From Celsius to Three Arrows Capital, major players in the industry lost out due to the crypto crash of 2022. Although the market appears to be stabilizing now, the ripple effect of the LUNA/UST collapse is still being felt by companies today.
The latest victim of it has been Singapore-based crypto exchange Zipmex, who recently filed for bankruptcy protection in Singapore.
Previously, Zipmex announced on July 20 that customers would not be able to withdraw their crypto holdings until further notice. The company cited reasons “beyond its control” such as volatile market conditions and difficulties arising from key business partners.
While it is true that Zipmex was not able to anticipate market volatility, it certainly would have been better prepared for it. In fact, the difficulties facing the platform appear to be due to mismanagement of funds – a decision that Zipmex has always controlled.
To understand this, let’s connect the dots between Zipmex and the LUNA/UST crash.
The main problem: positions with excessive leverage
At the beginning of the LUNA/UST crash, crypto lender Celsius was hit hard by a token called Lido Staked ETH (stETH), whose value was tied to Ether (ETH).
The company accepted ETH deposits from its client and pledged them against stETH. These deposits offered an interest rate of about four per cent. Next, Celsius used stETH as collateral to borrow more ETH. Finally, ETH is put into the stETH exchange, and the cycle will repeat.
To illustrate, let’s say you have 100 ETH, which you share for 100 stETH. At this point, you can expect a return of 4 ETH per year.
After that, you can use 100 stETH as collateral to borrow 70 ETH, and participate in that too. Now, your return rises to 6.8 ETH annually. You also receive 70 stETH which you can use to repeat the process.
By doing this over and over again, you are taking a position of increasing leverage. This is how Celsius has been able to offer its clients high returns on their ETH deposits.
As one might expect, as the leverage increases, so does the risk.
Going back to the example, you currently have a loan of 70 ETH secured by 100 stETH. The loan issuer assures that at any time, your loan cannot be more than 80 percent of your collateral.
Therefore, if the value of 100 stETH falls below the value of 80 ETH, you will either have to increase your collateral, or your position will be liquidated. If additional leverage is used, it will become more difficult to maintain your position, because you will be required to increase a larger amount in case of volatility.
The position of the percentage was dependent on the stability of the binding between ETH and stETH. The company did not hedge against a scenario in which this peg is broken.
As it turns out, that’s exactly what happened. The panic caused by the collapse of LUNA/UST caused the value of stETH to drop below that of ETH. If Celsius does not provide sufficient guarantees, its entire position will be liquidated, which means that the company will lose a significant part of its clients’ funds.
This forced a Celsius to stop withdrawals. Since the platform was using its funds to hold an excessively leveraged position, it no longer had the liquidity to meet withdrawal requests from its clients.
On July 13, Celsius announced that it had filed for bankruptcy.
This example of over-leveraged trading is not a one-time case, nor is it limited to ETH/stETH. It is the main reason behind the successive fall of crypto companies, which is what we are witnessing today.
How does this tie with Zipmex?
Zipmex offers its users annual bonuses of up to 10 percent on crypto deposits. The company generated these rewards by lending cryptocurrency to other platforms.
At the time of the LUNA/UST collapse, Zipmex had provided $48 million to Babel Finance and $5 million to Celsius. Both companies were exposed to excessively leveraged positions, and as a result were forced to freeze withdrawals when the market crashed.
Zipmex, which has now been unable to collect these loans, has had to freeze withdrawals as well. As it stands, the company has written off its loan to Celsius, but is working with Babel Finance to recover customer losses.
The market crash has highlighted the interdependence between different companies in the cryptocurrency space. The crash started with big companies managing billions of dollars in money, and now the consequences are mounting to the smaller companies they invested with.
How can individual investors avoid such risks?
By asking the right questions.
If a cryptocurrency exchange is offering a 15 percent interest rate on a coin, where will those returns come from? It is important to realize this while coding Can Offering attractive investment opportunities, it does not generate money out of thin air.
With centralized exchanges – such as Zipmex – it is not always clear how your holdings will be used for further investments. As has been evident over the past month, this creates inaccessibility risks if the company encounters liquidity problems.
To ensure that your funds are protected, it is best to use an exchange that is regulated by the Monetary Authority of Singapore (MAS). While a lot of cryptocurrency exchanges Based on In Singapore, many of them are not yet licensed and only operate under the exemption.
Purchasing cryptocurrencies through a licensed exchange ensures that you can seek legal recourse if the company has mismanaged your funds.
Using decentralized wallets and personally managing your holdings is another option.
In the long-term view of the industry, most DeFi builders, advocates, and commentators believe that the collapse of centralized platforms is a revolutionary case for DeFi, as users want self-custody of assets. as the saying goes, “It’s not your keys, it’s not your assets.”.
– Imran Mohamed, Head of Marketing, Keeper Network
Lending cryptocurrency and earning interest through DeFi protocols allows you to be fully aware of your risks and prevents losses from third party mismanagement.
Decentralized Exchanges (DEX) allow users to earn returns to provide liquidity. For example, let’s say you deposit your holdings of ETH and USD Coin (USDC) into a liquidity pool. When someone converts between two cryptocurrencies using DEX, you will earn a portion of the transaction fees that are charged. In this case, it is very clear where your returns are coming from.
“This is organic and sustainable, not guaranteed,” explains Mohamed. “You might see some of these pools with less than 1 percent of APRs and some with more than 100 percent of APRs, and these happen because of supply and demand in the market, not backed by external funding.”
Featured Image Credit: Zipmex / Outlook India