The cryptocurrency industry has been “abandoned” in recent weeks by a “Ponzi-style Ponzi scheme”. [Bernard] Madoff,” faced with a case similar to the one that “sinked Long Term Capital Management (LTCM),” research firm FSInsight said in a report on Friday analyzing the implications of the implosion of cryptocurrency hedge fund Three. Arrows Capital (3AC).
Madoff in that scenario would be 3AC founders Su Zhu and Kyle Davies, who used their reputation to “borrow recklessly from almost every institutional lender in the business”, resulting in pain for some big names in the industry, including Voyager Digital. , Babel Finance and BlockFi, said Sean Farrell, head of digital asset strategy at FSInsight.
At its peak, 3AC’s assets under management were reportedly in excess of $18 billion, according to the note. However, given the amount of debt now known to have been lent to them, it is unclear at this point how much real estate was at risk.
It is likely that the pair were simply “using borrowed funds to pay interest on loans issued by lenders, while glossing over the numbers to show massive returns on capital,” the report says.
Given the size of exposure that companies like Voyager and BlockFi had in the fund, it appears that the vast majority of 3AC’s assets were bought with debt and its collateral fee was quite small, according to Farrell.
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Several factors contributed to this loss of leverage and the drop in 3AC, FSInsight said.
“Macro conditions preceded the destruction of global asset prices, reducing the collateral value of any crypto asset, and 3AC invested heavily in LUNA/UST which did not help the situation, however we think the downward spiral started with the 3AC’s leveraged bet on the Grayscale Bitcoin Trust (GBTC),” the report states.
The main problem with 3AC’s use of this trade is that they were highly leveraged, and when the arbitrage business disappeared, 3AC was likely still locked into GBTC, FSInsight said.
However, rather than walking away with a small loss upon unlocking, 3AC likely doubled down, hoping the discount would converge to the net asset value (NAV) once a Bitcoin (BTC) exchange-traded fund (ETF) spot was approved, Farell added.
FSInsight says this trade will ultimately pay off for patient investors, but the timing is unclear as the spot ETF can be approved in weeks, but it could also take years.
As asset prices plummeted and margin calls triggered, 3AC was no longer able to maintain its “serial leverage chain,” which caused illiquidity issues throughout the cryptocurrency lending medium, the report said. report.
The super-leveraged nature of this arbitrage trading is similar to the types of trades that were the “death” for Long Term Capital Management, the report added.
Recent data shows capitulation among Bitcoin holders, FSInsight said, but there is still a risk that growing miner positions could be a source of further selling pressure.
While the short-term picture of digital asset prices remains “treacherous”, the market has reached a low price area for Bitcoin that long-term investors should take advantage of, he added.
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