The search for the source of the TerraUSD Crypto Bank Run continues

Cryptocurrency investors are still trying to figure out what led to the spectacular May meltdown of two digital tokens that were valued at more than $40 billion earlier in the month.

Last week, analytics firm Nansen pointed out that lending firm Celsius is one of a few users who contributed to the collapse of cryptocurrencies Luna and TerraUSD. While Celsius disputes the bill, the search for information about the cause of the wreck reveals the opacity of the world of decentralized finance.

With DeFi, it’s not easy to understand who is providing money for loans, where the money is going, or how easy it is to trigger currency meltdowns. This is one reason regulators are concerned about DeFi’s impact on investors and the financial system in general.

WSJ’s Dion Rabouin explains why Wall Street is now heavily into crypto and what that means for the new asset class and its future. Photocomposite: Elizabeth Smelov

Many investors place their wealth in crypto products that offer healthy returns; These services then lend the funds to others. The value of assets held on DeFi platforms, referred to as “total value locked,” has surged from $600 million in early 2020 to a peak of $317 billion on December 26, 2021, according to website DeFi Llama. It is now down to around $106 billion, falling concurrently with a fall in prices across the cryptocurrency market.

The Anchor protocol was a popular service for terraUSD holders as it offered users a 19.5% interest rate on borrowed cryptos. But in May, a flood of investors withdrew their money from Anchor, ultimately leading to the fall of terraUSD and Luna. It’s unclear who prompted the sale and if he intended to trigger the collapse.

Nansen’s report argues that Celsius was one of a few users to first withdraw hundreds of millions of dollars from Anchor early, which may have sparked the broader selloff on the platform.

Celsius said its risk management group identified “changes in the stability” of the platform that caused it to remove its assets solely to protect its customers’ money. The company did not benefit from the instability, it said.

Celsius accepts customer deposits and then lends that money to other users, such as exchanges and market makers. It charges a fee for the service and then passes that revenue on to its users as an interest payment. Celsius offers users yields of up to about 14%, so Anchor’s 19.5% yield was attractive to the company.

“It’s similar to traditional securities lending,” said Steven Ehrlich, CEO of Voyager Digital,

a Canada-listed company that offers a variety of crypto-related financial services, some of which offer a stated rate of return. “It’s almost identical to what happens in the traditional world.”

But these products and services are not operated like traditional financial services.

“It’s marketed as a better savings account and it’s not,” said Cory Klippsten, chief executive of crypto services company Swan Bitcoin.

There are no standards on custody, risk management or capital reserve issues. There are no transparency requirements. Investors often do not know how their money is being handled or who the counterparties are.

“What you’re really doing is you’re an unsecured lender,” said Mr. Klippsten. “They collect personal loans and invest them in lightly regulated activities behind the scenes.”

For example, investors were unaware that their money in a Celsius account might have been invested in the Anchor platform. Celsius, Voyager, and others in the industry typically don’t disclose their competitors.

Regulators are increasingly concerned about the risks of these lending platforms. In April, under pressure from regulators, Celsius stopped accepting new interest-bearing deposits from non-accredited US investors. A similar program planned by Coinbase was shelved after opposition from US regulators.

Also, unlike traditional bank accounts, there is no deposit insurance. When a DeFi service goes down or gets hacked — and they’re notorious for getting hacked — users are largely on their own.

“In the world of crypto, anyone and their dog can come out with a product,” said Michael Rosmer, the founder of DeFiYield, which publishes software to audit DeFi projects. “We realized very quickly that you have this wealth of complex instruments and products and there is no verification.”

Write to Paul Vigna at [email protected]

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