Singapore-based venture capital firm Three Arrows Capital (3AC) failed to meet its financial obligations on June 15, causing severe deficiencies among centralized lending providers like Babel Finance and staking providers like Celsius .
On June 22, Voyager Digital, a New York-based digital asset lending and yield firm listed on the Toronto Stock Exchange, saw its shares plummet nearly 60% after disclosing $655 million in exposure. at Three Arrows Capital.
Voyager offers crypto trading and staking and had approximately $5.8 billion in assets on its platform as of March, according to Bloomberg. Voyager’s website mentions that the company offers a cashback Mastercard debit card and would pay up to 12% annualized rewards on crypto deposits without blocking.
Most recently, on June 23, Voyager Digital lowered its daily withdrawal limit to $10,000, as reported by Reuters.
Contagion risk has spread to derivative contracts
It’s still unclear how Voyager took on so much liability to a single counterparty, but the company is prepared to take legal action to recover its funds from 3AC. To stay solvent, Voyager borrowed 15,000 Bitcoins (BTC) from Alameda Research, the crypto trading firm run by Sam Bankman-Fried.
Voyager also secured a $200 million cash loan and another $350 million USDC Coin (USDC) revolver loan to protect customer claims. Analysts at Compass Point Research & Trading LLC noted that the event “raises survivability questions” for Voyager, therefore, crypto investors are wondering if other market participants could face a similar outcome. .
– Trading derivatives and unsecured options on Deribit
– $650 million in unsecured debt with Voyager
– Offer protocol/wallet companies 8-10% APY on their cash balances
— Dylan LeClair (@DylanLeClair_) June 22, 2022
While there is no way to know how centralized crypto credit and yield firms operate, it is important to understand that a single derivatives contract counterparty cannot create contagion risk.
A crypto derivatives exchange could be insolvent and users would only notice it when trying to withdraw. This risk is not exclusive to the cryptocurrency markets, but is increased exponentially by the lack of regulation and weak reporting practices.
How do crypto futures contracts work?
The typical futures contract offered by the Chicago Mercantile Exchange (CME) and most crypto derivatives exchanges, including FTX, OKX, and Deribit, allows a trader to profit from their position by depositing margin. This means trading a larger position relative to the initial deposit, but there is a catch.
Instead of trading Bitcoin or Ether (ETH), these exchanges offer derivative contracts, which tend to follow the price of the underlying asset but are far from being the same asset. So, for example, there is no way to withdraw your futures contracts, let alone transfer them between different exchanges.
Additionally, there is a risk that this derivatives contract detaches from the actual price of the cryptocurrency on regular spot exchanges like Coinbase, Bitstamp, or Kraken. In short, derivatives are a financial bet between two entities, so if a buyer lacks the margin (deposits) to cover it, the seller will not take home the profits.
How do exchanges manage derivatives risk?
An exchange can manage insufficient margin risk in two ways. A “clawback” means withdrawing profits from the winning side to cover losses. This was the norm until BitMEX introduced the insurance fund, which eliminates every forced liquidation to handle these unexpected events.
However, it should be noted that the exchange acts as an intermediary because every transaction in the futures market needs a buyer and a seller of the same size and the same price. Whether it is a monthly contract or a perpetual futures contract (reverse swap), both the buyer and the seller are required to deposit margin.
Crypto investors are now wondering if a crypto exchange can go insolvent or not, and the answer is yes.
If an exchange incorrectly handles forced liquidations, it could impact all traders and businesses involved. A similar risk exists for spot exchanges when the actual cryptocurrencies in their wallets are shorter than the number of coins reported to their clients.
Cointelegraph has no knowledge of anything abnormal regarding Deribit’s liquidity or solvency. Deribit, along with other crypto derivatives exchanges, is a centralized entity. Thus, the information available to the general public is far from ideal.
History shows that the centralized crypto industry lacks reporting and auditing practices. This practice is potentially harmful to every individual and company involved, but with respect to futures, the risk of contagion is limited to participants’ exposure to each derivatives exchange.
The views and opinions expressed herein are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research before making a decision.