in Luna fiasco, tens of billions of encrypted hedge funds face bankruptcy and liquidation

Since June, cryptocurrencies such as Bitcoin and Ethereum have experienced a continuous plummet. The market value of the entire cryptocurrency has dropped from about $3 trillion in November last year to less than $900 billion at present. In just a few months It has shrunk by nearly 70%. Since last Tuesday, the downward trend has continued to deteriorate. Bitcoin once fell below $18,000 and Ethereum fell below $1,000.

The immediate cause of this week’s plunge is the emergence of explosive bad news-Three Arrows Capital (3AC), one of the largest venture capital firms in the crypto space and one of the hedge funds, is heading for bankruptcy.

Three Arrows Capital was founded in 2012 by two Columbia University graduates, former traders Zhu Su and Kyle Davies, and was previously headquartered in Singapore. Since its establishment, Three Arrows Capital has been focusing on investment in the field of cryptocurrencies. In addition to directly investing in cryptocurrencies such as Bitcoin and Ethereum, it also invests in various encryption projects such as DeFi, Game-Fi, and NFT.

Statistics show that Three Arrows Capital has previously managed assets of 10-20 billion US dollars and is one of the most active investment institutions in the cryptocurrency field.

Three Arrows Capital has always been a faithful believer in the field of encryption. In February last year, founder Zhu Su even proposed a “super cycle” theory, arguing that Bitcoin will rise to $2.5 million a piece in the future, and the total market value will be comparable to gold.

This super-optimistic expectation in the encryption field has also made Three Arrows Capital always very aggressive in its investment strategy. For example, using high leverage to buy Bitcoin, adding leverage to the revolving loan of stETH, making big purchases on various hype hotspots, etc.

The high-leverage play made Three Arrows Capital soar in the last wave of bull market, but it soon suffered a backlash. Among them, the first to go wrong was Luna, who they had bet heavily on.

Before Terra collapsed, Three Arrows Capital spent about $560 million to purchase 10.9 million LUNA, but these Luna were not traded in the market, but almost all pledged on the chain, that is, the so-called 20% Anchor wallet with annualized rate of return.

In addition, the revelations show that Three Arrows Capital not only bought a lot of Luna with its own money, but also obtained funds from multiple hedge funds and counterparties by borrowing to hold UST in Anchor, and then packaged these assets into income. Financial products with a rate of about 8% were sold to a large number of encrypted institutions.

Does it sound familiar? Yes, this is a sub-prime lending model that is layer by layer.

The nightmare of the subprime mortgage storm in 2007 reappears, and the collapse of the currency circle is being staged according to the script of the year

But what Sanjian didn’t expect was that the collapse of Luna-UST was too late. In just a few days of selling, they had no time to deal with a large number of positions in their hands. Today, not only is there about $600 left of its hundreds of millions of dollars in the Luna project, but the ripple effect of subprime lending is starting to unfold.

In an interview with the Wall Street Journal last week, Kyle Davies, co-founder of Three Arrows Capital, said that although the investment in Luna was completely lost, the loss at that time was still within an acceptable range. The real crisis came from a series of subsequent Spiral events triggered by Luna.

The subprime mortgage crisis in 2007 and the bankruptcy of Lehman Brothers

In the early 2000s, the U.S. real estate market continued to rise, and borrowers with bad credit could also use subprime loans (referred to as subprime loans) to obtain loans. Financial institutions lend money to those who cannot afford to pay off the loans, and then group these loans into mortgage-backed securities and financial derivatives, which are then packaged and sold to investors and other financial institutions.

At the time, rating agencies irresponsibly rated the bonds as AAA, and buyers thought they could hedge against risks, such as credit default swaps. In the case of these “products” being packaged and resold in layers, the institutions in the chain have underestimated the risks.

When U.S. home prices began to fall, subprime loans defaulted on a large scale, and those mortgage-backed securities lost most of their value. Caused a sharp decline in the capital of many financial institutions, Lehman Brothers went bankrupt, American International Group was on the verge of collapse, causing a tightening of credit around the world.

