New report reveals major source of recent crypto market chaos

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A new report from blockchain analytics company Nansen offers some insight into how major crypto trading firms including Celsius Network and Three Arrows Capital became over-exposed earlier this month.

“A lot of the selling pressure stemmed from the Terra collapse,” Niklas Polk, a Nansen research analyst and report author told to Yahoo Finance. “Many of these larger companies were way riskier players than expected. It suggests that if big players are all in the same position it’s not necessarily a good sign.”

Drawing a link to the more than $50 billion collapse of Terra’s LUNA (LUNA1-USD) token and algorithmic stablecoin UST (UST-USD) at the beginning of May, the report shows several large crypto players sought their next profit strategy by adding leverage to a high interest yielding derivative of the second largest cryptocurrency ether (ETH-USD).

The derivative in question is staked ether, or stETH, which allowed investors to lock their ether on the Ethereum blockchain ahead of “The Merge,” or the blockchain’s transition to proof-of-work from proof-of-stake.

From late April to mid-May, the price of ether had fallen by 35%. On May 11, 98% of more than 600,000 of ether-like assets were moved from Terra and converted into stETH.

Amid this panic, on May 12, Three Arrows Capital and Celsius yanked a combined $800 million worth of stETH from the DeFi exchange Curve. In a thinly traded environment, the moves contributed to a change in sentiment for stETH according to the report, but neither firm exited their stETH positions.

From May 12 to June 18, investors sold $4 billion worth of stETH holdings for ether amid deteriorating market conditions that saw ETH itself fallen 31% in a week. These outflows pushed the price of stETH as much as 8% below ether’s price according to Coinmarketcap.

Representation of Ethereum, with its native cryptocurrency ether, is seen in this illustration taken November 29, 2021. REUTERS/Dado Ruvic/Illustration

Representation of Ethereum, with its native cryptocurrency ether, is seen in this illustration taken November 29, 2021. REUTERS/Dado Ruvic/Illustration

The report notes that while stETH does not need to trade on a 1:1 basis with ETH, for most of its history stETH has generally been at par with ETH. As the spread between stETH and ETH widened, then, large investors who borrowed against their stETH holdings on DeFi platforms like Aave began receiving margin calls to add more collateral.

Between June 8-9, Celsius withdrew 50,000 stETH tokens in collateral as it used other crypto assets such as stablecoins to “either add collateral or repay debt,” the report states, with the stETH “ultimately in FTX deposit, presumably signaling an OTC deal.”

Shortly after, Celsius froze its customer’s accounts. The company remains a top lender and borrower for ether in DeFi marketplaces, holding a combined collateral value of $1 billion in ETH and other crypto derivatives on DeFi platforms including Aave and Compound.

“We cannot see their other positions or how much debt Celsius has, but for now, we don’t see any stETH positions at risk,” said Polk, adding that the firm will need to post more collateral on its positions if the price of stETH has a drawdown of more than 30%.

Silent for more than two weeks, the crypto lender Celsius Network, which according to its website held $12 billion in customer assets as of late April, has frozen its customer’s accounts and hired teams of lawyers as well as advisors with Citigroup, fueling customer fears the firm will soon go bankrupt.

Meanwhile, crypto hedge fund Three Arrows Capital has also stayed quiet, with Reuters reporting Wednesday the firm has entered liquidation.

Though Nansen’s report suggests Three Arrows wasn’t heavily involved in stETH until after Terra’s collapse, the firm took a total loss of 6,500 ETH — around $7.2 million at the current market price — given the depreciation of stETH, in addition to ether’s total loss of 50% for the period.

During the events on June 7, the firm also borrowed 29,054 stETH from crypto lender BlockFi, an offering a spokesperson for BlockFi told Yahoo Finance isn’t typical. Three Arrows used at least a third of the sum as collateral on Aave.

“Some of these people were super smart but they either held out too long or kept buying more into a position they knew full well would be very hard to get out of in a worst case scenario,” Polk added.

David Hollerith covers cryptocurrency for Yahoo Finance. Follow him @dshollers.

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