2022 in Review: Cascading Bankruptcies in Crypto

Posted on Feb 6, 2023 | ブログ


As a quick glance at your portfolio can confirm, 2022 was among the most devastating in the history of cryptocurrency, with some even calling the year an annus horribilis, possibly surpassing the carnage of 2014’s Mt.Gox detonation

After a banner year in 2021, in which Bitcoin hit an all-time high of nearly $70,000 and the world aped in for non-fungible tokens (NFTs), 2022 was a dismally sobering reality check, with the overall crypto market cap tumbling from $2.9 trillion in November 2021 to a modest $800B a year later, taking almost all of the bull run’s gains with it. 

Its woes came gradually and then all of a sudden for crypto, with a macro slowdown (driven by high inflation and resulting increases in interest rates) that weakened both retail and institutional appetites for risk-on assets, leaving many ill-prepared projects out in the cold. This slow-down resulted in a number of prominent crypto firms going belly-up after exposing said bellies through irresponsible overleveraging and outright criminal behavior. Meanwhile, related chains have seen an exodus of developers, projects and users as they flee to greener and safer pastures like Ethereum and Polygon. 

The collapse of FTX, 3AC, Voyager Digital, BlockFi and others helped herald in Crypto Winter, bringing with it so much pain for retail investors this year that it’s a near guarantee that regulators will accelerate their timelines for deforesting the shady crypto jungle in 2023.

In this Year-in-Review, we examine the metastasizing problem of decentralized finance (DeFi) hacks and what this means for the industry’s long-stated ideals. We will also take a look at this year’s cascade of crypto bankruptcies and what the industry can glean from them in order to get out of this current quagmire and get back on track toward mass adoption in 2023. 

What were 2022’s biggest crypto bankruptcies?

While the spate of crypto bankruptcies and disasters that characterized this year had origins in the larger macro picture, once they began, they very much became an interconnected series of events. The first mover was the collapse of the Terra network.

Terra network (May 2022)

In May 2022, the Terra network’s algorithmic stablecoin USD Terra (UST), which algorithmically tied to a governance token called Luna, infamously lost its peg. One token could be burned for the other, which in theory generated a deflationary balance through arbitrage opportunities.

UST began to freefall when $2B of it was unstaked from the ecosystem’s DeFi wing, the Anchor Protocol, with hundreds of millions worth then sold. The Anchor Protocol had been promising depositors subsidized yields as high as 20%, luring retail investors, hedge funds, and crypto projects alike.

After the first tranche of UST was unloaded, it was followed by a flurry of liquidations from other holders. The mad rush of exchange between UST and Luna led the latter’s value to drop from $82 to roughly zero in a week. When all was said and done, Terra Labs founder Do Kwon had become a fugitive, and the ecosystem’s collapse had wiped out around $60B in value, in what most believed was a generational shock that wouldn’t be repeated soon. In fact, Terra’s collapse merely set the scene for the beginning of the 2022 “Crypto Winter”, with the resulting contagion spreading far and wide to all reaches of the industry. 

Three Arrows Capital (June 2022)

Three Arrows Capital (3AC) was a hedge fund begun as a traditional finance venture in 2012 that later became deeply enmeshed in the crypto industry. Its significant ties to BlockFi, Genesis, Voyager Digital, and many other projects spelled trouble once the Terra fiasco took it off a cliff.

At peak value, 3AC held roughly $560M worth of UST and Luna deposited in the Anchor Protocol. This was an investment arranged without the relevant disclosures to clients. Later, after the two Terra tokens had finished circling the drain, the investment was worth about $600.

Following the Terra disaster, 3AC missed its margin calls, with news circulating of outstanding debts to crypto lender Voyager Digital of more than $665B. Voyager soon filed for bankruptcy blaming 3AC, while more under-collateralized loans taken out by the hedge fund on the DeFi protocol Aave amplified the gloom. By the end of June 2022, 3AC’s liquidation was ordered, followed by a bankruptcy filing soon after. Currently, 3AC founders Su Zhu and Kyle Davies are both fugitives.

Celsius (June 2022)

Shortly following the collapse of the Terra network, crypto lender Celsius announced it would have to suspend client withdrawals in early June 2022. A month afterward, the company filed for bankruptcy with a $1.2B hole in its balance sheet. Later, it was revealed that Celsius CEO Alex Mashinsky and other executives had withdrawn over $17M from their platform before filing for bankruptcy.

