Crypto crash exposes overleveraged trades, risking deeper losses
As prices of bitcoin and other cryptocurrencies continue to tumble, overextended investors pose the risk of a cascade of forced sales that could drive the tokens even lower.
In one of the latest developments in the cryptocurrency crash, Singapore-based hedge fund Three Arrows Capital, one of the biggest crypto players, failed to meet margin calls this week. Some of the fund’s positions were liquidated, the Financial Times and others report.
Three Arrows invests in a range of cryptocurrency companies and projects. One of the targets is a company behind Terra Classic USD, the stablecoin pegged to the U.S. dollar that lost parity last month and plunged.
Three Arrows’s assets under management once reached an estimated $10 billion, but had shrunk to $4 billion in recent months, the Financial Times reports, citing an industry source.
Many of the cryptocurrencies listed on Three Arrows’ webpage have sunk more than 80% in value from their peaks in 2021, owing to a combination of rising interest rates and concerns about the financial health of crypto players.
The value of bitcoin now hovers around $20,000, having dropped to a third of its peak in November.
Leveraged trades rely on borrowing, which makes the risks and rewards greater. There are an estimated 1,900 cryptocurrency hedge funds, and most appear to use leverage to trade at higher volumes while putting up only a small amount of collateral.
The Bank for International Settlement warned about the dangers of the high leverage characteristic of decentralized financing in a report published in December.
“When debt eventually needs to be reduced, [for example] because of investment losses or depreciating collateral, investors are forced to shed assets, putting further downward pressure on prices,” wrote BIS.
There is also growing alarm over the health of crypto lenders. Such platforms source cryptocurrency from retail investors with promises of annual returns up to 20%. The tokens are lent to funds or other investors, or managed by the platforms themselves.
BlockFi, a U.S. crypto lending platform that was reportedly among those that liquidated Three Arrows positions, said it had exercised that option against an unnamed “large client” that failed to meet obligations.
“We fully accelerated the loan and fully liquidated or hedged all the associated collateral,” BlockFi CEO Zac Prince wrote on Twitter.
This week, BlockFi announced it would cut a fifth of its workforce. Finblox, a midtier crypto lender, said Thursday that it is pausing distributions of yields to investors and imposing a tighter cap on withdrawals. The company described Three Arrows as a “prominent institutional borrower” and investor in Finblox.
The three biggest crypto lenders have raised roughly $34 billion from over 6 million people. Unlike banks, they are not governed by capital adequacy rules or other legally binding regulations.
The world’s second-biggest crypto lender, U.S.-based Celsius Network, told users Sunday that it will pause all withdrawals after facing a crisis like a bank run fueled by rumors of insolvency.
“Were the high returns really generated by lending or asset management?” Nana Otsuki, chief analyst at Japanese brokerage Monex, says of crypto lenders in general. “They might have been a financial juggling act that relied on funds from new members.”
