#30 Two other emperors have no clothes
Celsius and Three Arrows Capital show signs of insolvency. The Merge moves steadily, Coinbase lays off 18% of its team, Dorsey unveils his plans for bitcoin, and we salute whistleblowers and sleuths
Forced selling phase
Phase 1 of bear markets is a piece of cake: it feels more like a healthy correction. Like justice being served and dumb projects being exposed. People’s spirits remain up in Phase 1.
Phase 2 looks more is peak chaos and peak pain. It’s when hen things go South bad. Then, exacerbated feelings of defeat or epic calls for resistance relace smug confidence. Think of the bread-baking, home-exercising, TikTok-challenge-accepting times of the first lockdowns.
Phase 3 is when tedium kicks in, and people genuinely contemplate their lives’ decisions.
Recent events in crypto show that we are in the middle of Jason Yanowitz’s phase 2 of a bear market.
In Stage 2, diamond hands become forced sellers. They sell not because they want to, but because they have to.
It’s been just a little more than a month since Terra collapsed. At the time, it looked like crypto’s worst crisis to date: a $40B ecosystem went belly up in a matter of days, exposing the weaknesses of algorithmic stablecoins. In case someone needs a refresher, we wrote a report outlining the scenario back then. The last of the bullet points in our Conclusions sectors read like this:
The impact on hedge funds is yet to be measured, but it might be considerable given the broad exposure to UST, LUNA, or the Terra ecosystem in general.
Well, here it is. Celsius and Three Arrows Capital are presumably going through a solvency crisis. Celsius is the leading centralized lending platform, with reportedly 1.7 million customers and over $12B in assets under management. Celsius took money from the customers and invested it in DeFi protocols to obtain revenue to share with them. De facto, Celsius operated like a hedge fund for main street investors. Three Arrows Capital is a good old hedge fund with professional investors and partners. and an estimated similar amount of assets under management: $10-$12B. Both crypto giants seem to have clay feet.
On Monday, Celsius froze their customers’ accounts, stopping them from withdrawing, swapping, or transferring funds. Explanations were scant: three vague tweets in one week, saying little more than “(we are) working as quickly as possible and will share information as and when it becomes appropriate. Acting in the interest of our community remains our top priority.”
Thankfully, the on-chain analysis provided information and revealed three main pain points:
Celsius had probably been badly hurt in the Terra collapse. Something they denied, but that finally came to light with wallet analysis by Nansen.
They were stuck in a liquidity trap with their ETH. Their assets were either locked in Beacon Chain staking or invested in stETH, Lido’s derivative token for staked ETH that is going through price and liquidity problems.
They had several leveraged positions in lending protocols (Aave, Compound, and Maker) approaching liquidation.
In the meantime, rumors spread saying Three Arrows Capital was going through similar trouble. Their situation and actions are harder to trace, but all the information points in the same direction. Even their own, very brief words sound ominous.
Carbono sent out a report on Friday explaining the whats, the hows, and the whys. We introduce the main concepts -explaining things like staking, stETH, or leveraged positions to those less familiar with crypto or financial lingo- recap the facts, and offer our take on what we think the story is.
The facts are that the two emperors seem to have no clothes. It will probably take a while to understand everything that’s been happening because both Celsius and Three Arrows Capital are centralized companies with opaque operations.
The story is threefold:
First, we are witnessing the first significant episode of forced sales. Celsius and Three Arrows Capital are probably weathering their respective crisis by pushing their sizeable bags to the market, creating a selling pressure that’s bringing prices further down. This, in turn, adds pressure to the leveraged positions of all investors in DeFi lending protocols. Bear market Phase 2.
Mainstream papers will probably be too busy writing their “we told you” pieces to acknowledge that centralization and opacity were at the front and center of the crisis in Celsius and Three Arrows Capital and that these are two traits from traditional businesses that crypto is fighting with more strength than anyone else in the space. Of course, DeFi is not immune to crises, and it will surely not leave this unscathed, but it does provide a more leveled playing field and avoids information asymmetry in unseen ways.
Finally, that hope is not lost. This is not crypto’s first bear market. The previous one saw the birth of projects like Uniswap, Aave, Compound, and Synthetix. You’ve probably heard this before: bear time is build time.
We don’t want to underestimate this crisis. We might see Phase 3 when crypto goes flat, silent, and boring. But from our perspective, what is going down these days is the most speculative use case of crypto. The era of fast and easy money. We needed this era to build the muscle, stress test security and scalability, identify potential features and business models and attract capital and talent. What remains are the principles of transparency of DeFi, the anti-fragility of open protocols, the general efficiency of the space, and lots of well-funded companies formed by brilliant minds. You cannot stop innovation when it’s so blatantly better than its predecessors.
It will probably take us ages to learn what happened behind the closed doors of Celsius and Three Arrows Capital. Terra, on the other hand, collapsed in a week. This is a feature, not a bug. Celsius and Three Arrows are centralized companies, more traditional in their operations, even if they invested in DeFi. Terra was pure crypto, and things that don’t work, die fast in crypto.
This is the industry we want to be in.
⬡ Six Angles
We select six topics to illustrate the very different angles crypto can be approached from. We could choose dozens, but six is the atomic number of carbon… and otherwise we'd be writing for ages.
