the money game

Crypto Has Entered the Next Phase of Its Crisis

Photo-Illustration: Intelligencer; Photo: Getty Images

The months-long fall in crypto markets has, for the most part, been a kind of contained demolition. But the fallout is starting to spread.

The collapse is now affecting the corporate and financial infrastructure of the digital-currencies realm. The question of how much trouble — and how much contagion — is still ahead came into stark relief when Voyager Digital, a New Jersey–based lender central to the crypto market, announced that it had filed for Chapter 11 bankruptcy in Manhattan federal court on Wednesday. What made Voyager’s implosion so shocking was that, in an industry rife with apparent fraud and shady characters, here was a company that had striven for the kind of steadiness and transparency one might expect of a traditional finance company. It went public on the Toronto Stock Exchange in 2019. The co-founders included the CEO of E*Trade’s professional arm and Uber’s founding chief technology officer as well as executives from Morgan Stanley and Warner Music. And it got backing from Sam Bankman-Fried, the co-founder of crypto exchange FTX and hedge fund Alameda Research — and even though the guy looks like he repairs iPhone screens for his summer job, he has a $10 billion net worth.

Voyager’s core business was to act as middleman between crypto buyers and sellers. It attracted depositors’ money with sky-high interest rates and then turned around to let one particular hedge fund, Three Arrows Capital, trade with a very large share of of that borrowed capital. Unfortunately for Voyager, Singapore- and Dubai-based Three Arrows blew up last month in a supernova of what is, at best, speculative stupidity. The result? Voyager is now telling customers that it’s not able to access their money while it goes through the courts, though it could, maybe, end up with some of their money back after the whole process is over.

Of course, Voyager isn’t the only one out there facing tough times. The crypto market overall has lost two-thirds of its total value, dropping to around $900 billion from a peak of around $3.3 trillion in November. Any ride down that far and that fast involves casualties. What’s becoming clearer now is the role that crypto lenders — an unglamorous but crucial node in the financial ecosystem — have played in bringing the market down. Another lender, Genesis, is reportedly out hundreds of millions of dollars, also from its exposure to Three Arrows. Various other big-in-crypto companies have also curtailed withdrawals, including Celsius, BlockFi, Babel Finance, and CoinLoan. Even the lender Vauld, backed by Silicon Valley royalty like Peter Thiel, is calling it as holders run for the exits. With Celsius and BlockFi — two of the largest lenders — each holding a little more than $10 billion in customer deposits as of June, and Voyager filing a report saying it holds more than $1 billion in assets and liabilities, this has effectively sucked out tens of billions of dollars’ worth of tradable crypto from a market that’s already seizing up.

At a basic level, crypto lenders operate like your typical Chase branch, taking in people’s money and lending it out to other investors for a fee — except they do it without the regulations that apply to traditional banks. This doesn’t mean that what they’re doing is illegal (though a few, including Celsius and BlockFi, have been investigated or had to pay fines), but banks have rules about leverage, essentially limits on how they can use customer deposits. Those regulations exist for a reason: Loans are bets that a company, or a person, will pay the bank back. What we’re seeing now is that these crypto companies lent out too much money at a really bad time. Now, in order to survive, they have to hang onto their deposits (want your money back? Tough luck!) while also seeking legal protection from bankruptcy courts and bailouts from rich crypto investors. In that latter capacity, Bankman-Fried, in particular, has been happy to jump in and spread money around, injecting hundreds of millions of dollars into BlockFi and Voyager. It’s a spending spree that could wind up giving him extensive, perhaps unprecedented, control of the crypto markets of the future. He says he still has billions in untapped funds if he needs to go in and rescue more companies.

The present woes didn’t come out of nowhere. The global inflation crisis and rising interest rates was sucking money out of the financial system in May, when TerraUSD and Luna, two of the largest digital currencies, collapsed, erasing some $60 billion from the markets. Those currencies were propped up by a lending program subsidized in part by Three Arrows, which was also a large holder of those now nearly worthless tokens. As the broader crypto markets dropped, Three Arrows struggled to meet its obligations, and it was forced to file for bankruptcy protection in New York after a British Virgin Islands court ordered it to liquidate.

The details of the Voyager restructuring here are complex, but the gist of it is that the little guys — including some who have the most to lose — are going to have to wait before they get their money.

Market collapses don’t have easy solutions. The sheer size of Voyager’s balance sheet means it has deep obligations to the wider world of crypto finance. The money it corralled helped prop up the wider crypto market, and now the demands of the market are dictating who will get paid, if anyone gets their money back at all.

At the end of all this, there are still difficult questions left to be answered: How much money would it take to make all these lenders operate normally again? What would be different about the next run on the crypto banks? With so many lenders stopping withdrawals, it’s not clear how extensive the contagion may be or if there’s anything that could stop it.

Crypto Has Entered the Next Phase of Its Crisis