In December 2022, a U.S. judge overseeing the bankruptcy ordered the company to return around $44M worth of crypto to depositors. Those who placed their funds in the company’s “Pure Custody” arrangement will see the entirety of their funds returned, while the vast majority of depositors (who used the platform’s riskier lending products) will have their claims capped.

Voyager Digital (July 2022)

In the aftermath of 3AC’s ultra-high-stakes bet on the Anchor Protocol, Voyager Digital, a publicly listed crypto lender on the Toronto Stock Exchange, knew it was in trouble.

The $665B unsecured loan it had made to 3AC was the single largest loan on Voyager’s books, and it had to freeze customer withdrawals and file for bankruptcy in short order. Furthermore, the company is now on the wrong end of regulatory attention over its misleading statements regarding deposit insurance.

The Voyager episode in particular demonstrated the pitfalls of an industry where companies are bound together by massive leverage and tend to silo their investments in a single sector. These practices may work in the rising tide of the bull market, but in the falling tide of the bear, not so much.

Ironically, the now-defunct exchange FTX stepped in with a pledge to acquire Voyager over the summer; however, when FTX itself went bust in November 2022, those plans came crashing down.

FTX (November 2022)

What has become the most infamous collapse in crypto history began in early November 2022, when a Coindesk report indicated accounting discrepancies at the hedge fund Alameda Research. The fund was the sister firm of the exchange FTX, the third-largest centralized exchange at the time of the report.

What followed these revelations was a time of chaos for crypto, in which FTX CEO Sam Bankman-Fried (SBF) and Alameda CEO Caroline Ellison at first tried to deny the existence of a problem. When Binance CEO Changpeng Zhao announced he would be liquidating his company’s massive pile of FTT, the native token of the FTX ecosystem, the subsequent run on the once $32B-valued exchange destroyed it in short order.

Within days, FTX filed for bankruptcy, and SBF began a media tour against the advice of counsel. Over time, a picture began to emerge that indicated the exchange had been illegally lending out customer deposits to Alameda to cover huge losses, some stemming from the Terra collapse. The company had also been widely invested in a range of crypto projects, even attempting to bail out distressed entities such as Voyager and the crypto lender BlockFi, which further spread the disaster.

In December 2022, SBF was arrested in the Bahamas and extradited to the US. He is currently facing charges that could see him spending up to life in prison. 

What can we learn from 2022’s crypto disasters?

With so much horror unfolding in the crypto industry, it’s understandably tempting for many people to turn away from crypto entirely, just as they did during the last bear market of 2018, when the ICO craze and Bitcoin surge of 2017 fizzled out and pulled the whole industry down with it. However, there is another way of looking at this moment, which is as part of a larger evolution in a powerful new technology and sector. 

Part of that evolution is away from centralization and the problems of the traditional financial world, which very much played into the problems at 3AC, Voyager, and FTX. While the DeFi ecosystem is still somewhat nascent and vulnerable to hacks, it does offer at least a potential way forward for crypto based on the principle of decentralization.

What remains of the centralized-exchange sector will, at a minimum, need to incorporate transparency solutions like proof of reserves. Crypto deposits are not insured and customers need to have absolute clarity on where they put their money. Moreover, large organizations will have to submit their books to a proper Big 4 audit in order to assuage the fears and concerns of investors (and regulators), or risk making the recent FUD panic that resulted in users withdrawing billions of dollars from them a more frequent occurrence. 

Another takeaway from the madness is that the unsustainably high yields that began in the “DeFi Summer” of 2020 and lured many newcomers were always problematic. The investment practices that spawned these unstable yields are unlikely to have a place in the more sober and regulated version of crypto going forward.

And of course by far the most important lesson of 2022 is that crypto assets are only as secure as the place in which they are stored. Custody providers like FTX, which illegally trade customer funds without their consent, are a scourge on the industry.

Hardware wallets and other self-custody options provide safer crypto storage for individuals, while for institutions in need of more complicated and demanding solutions. Meanwhile, trusted third-party service providers like Circle-owned CYBAVO who provide the transparent and secure custody of assets only without touching users’ funds, will play an essential role going forward to guide the industry going forward and help revive the future of digital assets once again. 

As any veterans of the 2018 and 2014 bear markets can attest to by now: what doesn’t kill crypto, only serves to make it stronger. As such, we are confident that 2022’s annus horribilis will do just that, eventually being viewed as a year of invaluable experience that taught the industry and its players some much-needed lessons which has helped the entire crypto space to chase out bad actors and mature.