Cryptography: A Bernie Madoff-style scheme may have crushed prominent lenders
An unprecedented crisis of confidence has affected the cryptocurrency industry for several months.
To gauge this, just look at cryptocurrency prices, which are often associated with a platform or project. The cryptocurrency market has lost $2 trillion in value since hitting an all-time high of $3 trillion in early November, according to data firm CoinGecko. The price of Bitcoin, the king of cryptocurrency, has fallen by more than two-thirds since it reached an all-time high of $69,044.77 on November 10.
The crisis intensified earlier this spring with an event that appears to have been contained. In early May, its sister coins Luna and UST or TerraUSD collapsed. The reason for the fall of the two cryptocurrencies was the fact that several investors wanted to liquidate their positions at the same time. At least $55 billion was wiped out in this disaster.
What had appeared as an isolated event finally revealed itself as an octopus with multiple ramifications. A month later, crypto lender Celsius Network, which acts as a bank, announced that it would suspend withdrawals, thus preventing its customers from accessing their funds. A few days later, Three Arrows Capital, or 3AC, a Singapore-based hedge fund, said it was surprised by the destruction of Luna, a digital currency in which the company has been exposed to more than $200 million.
Voyager Digital, another cryptocurrency lender, has announced that 3AC has defaulted on a loan of at least $630 million it provided to it. Babel Finance, CoinLoan, CoinFlex and other cryptocurrency lenders have also suspended withdrawals. BlockFi, one of the big names in the sector, has been forced to seek help from young crypto billionaire Sam Bankman-Fried, founder of the FTX.com platform. The liquidity crunch has spread to other small lenders such as Fuld. Crypto exchange Blockchain.com has warned its shareholders that it could lose $270 million in connection with 3AC.
The dominoes began to fall: 3AC was forced into liquidation, and Voyager Digital and Celsius Network filed for Chapter 11 bankruptcy. BlockFi has been bailed out and the future of the others remains uncertain. As for their clients, they don’t know if they will be able to get a small portion of their money back.
The link between all these companies and platforms is 3AC, the hedge fund. From the company’s statements and official documents, it appears that a large number of cryptocurrency lenders have lent them money. But they didn’t seem to know that they were mostly hedge fund creditors.
3AC is an ‘old-fashioned Madoff-style Ponzi scheme’
Research firm FSInsight, an independent research firm, said in a recent report that Three Arrows Capital was operating like a disguised Bernie Madoff Ponzi scheme. FSInsight said the company was an “old-fashioned Madoff-style Ponzi scheme” that had taken positions similar to those that sank Long Term Capital Management (LTCM).
Long Term Capital was a famous hedge fund, which was run by famous Wall Street traders and Nobel Prize winning economists. The company fell in 1998, forcing the government to intervene to prevent the markets from crashing.
In the case of Three Arrows, Kyle Davis, 35, and Sue Chu, 35, were working like Bernie Madoff, says the research note delving into the hedge fund’s internal meltdown. FSInsight wrote that Davis and Zou “abused their reputation to borrow recklessly from every lender in the company.”
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The note added that Chu and Davis were likely “using borrowed money to pay interest on loans issued by lenders, while ‘cooking their books’ to show massive returns on capital.”
This conclusion suggests questions about whether 3AC’s financial disclosures are correct. At its peak, the hedge fund said it had more than $18 billion under management. But given the amount of exposure that crypto lenders have had to the hedge fund, it is likely that most of its assets were bought with debt and its collateral ratio was very small, according to Shaun Farrell, head of digital assets at FSInsight.
A Ponzi scheme is a fraudulent financial arrangement consisting of paying large returns to existing investors using the capital invested by new investors. This fraud feeds on the naivety of those who have been deceived. Often they are revealed only when the money brought in by the new investors is not enough to cover the payments to the previous investors. This fraudulent system was used by former Nasdaq President Bernard Madoff for the largest Ponzi scheme in history.
People may call us stupid
Davis attempted to explain in June: “Terra Luna’s attitude surprised us a lot.”
Since then, the two former Traders of Credit Suisse, who became friends in high school, are in hiding. They recently gave a phone interview, published July 22, to Bloomberg News.
“People might call us stupid. They might call us stupid or delusional. I will accept that. Perhaps,” Chu said to the outlet. “But they will say, ‘You know, I ran away with money during the last period, as I’m actually giving back more of my personal money. It’s not true.'”
“The whole situation is unfortunate,” Davis told outlets. “A lot of people lost a lot of money.”
“What we failed to realize was that Luna was able to collapse to actual zero in a matter of days, and that this would induce credit pressures across the industry, which would put a significant strain on all of our illiquid positions,” Chu added.
Looking back, the two former Credit Suisse traders say their disaster is like losing out to LTCM.
“It was very much like the LTCM moment for us, like the long-term capital moment. We have different types of deals that we all thought were good, and other people had these deals as well,” Chu said. And then they were all flagged at breakneck speed. “
The companies responsible for liquidating the hedge fund have complained about the founders’ refusal to cooperate, which the latter refused.