Terra’s collapse sent shockwaves across crypto markets. Coupled with a wider market downturn due to bearish macro factors, crypto firms are being hit hard.
Just look at the recent stETH crisis and Solend’s controversial proposal to take over a whale’s account — they are signs that our $900 billion crypto industry (a major slump in market cap from November’s $3 trillion) is facing a liquidity crunch and contagion risks.
What is Contagion Risk?
Crypto is experiencing a sell-off as investors choose to go risk-off, relinquishing their coins and tokens in favour of safer or more liquid assets like bonds, gold and cash.
Already, this huge demand for liquidity has seen major DeFi players accrue bad debts. Crypto lenders Celsius and Babel Finance have frozen withdrawals, citing liquidity pressures. Even prominent crypto hedge fund Three Arrows Capital (3AC) is facing liquidity troubles. These companies are systemically important firms. Their collapse could trigger a negative cascade and spread to more key players in the market who are financially exposed to them.
For example, crypto exchange Voyager Digital was revealed to have had around $667 million in exposure to 3AC. While Voyager requested 3AC to repay its debts by the end of June, 3AC may be unable to meet this deadline. This means that Voyager now does not have enough liquid assets to fully meet customer liquidity needs.
After crypto’s 2021 boom, there is now a lot more leverage in the system. DeFi projects are also promising high, unsustainable returns to customers and lending funds to other firms in a circular fashion. Thus, when one firm starts experiencing liquidity pressures, other firms connected to it face problems as well. More contagion risks like this would destabilize the industry and potentially affect the overall financial system.
Do bailouts truly benefit us?
At this time, the industry is depending on large players to bailout those in trouble. For example, crypto lending platform BlockFi announced that it had secured a $250 million revolving credit facility from FTX, one of the largest centralized crypto exchanges, to fulfill client balances across all accounts.
But ask yourself: Are bailouts necessarily the best solution? They may be a lifeline for struggling companies now, but these are merely bandaids put over gushing wounds. Many quickly forget what caused these troubles in the first place — lack of proper risk management, inflated yields and unscrupulous marketing. Bailouts now do not guarantee a change in these negative practices, especially if entire business models are built on top of them. In the long run, the crypto industry will continue to suffer.
The alternative solution — survival of the fittest — looks harsh, but until a better solution comes along, perhaps this is necessary to weed out a majority of unsustainable projects and practices in DeFi. It is imperative today that firms take up responsibility to answer to their users and the industry, and help set a solid foundation for a truly value-adding crypto ecosystem.
The views expressed in this article are the author's alone and do not necessarily represent the views of ApolloX.
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