When the annals of digital finance are written, 2022 will be remembered as a year of significant upheaval for the cryptocurrency sector. A series of shocks triggered a tsunami of changes in the industry, particularly for crypto platforms which experienced an explosive growth. This growth was spurred by a unique combination of events, market dynamics, and consumer behavior.
A shockwave of instability
The dominoes began to fall in May 2022, when TerraUSD, a once-reliable stablecoin, collapsed. It sparked doubts about the viability of its stabilization mechanism and led to a mass exodus of customer funds from platforms like Celsius and Voyager Digital.
A staggering $935 million had been invested by Celsius in TerraUSD and the Anchor protocol alone, making its 20% loss of customer funds in the ensuing eleven days a significant hit.
Similarly, Voyager Digital hemorrhaged 14% of its customer funds. The aftershocks of TerraUSD’s demise were also felt by BlockFi, which reported outflows of a whopping $4.4 billion from January to May 2022.
The downfall of Three Arrows Capital (3AC), a hedge fund specializing in crypto assets, was the second shock to the system. Its collapse, in part due to the TerraUSD debacle, sparked another round of withdrawals from Celsius and Voyager Digital, estimated at 10% and 39% respectively.
This turmoil undoubtedly contributed to the $3.3 billion outflows from BlockFi reported between June and November 2022. It was found that each firm had loaned significant assets to 3AC, resulting in colossal losses and frantic efforts to secure financial support when the hedge fund failed.
The final blow: FTX’s collapse
The crypto world was rocked again in November 2022 with the failure of FTX. This shockwave resulted in outflows of 37% of customer funds. Genesis and BlockFi also suffered, with customers withdrawing about 21% and 12% of their investments, respectively, leaving BlockFi a mere shell of its former self.
The 2022 events illustrate the perils that can befall platforms operating on high-risk business models, offering high-yield investment products with the ability to withdraw funds on demand.
These platforms used customer funds for illiquid and risky investments, making them susceptible to runs. It became apparent that the large size and rapid pace of these runs were influenced by a lack of deposit insurance and trust issues, along with the platforms’ recent establishment and untested resilience.
Moreover, the runs were primarily initiated by customers with large holdings, some of which were sophisticated institutional customers, revealing a significant disparity in the risk appetite among different investor types.
The ease of electronic withdrawals also facilitated the runs, highlighting how digital technology can exacerbate financial crises.
Lastly, the quest for high returns led to these platforms holding insufficient liquidity buffers. Despite FTX, Celsius, and BlockFi’s attempts to maintain substantial liquidity buffers, all proved inadequate when faced with the magnitude of these crises. It has called into question whether these buffers were ever truly existent.
The manner in which these events unfolded underscored the importance of maintaining adequate liquidity buffers. The platforms’ pursuit of high returns, which involved taking on illiquid and risky investments, proved detrimental when the tides turned.
As we reflect on 2022, it’s clear that this explosive growth was not a sign of robust health in the crypto sector but was instead a symptom of an underlying fragility.
