USD Coin Stablecoin Interest Update: CeFi Implosion

In my article USCoin: How To Earn 6-12% Interest Safely With Stablecoins, I recommended considering high interest stablecoins to avoid the melting ice cube problem — optimizing portfolios to fight inflation, even for cash reserves. My thesis was to hold high interest stablecoins on reputable exchanges to offset dollar value destruction.

And for me, the best stablecoin for crypto yield is still USD Coin (USDC-USD). USDC is fully backed by cash and short-dated U.S. government obligations, and always redeemable 1:1 in US dollars.

But since that article the entire crypto industry has experienced turmoil around specific coins and institutions leading to cascading liquidations, huge waves of selling, and the destruction of almost a trillion dollars from the global cryptocurrency market cap. The companies offering crypto interest were deeply affected and several have entered bankruptcy due to reckless and risky investments.

This update will trace the events that brought us to this point and revisit the financial health of the platforms reviewed in my first article.

The Precipitating Event: The Terra Disaster

In May of this year the algorithmic stablecoin Terra (UST-USD) broke its dollar peg; value rapidly shrank to zero for UST and its companion token (LUNC-USD). Between the two coins, about $60 billion of value disappeared in a breathtaking fashion.

In my stablecoin article, I warned my readers to stay away from UST. No algorithmic stablecoin has succeeded long term and the attempts are far too risky for the prudent investor. But incredibly, some of the biggest names in the crypto lending and investment funds had significant exposure to UST or LUNA and suffered because of it.

As shocking as the Terra blowup was, analysts were rightly concerned about collateral damage, called contagion, appearing elsewhere.

The Next Domino: Three Arrows Capital

Three Arrows Capital Ltd. is a hedge fund established in 2012 and was focused on providing superior risk-adjusted returns, founded by Su Zhu and Kyle Davies. 3AC lost over $200 million in LUNA when the Terra ecosystem imploded in mid-May. “The Terra-Luna situation caught us very much off guard,” Davies told the WSJ.

3AC was also one of the largest holders of Grayscale Bitcoin Trust (GBTC) and staked Ethereum (stETH) tokens. When both of these assets experienced steep declines, their loans began being liquidated by lenders.

A New York bankruptcy court has frozen all remaining assets of 3AC. According to lawyers representing the creditors the whereabouts of Zu and Davies are unknown.

The CeFi Bank Run Panic

Because of the Terra Luna disaster and the 3AC blow-up, doubts began mounting that the Centralized Finance (CeFi) banks were solvent. These are crypto lenders that take in customer assets, lend them back out to hedge funds and other institutions, and pay a portion of the interest they receive back to individual clients.

The biggest potential issues with CeFi platforms were always cyber security (avoiding loss through hacks) and risk management (losing funds to poor investment choices). The problem for investors was a lack of transparency around what these firms were doing to generate yield.

People began to openly question these platform’s risk management strategies, if they were affected by the Three Arrows Capital debacle, and whether they had sufficient liquidity to cover a bank run type event where customers attempted to withdraw all their assets.

CeFi Health Check

Here’s the current status of the platforms I listed in my previous article.

Abra Status: Normal operations

Abra has touted their sound risk management practices and so far they appear to be unaffected by the bank run plaguing other platforms. I personally have recently withdrawn a substantial amount of coins from Abra because my assets got locked on two other platforms and I couldn’t take any more risk during this turbulent time. The withdrawals were processed without an issue.

In a Twitter message exchange with Abra CEO Bill Barhyde, I expressed the need for CeFi platforms to release a proof of reserves attestation to give depositors assurance that funds are present. He agreed and said Abra has started that process, and that they are fully committed to releasing it when their auditor is ready.

BlockFi Status: Normal operations

BlockFi was pummeled by a “bank run” panic after Celsius paused withdrawals, but never wavered in their operations. This was partially because they had better risk management procedures but perhaps more importantly received a $250 million credit facility from FTX.

Celsius Network Status: Withdrawals closed, filed for bankruptcy

Celsius paused all withdrawals, swaps, and transfers between accounts on June 12 and hired external Legal and Finance teams to advise on how to restructure the company.

Over the next several weeks, analysts watched a series of moves in crypto wallets associated with Celsius as the beleaguered company began repaying DeFi loans to free up capital once used as collateral.

Although some loyal Celsius users held out hope the company could unwind enough assets to resume normal operations, the other shoe dropped on July 14 when the company filed petitions for Chapter 11 reorganization.

The bankruptcy document signed off by CEO Alex Mashinsky shows the company holds around $4.3 billion in assets against $5.5 billion in liabilities, a $1.2 billion deficit.

With the huge hole in the balance sheet and no white knight appearing to rescue Celsius, prospects for depositors appear grim.

Crypto.com Status: Normal operations

As far as I can tell, Crypto.com has not been affected by recent events.

Hodlnaut Status: Normal operations

As far as I can tell, Hodlnaut has not been affected by recent events.

Vauld Status: Withdrawals closed, signed a 60 day letter with Nexo

On July 4, Vauld suspended all withdrawals, trading, and deposits and as with Celsius, hired Legal and Finance advisors to look at restructuring the company. Vauld has disclosed assets worth ~$330 million and liabilities worth ~$400 million at this time.

Vauld has signed a term sheet with Nexo for a 60-day exclusive period. This allows an:

exploratory period related to its intended acquisition of Vauld, pending a satisfactory outcome of the initiated due diligence process. Upon successful completion of the transaction, Nexo plans to acquire up to 100% of Vauld and reorganize its future operations with the aim to accelerate its deeper presence in Asia.

Voyager (OTCPK:VYGVQ) Status: Withdrawals closed, filed for bankruptcy

Voyager “temporarily suspended” trading, deposits, withdrawals, and rewards on July 1, 2022 and has voluntarily entered in Chapter 11 bankruptcy to reorganize their financial obligations and hopefully resume normal operations sometime in the future.

Voyager unexplainably made a $670M unsecured loan to 3AC which is now in default. This extremely risky transaction was either based on 3AC’s previous stellar industry reputation or faulty financial information. From Bloomberg:

On June 30, the Monetary Authority of Singapore reprimanded 3AC, without a fine or other sanction, for providing false information and exceeding the limit on its assets under management.

Skin In The Game

Had I known that any CeFi lenders had exposure to Terra, were making unsecured loans, or engaging in any other risky investments, I would have eliminated them from any consideration for high interest yield. Unfortunately, we don’t know who is swimming naked until the tide goes out.

This is a tough lesson learned both for me and other content creators. Bitboy creator Ben Armstrong (1.45M YouTube subscribers) promoted Celsius Network with referral links, and now has multiple millions stranded there. Scott Melker, also known as “The Wolf of All Streets” stated he is listed among the top 50 depositors on Voyager, a sum he described as “millions.”

I had a few assets on Celsius and Vauld which totalled a very small percentage of my overall holdings. But Simon Dixon, a Celsius depositor, shareholder, and head of Bank to the Future, has related stories of people who staked their life savings on Celsius and are now desperate for help. The Celsius situation is especially tangled and may have additional twists and turns before the whole story is revealed.

I still believe yield generated from institutional lending is possible with crypto just as it is for traditional finance institutions such as JP Morgan (JPM). However, CeFi banks must provide a higher level of transparency to give depositors confidence again. Congress will certainly jump on these events as an opportunity to regulate the industry — which may be a good thing.

As mentioned above, I also had coins on Abra, which I successfully withdrew just to be safe. Going forward, Abra is the one platform I’ll carefully test with redeposits, but only after they publish their promised attestations.