1. Technology | The road to The Merge
The Merge was meant to be the highlight of the year in crypto. Then came more lockdowns, the war in Ukraine, a battle against inflation, and a few major crypto crises.
Still, The Merge is meant to be one of the most crucial developments in crypto for years to come, and today it’s closer than ever. After months and months of doubts and delays, The Merge has undergone its latest and greatest “dress rehearsal” with the transition to Proof of Stake of its most important testnet, Ropsten.
The Merge is the transition of the Ethereum blockchain from a Proof of Work validation mechanism to a Proof of Stake. The change has great implications. Ethereum’s energy consumption will drop drastically, answering one of the major concerns about blockchains brought forth by regulators. It also modifies the whole business model of block validation, from one where miners sold their computational power to one where it’s all ruled by financial incentives. This is not supposed to affect the security of the network.
Transaction speed and fees will not be affected, though. This is a common misconception: many believe Ethereum will become faster and cheaper. Ethereum’s most important change in its scalability roadmap, sharding, was excluded from The Merge to avoid further delays. This leads us to a short-term future where L1 and L2 solutions remain one of the most active spaces for innovation. Blockchains, sidechains, and rollups will improve Ethereum`s cost efficiency: one of the most noticeable areas of improvement for end-users.
2. Human Resources | Coinbase layoffs
Hiring was one of the strongest bull signs. Talent is the answer to all problems because, at the end of the day, human ingenuity solves problems - technology is just the tool. So Coinbase’s slashing of 18% of its workforce is bad news, and it piles on top of other layoffs, such as those in Blockfi or Crypto.com.
In the meantime, other companies like Binance, Kraken, and Polygon are taking the opportunity to show ambition and good health with a dose of vitriol.
3. Stablecoins | Tron depeg
How fast does one get desensitized to de-pegs? Tron’s USDD has been fighting to maintain its 1:1 ratio with the dollar for a week now.
USDD was Tron’s response to Terra’s success. Justin Sun, the founder of the blockchain Tron, decided to make a copy of UST and follow its steps, back when those steps led up only fast. After Terra’s collapse, USDD pivoted to include some safety measures to improve its chances of success, namely overcollateralization and Tron’s version of the Luna Foundation Guard, the Tron DAO Reserve ready to deploy capital to balance prices.
So far, things are not looking too good for this next attempt at an algorithmic stablecoin.
4. Regulation | Bipartisan bill in the US
US Senators Lummis and Gillibrand are probably crypto’s most beloved regulators today. They are a bipartisan couple (Lummis is Republican and Gillibrand Democrat) who have taken their time to understand crypto and outline a regulatory approach that’s respectful of its peculiarities. Together they have produced the most advanced crypto bill to date.
There are a few things to be excited about:
It is a bipartisan bill that de-politicizes crypto. Crypto has so far remained devoid of ideology (at least in the traditional left VS right narrative). As long as it remains like this, it will elude some unnecessary associations.
The bill attempts to draw a clearer line between commodities and securities in crypto. Bitcoin and Ether are considered commodities under their definition, while mostly all altcoins are securities.
This division leaves Bitcoin and Ether under the CFTC’s roof. The Commodity Futures Trading Commission is a government supervisory agency that has been less confrontational with crypto than the SEC.
The Lummis-Gilbrand bill also contemplates tax exemptions to certain amounts of crypto transactions, which fit with crypto’s mission of becoming the fast and secure form of transaction of the masses and not an exclusive club for deep pockets.
There’s one thing to be skeptical about, though: at this moment, the bill is currently little more than a public gesture. A bill like this goes through a long process of consideration where it gets radically modified, and that’s once it becomes an issue on the table, which crypto is not at the moment. So, for the time being, we can only take it as proof that some people in Washigton get things right and might be the sensible voice in future debates.
5. Bitcoin | Dorsey reveals his plans for Web 5
Remember when Jack Dorsey said he wanted to build smart contracts on Bitcoin? That was back when he was still Twitter CEO and hadn’t devoted 100% of his efforts to promoting Bitcoin from his position in Block. He announced the launch of a project aptyl named TBD (To Be Defined) that would make Bitcoin more similar to Ethereum in capabilities.
This was Jack in July 2021:
Today TBD has a name: it’s called Web 5 (with all crypto mockingly asking where Web 4 went already). It is mostly just a name and a declaration of intent: Dorsey said he would share the project’s progress, not only the outcomes, and that’s what he’s doing. There’s a deck in circulation expressing the main goals and tools of Web 5: TL;DR; Dorsey wants to create the backbone for decentralized identity and decentralized storage over bitcoin. That simple, that powerful.
6. On-chain analytics | On-chain analysts, sleuths, and whistleblowers
Blockchain information is public and transparent. Every action happening in wallets, smart contracts, and open networks is available to anyone who knows where to look. Introducing on-chain analysts, sleuths, and whistleblowers: the informal policemen that patrol the streets of crypto and reveal injustice or malpractice. They are the captains of critical thinking, the people who poke holes in walls to let everyone sneak a peek into the insides of projects, leveling the playing field.
Their role has been critical in recent weeks. While the project leaders remain silent, they shed light on the evolution of cases like Terra, Celsius, and Three Arrows Capital. They identify wallets and trace their activity; they access key Telegram and Discord groups and leak information. They point at weaknesses, inconsistencies, and lies. It’s like good old investigative journalists were now equipped with X-Ray vision.
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