The reasons for the financial crisis are different, but generally considered to be: underestimation of systemic risk, moral hazard, dereliction of duty by rating agencies, and lack of financial supervision.

Scholars have suggested the causes of this crisis are diverse and complex. The crisis can be attributed to a number of factors pervasive in housing and credit markets that have only emerged for several years. Suggested causes include inability of homeowners to repay their mortgages, poor judgment of borrowers and/or lenders, speculation and overbuilding during housing booms, risky mortgage products, high personal and corporate debt levels, fragmented and/or Financial products with hidden loan default risks, monetary policy, uneven international trade, and lack of government regulations and controls. Still, moral hazard ultimately plays a central part in many causes.

Back to the present, after the collapse of Luna, the entire encryption field was in a panic, causing Bitcoin, Ethereum and other cryptocurrencies to plummet. In order to make up for Luna’s losses, Three Arrows Capital also had to start selling its crypto assets. But as we said before, the previous investment of Three Arrows Capital can be said to have added high leverage everywhere. According to reports, only less than 30% of the liquid assets on its account are available, and almost all the rest are pledged to obtain leveraged funds.

After the collapse of Luna, many institutions were reluctant to lend funds to Three Arrows Capital and required it to add margins. Many institutions that had previously purchased Three Arrows wealth management products also began to demand redemption of funds. But the problem is that at this time, the three arrows can’t get the money at all. Earlier last week, the liquidity crisis of Three Arrows Capital was still in a state of rumors, until its founder released a tweet on Tuesday saying that “it is dealing with these issues with relevant parties”, which almost confirmed the market speculation and caused panic to start. Scope spread.

Twitter of Zhu Su, founder of Three Arrows Capital

It is understood that there are many institutions in the encryption field that have capital transactions with Three Arrows Capital, including BlockFi, Genesis, Celsius and many other large lending platforms. Everyone knows that once the liquidation of Three Arrows Capital begins, the relevant institutions have no choice but to choose to sell the pledged assets to force liquidation, which will inevitably cause “earthquake-level” damage to the entire market.

Sanjian has not updated any information since the news that it was “solving the problem” last week, and has also deleted social accounts such as Instagram. At the same time, some people noticed that Sanjian was frantically selling its assets.

In the past week or so, Three Arrows Capital has sold about 170,000 Ethereum, and its NFT fund StarryNight has emptied its total of 70 NFT collections. Previously, many people believed that Celsius, the lending platform that had previously reported the news of the suspension of trading, was the “culprit” in selling stETH, but recently everyone discovered that the biggest seller was actually Three Arrows Capital.

A more dangerous signal is that Sanjian was also exposed to privately embezzling user funds to fill the hole. Last week, Danny, the co-founder of the well-known market maker 8blocks capital, posted a long post on Twitter, saying that Three Arrows Capital violated the agreement privately and removed $1 million from the 8BC account without notifying them. This has no replies and is almost disconnected.

The nightmare of the subprime mortgage storm in 2007 reappears, and the collapse of the currency circle is being staged according to the script of the year

Many platforms suspend trading under the tide of running, and the currency circle begins to “self-rescue”

Under the bankruptcy and liquidation crisis of Three Arrows, panic spread widely, and both institutions and retail investors began to sell their assets, and there was obvious transmission risk in the market. In the case of a run on the run, many small and medium-sized trading platforms had to choose to suspend redemption and withdrawal.

On June 16, the encrypted trading platform AEX announced that it would suspend the withdrawal of mainstream assets such as Bitcoin and Ethereum for a period of 36 hours.

On June 17, Babel Finance, an encrypted trading platform, announced that it would suspend all account redemption and withdrawal functions, saying that in the face of greater liquidity pressure, there have been conductive risk events in the industry.

