Singapore-based crypto venture firm Three Arrows Capital (3AC) failed to meet its financial obligations on June 15 and caused severe losses among centralized lending and staking providers such as Celsius and Babel Finance.
On June 22, Voyager Digital, a New York-based digital asset lending and yield company listed on the Toronto Stock Exchange, saw its shares fall by nearly 60%. Disclosure of exposure of $655 million in Three Arrows Capital.
According to Bloomberg, Voyager offers crypto trading and staking and had approximately $5.8 billion in assets on its platform in March. Voyager’s website mentions that the firm offers a MasterCard debit card with cashback and reportedly 12% annual rewards on crypto deposits without lockups.
Most recently, on June 23, Voyager Digital reduced its daily withdrawal limit to $10,000, as reported by Reuters.
Contagion risk spread in derivatives contracts
It is unknown how Voyager took on so much liability to a counterparty, but the firm is prepared to take legal action to recover its money from 3AC. To remain solvent, Voyager borrowed 15,000 bitcoins (BTC) from Alameda Research, a crypto trading firm led by Sam Bankman-Fried.
Voyager has also secured a $200 million cash loan and another 350 million USDC Coin (USDC) revolver credits to protect customer redemption requests. Analysts at Compass Point Research & Trading LLC said that the event “raises survival questions” for Voyager, therefore, crypto investors question whether further market participants could face a similar outcome.
– Unsecured derivatives and options trading on Deribit
– Voyager. unsecured loan of $650 million with
– Offering protocol/portfolio companies 8-10% APY on their cash balances
what else?— Dylan LeClair (@DylanLeClair_) 22 June 2022
Even though there is no way to know exactly how centralized crypto lending and yield firms work, it is important to understand that a single derivatives contract counterparty cannot pose infectious risk.
A crypto derivatives exchange can go bankrupt, and users will only notice this when an attempt is made to withdraw. This risk is not specific to the cryptocurrency markets, but has grown exponentially due to a lack of regulation and weak reporting practices.
How do crypto futures contracts work?
Typical futures contracts offered by the Chicago Mercantile Exchange (CME) and most crypto derivatives exchanges, including FTX, OKEx and Deribit, allow a trader to leverage their position by depositing margin. This means trading a larger position than the original deposit, but there is a catch.
Instead of trading bitcoin or ether (ETH), these exchanges offer derivative contracts, which track the underlying asset price but are far from being a single asset. So, for example, there is no way to withdraw your futures contracts, let alone transfer them between different exchanges.
In addition, there is a risk of this derivatives contract depreciating from the actual cryptocurrency price on regular spot exchanges such as Coinbase, Bitstamp or Kraken. In essence, a derivative is a financial bet between two entities, so if a buyer lacks the margin (deposit) to cover it, the seller will not take the profit home.
How do exchanges handle derivatives risk?
There are two ways in which the exchange can hedge the risk of insufficient margin. A “clawback” means taking a profit away from the winning side to cover the loss. This was the norm until BitMEX introduced an insurance fund, which does away with every forced liquidation to handle those unforeseen events.
However, one should note that the exchange acts as an intermediary as every futures market trade requires a buyer and seller of the same size and price. Regardless of whether there is a monthly contract, or a perpetual future (inverse swap), both buyer and seller are required to deposit a margin.
Crypto investors are now asking themselves whether or not a crypto exchange may go bankrupt, and the answer is yes.
If an exchange handles forced liquidations incorrectly, it can affect every trader and business. A similar risk exists for spot exchanges when the actual cryptocurrency in their wallet is less than the number of coins reported to their customers.
Cointelegraph is not aware of anything unusual about Deribit’s liquidity or solvency. Deribit as with other crypto derivatives exchanges is a centralized entity. Thus, the information available to the general public is less than ideal.
History shows that the centralized crypto industry lacks reporting and auditing practices. This practice is potentially harmful to everyone involved and to the business, but as far as futures contracts are concerned, the risk of infection is limited by the exposure of participants to each derivatives exchange.
The views and opinions expressed here are solely those of Author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should do your own research when making a decision.