The crash of Luna has been a watershed event for the entire crypto markets- perhaps, the most talked about in the last month. The shockwave sent across the different ecosystems by the damage to the UST stablecoin has created systemic havoc that is not showing signs of abating. Terra USD (UST) is Terra’s stablecoin that relies on an algorithm to maintain its US$1 peg and is backed by the native token Luna. Luna, which was meant to stabilize UST’s price, had to ensure a mechanism whereby users could return 1UST for US$1 worth of Luna, no matter the value of UST against US$1. In essence, Luna and Terra USD function in the manner that one could be burned or traded for an equivalent amount of the other. But for either coin to maintain its value, Luna’s market cap must not fall below the market cap of UST, for which it was meant to serve as a kind of shock absorber. The shocker came last month when Luna’s market cap approached the threshold where it would initiate a collapse. Luna was sold off at the rate faster than one could sell their $1 worth of Luna for $1, and it began to lose its value. The value plummeted from US$87 to $US0.0005 within a week (from May 5, 2022, to May 13). Terra USD also plunged from the peg of 1:1 USD to 0.03:1USD.

Stablecoins are intended to have a fixed value of around the currency that they are pegged to be a more reliable store of value. However, many analysts have faulted the Terra protocol for using a sister token that depends on an algorithm to back the dollar-pegged token rather than the actual value. This event has triggered massive losses to other altcoins, with Bitcoin dropping from around #33,500 to $28 645 and ETH from $2,300 to $1,895.

While Luna and UST holders are still counting their losses, Celsius and 3AC have joined the list of networks caught in the downward spiral of massive liquidity problems.

Celsius Network and Its Decline

About a week ago, Celsius Network announced to its 1.7 million customers it would pause all withdrawals, swaps, and transfers between accounts. It said the network decided to honor its withdrawal obligations. While acknowledging it was a difficult decision to take, Celsius stated that it was the most responsible action it could take to protect its community and stabilize liquidity.

How Celsius Work

Alex Mashinsky, Celsius founder, described the company as the flagship centralized (Ceci) and decentralized (DeFi) platform. Celsius is one of the platforms that offer a high yield on investment. Its model is similar to the operational method of the traditional banks, only that it is crypto-based. Celsius receives deposits and gives them as loans, offering as high as 18.63% yield. Mashinsky claimed that his company’s ability to offer such a high yield on investment is a result of the use of smart contracts and open ledgers, and aggregating custodial wallets, asserting that the Celsius network is the safest crypto yield earning platform. Some have, however, argued that Celsius had all the red flags of the Ponzi scheme.

The Four Methods Celsius claims their double digits return.

1. Institutional Borrowers: According to Celsius, most of its earnings come from institutional borrowers paying between 7 to 15% interest. However, it never made known the collateral for the loan and the identity of the institutional borrowers.

2. Retail lending service: Another method identified by the network is retail lending. This service gives customers the window to take out a USD stable coin loan for Celsius with the condition that they give a Bitcoin or Ethereum collateral of at least twice the value of the loan. The business logic here is flawed considering the interest rate of 1 to 8.85%, whereas the network pays investors between 10 – 12.68%.

3. DeFi investment: The third method is investing digital assets in DeFi protocols. The returns on most DeFi protocols are also lower than what Celsius offers to pay. Added to this is the risk of hacking and compromise in DeFis. For example, Celsius lost 900BTC ($50 million USD) in the Badger DAO hack in December 2021.

4. Mining Operation: Celsius once announced it would invest $300 million USD in Bitcoin mining, but that never happened.

Celsius Problems with Regulators

Celsius has had some problems with regulators bordering on transparency and above-board practices. In New York, it was included among the platform requested to provide information on their activities and products. State regulators in New Jersey, Texas, and Kentucky have issued cease and desists against the network. In Alabama, Celsius is issued an inquiry why it shouldn’t be banned within a month.

In what almost turned out to be a scandal for the network, the Chief Financial Officer, Yaron Shalem, was arrested in Israel in November 2021, along with seven others, on charges bordering on money laundering and fraud. Celsius, reacting to the saga, said it was in no way related to his work at the company and that he had been suspended.

The Celsius token CEL has plunged by about 92%, trading at 23 cents from its $7 value a year ago. The network is yet to announce when customers will be able to withdraw again, warning that there may be delays.

Mashinsky's Tweet

Three Arrows Capital (3AC)

One of the companies that have confirmed the direct effect of Luna’s crash on their liquidity is Three Arrows Capital (3AC). Three Arrow Capital was launched in 2012 by Su Zhu and Kyle Davies. It became a household name as one of the most significant crypto hedge funds. At its height, its valuation was put at $18 billion in assets under management. 3AC has invested in several crypto projects across the broader industry. Speculation about the collapse of the hedge fund gained momentum last week as the rumor about its margin calls and liquidation ran rife. In an interview with the Wall Street Journal, Davies disclosed that the company lost $200 million on Terra’s implosion. 3AC has also revealed it is open to a buyout from another firm while it considers selling off its illiquid assets to enable it to reach an agreement with its creditors.

Zhu's Tweet

Implications of 3AC’s Collapse