The first cold wave in 2022: Ethereum liquidation and the defeat of Three Arrows Capital

Liquidated ETH

June 18, 2022 is a day destined to go down in history in the cryptocurrency industry - on this day, Bitcoin and Ethereum, the leaders of cryptocurrency assets, both suffered an unprecedented plunge.

On this day, Ethereum, the second largest asset in the crypto asset industry, plummeted 7.3% on the day, with the lowest price being only $1,000, the lowest level since January 2021. It fell nearly 80% from its previous high.

According to Coinglass data, as of 23:00 on June 18, a total of 77,000 accounts in the crypto asset field were liquidated, with a total amount of US$270 million. Luna collapsed, Celsius was insolvent, stETH was de-anchored, and various negative news were continuously realized. The market, which had lost confidence, continued to fall, and the price of crypto assets continued to hit new lows.

The massive decline of Ethereum and Bitcoin has increased the panic in the market. Investors in panic have been selling their crypto assets, causing their prices to fall. The price drop has led to the liquidation of a large number of Ethereum on the chain. According to data provided by eigenphi.io, on June 16 alone, 894 Ethereum accounts were liquidated, and the total amount of Ethereum liquidated was as high as US$104,640,734.71.

Figure 1, the number and total value of Ethereum accounts liquidated in the past 30 days, source: eigenphi.io

But the Ethereum liquidation amount on June 16 was still only a small part of the total amount.

According to parsec.finance data, between US$1,100 and US$1,250, there was a total of nearly US$1 billion in on-chain lending liquidation quotas, and these quotas were mainly composed of Maker, Aave and Compound.

The liquidation logic of Ethereum is that when the price of the pledged assets drops, causing the value of the pledged assets to be lower than the value of the loaned assets, a certain proportion of the pledged assets will be sold, and the liquidated users will also need to pay a sum of money as a penalty.

Take Three Arrows Capital, a well-known VC in the crypto asset industry, for example. As the price of Ethereum continued to fall, Three Arrows Capital's addresses were liquidated continuously, and some addresses were even liquidated as many as 20 times.

The continuous liquidation caused by the decline in Ethereum prices has caused many accounts to suffer heavy losses. According to data from eigenphi, the top accounts that were liquidated lost more than 10 million yuan in pledged Ethereum. For example, the address with the most serious losses, 0x716034C25D9Fb4b38c837aFe417B7f2b9af3E9AE, has experienced 21 liquidations in total, with losses of more than 67 million US dollars in liquidations.

Figure 2, a list of addresses with the largest amount of liquidation, data source: eigenphi.io

2022 is the first year that institutions have encountered a bear market after entering the market. Under the stimulation of the previous bull market, profit-seeking institutions have pursued profits through circular leverage. When the price of the token rises, this operation can undoubtedly bring multiple profits; but if the price of the token falls, continuous liquidation is inevitable.

The leverage business logic of Three Arrows Capital

Amid the pessimism of the entire crypto asset industry, another extremely important news attracted the attention and discussion of the entire crypto asset industry. Zhu Su, founder of Three Arrows Capital, said, "We are communicating with relevant parties and are committed to resolving the issue."

Figure 3, screenshot of Zhu Su’s Twitter

Before Zhu Su's vague tweet, the news that Three Arrows Capital was in a liquidity crisis and insolvent had been fermenting in the entire crypto asset industry. The Three Arrows Capital's experience was cascading and catastrophic. Because Luna's project, which had a valuation of tens of billions of dollars, almost went to zero, dealt a heavy blow to Three Arrows. After that, Three Arrows Capital began to continuously sell stETH in exchange for ETH to repay its debts.

To make matters worse for Three Arrows Capital, as the price of ETH plummeted, its staked Ethereum also suffered continuous liquidation.

The logic behind the circular use of Ethereum for leverage is: first pledge Ethereum to Lido in exchange for stETH, a stable token anchored to ETH, and then use stETH to pledge to Aave and other platforms in exchange for stable assets before investing.

Layer upon layer of leverage ensures that Three Arrows Capital can invest in various fields at low cost and high leverage. The continuous leverage behavior ensures that extremely lucrative profits can be obtained under favorable market conditions;

However, since leverage has always been a high-risk and high-return financial tool, once leverage goes against the market cycle, the only result is liquidation.

Three Arrows' Self-Rescue

Judging from the chain of crises triggered by this bear market, Three Arrows Capital has not thought about saving itself.

The most obvious method is that it continuously sells its stETH in exchange for ETH to replenish its margin.

Three Arrows Capital’s selling of stETH caused the ratio of stETH to ETH to decouple to 1stETH = 0.94ETH;

In addition, Three Arrows Capital withdrew 127,000 stETH of liquidity from Curve.

The self-help measures did not stop there. After Zhu Su tweeted that he was "solving the problem", Danny, the head of trading at 8BlockCapital, said that $1 million in his trading account at Three Arrows Capital had been withdrawn.

At the same time, several DeFi protocols claimed that the funds they deposited in the Three Arrows Capital OTC platform were missing. These assets were the Treasury management proposal made by Three Arrows Capital after it completed its seed round of financing. The management proposal required these protocols to be under the jurisdiction of the Three Arrows Capital OTC platform.

In return, Three Arrows Capital promised them an 8% annual return.

However, the entire self-rescue operation had little effect amid the dramatic Ethereum market crash.

In a June 17 Wall Street Journal article, Three Arrows Capital was mentioned to be considering selling assets to obtain a bailout. Its co-founder Kyle Davies said in an interview that Three Arrows Capital has hired legal and financial advisors to help it develop solutions for investors and lenders.

But whether Three Arrows Capital can get through this difficult time safely remains to be tested by time.

Conclusion

Luna's price collapsed, Celsius was insolvent, and Three Arrows Capital was in a liquidity crisis. They are undoubtedly victims of the cold winter of the crypto asset industry in 2022. But this may only be the first cold wave of the entire winter. It is unpredictable whether more VCs or crypto asset projects will be affected after this.

This cold winter does not seem to be over yet, and there may be more victims due to the chain reaction in the industry.

Celsius’ insolvency may raise another worrying association - what will happen to Tether, which has invested in Celsius?

The stable token USDT issued by Tether has always been regarded as the general equivalent of the crypto asset industry. So, does the collapse of Celsius mean that Tether may be affected?

In this cold winter of the crypto asset industry, does a so-called "Lehman moment" really exist? If it does happen, what impact will it have on the crypto asset industry? But another point we always believe is that although many projects and VCs may fall in this bear market, the crypto asset industry will still bottom out and rebound one day.

This is just like the world economy continued to move forward after the Great Depression of 1929, the collapse of the Bretton Woods system in 1973, and the Great Recession of 2007. The crypto asset industry has experienced more than one bear market, but it always reaches a new peak again.

The industry will always move forward, but the bumpy process will always leave victims. The market is risky and investment should be cautious. This principle, which has been mentioned countless times, is still ringing in our ears today. Countless investors have paid, or are paying, for their reckless or aggressive capital operations. Today, UST, Luna, Celsius and Three Arrows Capital are just another new annotation of this principle.