Here is some crypto contagion for you:
The fallout from troubled crypto hedge fund Three Arrows Capital Ltd. has reached Voyager Digital Ltd., sending shares of the crypto exchange down 51% in Toronto trading with analysts raising the prospect of further damage.
Voyager said it may issue a notice of default to Three Arrows for failure to repay a loan, the exchange disclosed in a statement. The broker’s exposure to Three Arrows includes 15,250 Bitcoin and $350 million of stablecoin USDC, worth roughly $660 million based on Bitcoin’s price on Wednesday in New York.
New York-based Voyager, which offers crypto trading, staking -- a way of earning rewards for holding certain cryptocurrencies -- and yield products, is listed on the Toronto Stock Exchange and its shares are traded over-the-counter in the US. It had about $5.8 billion of assets on its platform as of quarter-end in March.
Voyager is a public company, so you can look at its financial statements. Its most recent financials — as of March 31 — report about $6 billion (USD) of assets, of which about $2 billion are “crypto assets loaned,” and about $5.7 billion of liabilities, of which about $5.5 billion are “crypto assets and fiat payable to customers”; shareholders’ equity is about $258 million. The loan to Three Arrows is for more than twice Voyager’s total capital. From the notes to those financial statements:
The Company utilizes the functional authority granted by customers in the user agreement to pledge, repledge, hypothecate, rehypothecate, sell, lend, stake, arrange for staking, or otherwise transfer or use any amount of crypto assets held in customer accounts. …
The crypto assets lent by the Company are exposed to the credit risk of the institutional borrowers. The Company limits such credit risk by lending to borrowers that the Company believes, based on its due diligence, to be high quality financial institutions with sufficient capital to meet their obligations as they come due. The Company’s due diligence procedures for its lending activities may include review of the financial position of the borrower, liquidity levels of the borrower in applicable assets, review of the borrower’s management, review of certain internal control procedures of the borrower, review of market information, and monitoring the Company’s risk exposure thresholds. The Company’s Risk Management Committee meets regularly to assess and monitor the credit risk for each counterparty. As of March 31, 2022, the Company has not experienced a material loss on any of its crypto assets loaned.
If you put your Bitcoins with Voyager, it can lend them out. As of March 31, that was a good business that did not lose money. As of June, not so much.
It is striking that the crypto world is having, in miniature, a 2008 financial crisis. Voyager is in some loose sense a bank: It has customers who deposit money or Bitcoin at Voyager and expect to get that money or Bitcoin back.[5] But it “utilizes the functional authority granted by customers in the user agreement” to do stuff with that money or Bitcoin to make a profit. It is a fairly thinly capitalized bank, with shareholders’ equity representing about 4.3% of assets. And it is a bank that makes concentrated loans to crypto hedge funds. You thought your deposits were safe, but really they were being loaned out to a risky hedge fund, and now they are in danger.
In 2008 the problem was mostly addressed with government bailouts, but it was also addressed a little bit by Warren Buffett coming in and giving banks (1) a vote of confidence from a famous rich guy and (2) some cash for a subordinated claim on their assets. In crypto the role of Warren Buffett is played by Sam Bankman-Fried:
Sam Bankman-Fried, the crypto billionaire who co-founded digital-asset exchange FTX Trading Ltd., is providing credit lines to try to stem contagions for his beleaguered industry.
Crypto lending platform BlockFi Inc., which had been raising funds at a reduced valuation, said on Tuesday that it secured a $250 million revolving line of credit from FTX. Last week, crypto exchange Voyager Digital Ltd., whose shares are down 90% this year on Toronto Stock Exchange, got a $200 million credit line -- a mix of cash and USDC stablecoins -- as well as a separate, 15,000-Bitcoin revolving facility from Alameda Research, Bankman-Fried’s trading firm.
Here is a press release about the credit facility, which is “intended to be used to safeguard customer assets in light of current market volatility and only if such use is needed.”
Mostly what I think is interesting here is that there is a story about crypto that says it is a reaction to the 2008 financial crisis. In this story, people lost confidence in the traditional banking system because it was opaque and overlevered; people thought their money was safe but then it turned out that their banks were putting their deposits into scary hedge funds and losing their money. People draw a line between Occupy Wall Street and crypto: Crypto, the theory goes, is a financial system that (1) does not rely on the evil legacy banks and (2) addresses some of the worst tendencies of those banks.
For instance, crypto avoids fractional reserve banking: A Bitcoin is a Bitcoin, not the debt of some bank, so there is no buildup of leverage in the system as investors hunt for safe assets. Crypto avoids the opacity of traditional banks: Crypto transactions occur on an open transparent blockchain; there are no hidden obligations that can bring the system down. Crypto is decentralized and open; “code is law”; mistakes lead to failures, not bailouts. “The basic philosophical difference between the traditional financial system and the cryptocurrency system is that traditional finance is about the extension of credit, and crypto is not,” I wrote earlier this month.
But the current crypto winter shows that this is amazingly untrue in practice. There is a ton of leverage and interconnection, and who owes what to whom is surprisingly opaque, and when it causes problems it is addressed by negotiated bailouts from large crypto players. Crypto has recreated the opaque, highly leveraged, bailout-prone traditional financial system of 2008.
I don’t know what to make of that. Mostly I just want to say: What an accomplishment! Rebuilding the pre-2008 financial system is a weird achievement, but certainly a difficult one, and they went and did it. One other possible conclusion is that that system was somehow … “good” might not be the word, but “natural”? Like, something in the nature of finance, or in the nature of humans, tends toward embedding opaque leverage in financial systems? Crypto was a reaction against that tendency, but as time went on, that tendency crept into crypto too.