Hedge fund Three Arrows Capital (3AC) looks like the biggest casualty of the crypto price collapse so far after filing for bankruptcy in the U.S., but according to blockchain business advisor Anndy Lian, the worst may be yet to come.

“It will have a snowball effect,” said Lian, who is a fund manager for blockchain investments at Passion Venture Capital Pte. in Singapore and advises Mongolia’s government on the industry. “[The impact] will not just be on 3AC, it will be on 3AC’s involvement as an investor or as a fund manager, then it will snowball down,” Lian said in an interview with Forkast. 

That snowball has already hit crypto lending platform Voyager Digital Ltd., which filed for Chapter 11 bankruptcy on Wednesday in New York. Yet as more companies get swamped, some in the industry are calling it a necessary shakeout after the excesses of last year’s record-setting crypto price surge.

Voyager Digital had earlier halted or limited customer withdrawals, a move adopted by other lenders such as BlockFi. Crypto exchange Celsius was one of the first lending and staking platforms to halt withdrawals in early June, citing the common refrain “extreme market conditions.” 

3AC, which has filed for Chapter 15 bankruptcy to protect U.S. assets from foreign creditors, had as much as US$10 billion under management at one stage, according to blockchain analytics firm Nansen, but fell victim like many others to the implosion of the Terra stablecoin and Luna cryptocurrency in May. 

The collapse of Terra, which some argue helped trigger the bankruptcies now being filed, saw its Luna token fall from the ranks of a top 10 cryptocurrency with a market capitalization of almost US$30 billion to effectively zero in a matter of days.

Broken arrow

Any firm with significant exposure to the Terra project was hit hard by the collapse, including 3AC, which had a US$200 million investment in Luna Foundation Guard, the organization behind the Terra stablecoin, effectively wiped out when the project went south.

As 3AC sank into funding trouble, Voyager got hit after disclosing it had loaned over US$650 million in the USDC stablecoin and Bitcoin to 3AC, which it might not be getting back. BlockFi was among the lenders that foreclosed on roughly US$400 million in loans to 3AC. 

Meanwhile, lawyers hired by crypto lender Celsius are reportedly advising the firm to also file for Chapter 11 bankruptcy. Even though it did pay off nearly US$150 million in debt since July 1, more is still owed. 

Chapter 11 generally allows for a company to come up with a plan to pay off creditors and rebuild the business. 

In the crypto boom times, many of these companies with lending and staking platforms were venturing into ever more risky areas for profits, Igneus Terrenus, head of communications at crypto exchange Bybit, said in an interview with Forkast

“It’s almost a repeat or like a rhyming [with] what happened with the subprime mortgage crisis (which led to the Global Financial Crisis of 2008),” he said. “These firms just have to go further and deeper into more risky area because there is so much appetite.” 

During the 2008 crisis, the U.S. government stepped in to backstop the banks and Wall Street firms at risk of collapse, because of the threat to the global economy. The crypto industry doesn’t have such a backstop, but it does have Wall Street looking to move in on distressed assets

One of the world’s largest investment banks, Goldman Sachs is said to be looking to raise US$2 billion to buy distressed assets from Celsius, though Goldman hasn’t commented on the speculation.

Smaller pond

Companies native to the crypto industry are also looking for opportunities, with Bahamas-based crypto exchange FTX providing a US$400 million loan to BlockFi that includes an option to buy the troubled crypto lender.

Buying these firms out is a “smart move” Terrenus said, not only as a business opportunity, but in the case of FTX it creates a positive impression of a “savior” within the industry and grants confidence back to those firms and the market in general.

“It buys more time for those stressed institutions to quell the worries of their customers and then to give them more time to find a way to get back on their feet,” he added. 

While the so-called contagion spreads in the crypto industry, it hasn’t reached broader traditional markets — this time around. 

In its recent Financial Stability Report, the Bank of England highlighted how vulnerabilities in the crypto market, such as over-leveraging and breakdown of confidence in stablecoins, have contributed to the crypto crash. 

The BoE recommended increased regulation of the industry to minimize the risk to broader markets as crypto adoption grows and become further entwined within traditional finance.  

Downturns like what are being seen in the crypto industry are inevitable as a market matures, Andrew Sullivan, a market analyst and former equities broker, told Forkast in an interview. 

“It happens to everybody,” he said. “The fact that it’s happening to crypto now I don’t think should come as a surprise to people. The really important thing is what the crypto industry does now that it’s happened.” 

Some of these firms will have to look at strengthening their balance sheets and internal controls, Sullivan added. 

Many of these firms that are in trouble at the moment are not true DeFi (decentralized finance), but traditional centralized businesses just focused on cryptocurrency, he said. 

True DeFi protocols have been largely spared the carnage seen in the more centralized elements of the market. While the total value locked in DeFi fell more than 60% from early May to about US$75 billion, major protocols such as Aave, Compound and Curve have remained resilient. 

Total value locked in these protocols has decreased in the past few months, but there have not been the collapses as has been seen in more centralized firms.

“Decentralized protocols actually performed exactly how they intended to and avoided the perils that the likes of BlockFi, Celsius and Voyager are experiencing,” Sullivan said.