On June 19, the crypto trading platform Hoo announced through its official Twitter account that it would stop withdrawals, saying it would restart trading within 72 hours in order to “handle a large number of users.” On the same day, Finblox, a cryptocurrency trading platform supported by Three Arrows Capital, suspended the distribution of rewards and set a monthly withdrawal limit of no more than $1,500, clearly stating in the announcement that there was a problem with Three Arrows Capital’s business.

The nightmare of the subprime mortgage storm in 2007 reappears, and the collapse of the currency circle is being staged according to the script of the year

It can be said that the institutions associated with Three Arrows Capital in the current encryption field are in a state of danger, and for a while, rumors and conjectures that Three Arrows Capital will cause a systemic collapse are also rampant.

In order to help stabilize the market sentiment, some “mainstays” in the circle have also stood up recently. Some have made it clear that they have nothing to do with Three Arrows Capital and will not be affected, while others have begun to help save the market.

On June 15, Tether, the company behind the world’s largest stable currency USDT, made it clear that Tether had no Celsius in its reserves and had never contacted Three Arrows Capital. At the same time, Tether had reduced its commercial paper holdings by nearly 50% since April.

The encrypted lending platform Nexo also issued an announcement on the same day that Nexo and Three Arrows Capital have zero business and risk, saying that they rejected Three Arrows Capital’s unsecured credit request as early as two years ago.

For those institutions seriously affected by the Celsius and Three Arrows capital issues, the crypto exchange giant FTX also lends a helping hand at a critical moment.

After the thunderbolt of Three Arrows Capital, some analysts said that the next turn would be BlockFi, a centralized financial service institution giant, because it is deeply linked to Celsius and Three Arrows Capital, which is one of the most worrying thunders in the market. But just yesterday, BlockFi CEO Zac Prince posted that he has obtained a $250 million revolving credit line provided by FTX to help alleviate the platform’s liquidity problems when necessary.

Image via OtterooooTwitter

Additionally, today crypto platform Voyager Digital plunged as much as 60% after disclosing its $660 million exposure to Three Arrows. But it also said that Alameda Venture, backed by the CEO of FTX, last week provided it with a line of credit worth $200 million and USDC stablecoins and 15,000 bitcoins to help ease customers’ liquidity needs.

The crisis is not over yet, and a bigger tsunami may be ahead

Although FTX took the lead in starting self-help within the circle, the extent and extent of the impact of Three Arrows Capital is still unknown.

From the announcement released by Nexo, it can be seen that the leverage of Three Arrows Capital has been greatly increased. In addition to asset mortgages, it is also using a large number of unsecured credit loans to obtain funds. While Nexo didn’t lend to it at the time, sources suggest a number of institutions were involved.

Judging from the current situation, the liquidation has not really begun, and Three Arrows Capital is still in a state of selling assets and raising funds to try to fill the holes. For example, Voyager, whose stock price plummeted today, said that their request to Sanjian is to repay $25 million in USDC by June 24, and then repay the entire balance of other USDC and Bitcoin by June 27.

If Three Arrows Capital fails to repay as required by then, the real liquidation and legal process will begin. Voyager who disclosed information today may be just one of the institutions involved in the Three Arrows incident, and more institutions may surface in the future. What is even more worrying is that many institutions are actually playing high leverage like Three Arrows, so once a large-scale explosion occurs, it may trigger a real tsunami.

Share price performance of Voyager trading platform today

Unlike the past few crypto winters, the slump in the currency circle has been squeezed by multiple internal and external factors.

Inside the industry, popular plans collapse, platforms freeze withdrawals, and then hedge funds go bankrupt, pressure is transmitted layer by layer, and market risks spread; outside the industry, the economy is sluggish, inflation is soaring, and the capital market has entered a bear market. In addition, governments of various countries have also accelerated the pace of formulating policies to regulate the encryption market, and the encryption market will be more constrained and regulated.

For the entire encryption field, how to successfully survive this crisis without the central bank’s adjustment and rescue may be a big test for the decentralized financial system.

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