"Hear ye, hear ye. The lenders are out of tender." 

BlockFi, Celsius, CoinFLEX, 3AC, and Voyager are all either freezing client assets. Or openly discussing liquidity issues. 

Domino after domino, major cryptocurrency funds, lenders and custodians are publicly announcing their levels of distress. 

Why? What do they all have in common? 

To put it simply, excessive collateralising, more specifically cross collateralisation. 

Cross collateralisation is using an asset that's collateral for an initial loan as collateral for a second loan. Suppose the debtor (loan holder) cannot make either loan's scheduled repayments on time. In that case, the affected lenders can eventually force the liquidation of the asset and use the proceeds for repayment – Investopedia. 

Essentially, each debt obligation denoted in dollars kept getting stacked on top of a fixed amount of cryptocurrency collateral. But, here is where it gets interesting... 

And for digital assets like cryptocurrency, we're only just getting started 👇

The borrowed funds usually flowed back into the cryptocurrency market and drove prices up further, which allowed these companies to leverage more debt. 

A dangerous game of hot potato (though hot grenade is probably more appropriate) gets tossed back and forth between the same entities. 

How the world's most dangerous game of financial hot potato works:

(1) Borrow money using cryptocurrency as collateral -> (2) inject borrowed funds into the cryptocurrency market to push prices higher -> (3) leverage the newfound appreciation in the collateral to borrow more and repeat. 

In a bull market with loose monetary lending provisions, no problem!

But we are not in a bull market.

When markets become turbulent and suddenly crash, the value of the underlying collateral becomes compromised, and the debt starts to unwind. 

When this unwinding occurs across multiple lenders, funds, custodians, and other institutional bodies, it generates a contagion effect. 

Contagion is the spread of an economic crisis from one market or region to another and can occur at a domestic or international level, depending on the severity.

Usually associated with credit bubbles and financial crises, contagions can manifest as a crash in one market, leading to a crash in other markets. – Investopedia 

In Layman's terms, when the cryptocurrency market started tanking, it created a contagion effect between the lenders involved. 

It wasn't until Three Arrows Capital (3AC) founder, Zhu Su, mentioned that "we are in the process of communicating with relevant parties and fully committed to working this out" did the market become unnerved. Rumours began circulating that client funds, and lender claims may no longer be safe. 

One of the affected lenders, Voyager Digital Ltd. is owed roughly US$ 657M from 3AC. As a result, Voyager quickly restricted clients' withdrawals to avoid a bank run scenario. 

A bank run occurs when large numbers of customers of a bank or other financial institution withdraw their deposits simultaneously over concerns of the bank's insolvency – Investopedia. 

What happens now? 

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Many practitioners, my father included, are drawing similarities to the 08' GFC, where CDOs kept getting piled onto the balance sheets of key financial institutions. 

A CDO or 'Collateralised Debt Obligation' is a complex structured finance product backed by a pool of loans and other assets and sold to institutional investors. CDOs are a particular type of synthetic derivative because, as the name implies, its value is derived from another underlying asset. 

These assets become the collateral if the loan defaults – Investopedia. 

It wasn't until mortgage delinquencies triggered an unwinding forcing the Federal Reserve to step in and backstop the entire market as a lender of last resort. 

Cryptocurrency won't see that level of plunge protection. 

Companies either default and become insolvent or are bought out by their competitors. This is referred to as a bail-in as opposed to a government bailout. 

And you guessed it, that's exactly what's happening:

(1) - Goldman is supposedly raising USD $2B to buy the assets owned by the Celsius Network. 

(2) - Alameda Ventures if offering Voyager USD $485M and 3AC USD $200M 

(3) - FTX is offering BlockFi USD $250M 

To surmise, the real difference to the 08' GFC is there is no stimulus, taxpayer money bailouts, coercion or socialized losses. 

The parties that take the risk are now paying the price.

On a lesser technical note, Bitcoin failed to sustain the breakout due to the lack of supportive volume. As a result, the strength of what looked to be a bullish structure is now decaying, and seller momentum is gaining momentum. 

Bitcoin vs. US Dollar, $BTC - 4 Hour (H4)

Unless the bulls reclaim US$ 20K, BTC/USD is left in a vulnerable position where the .786 Fibonacci retracement around USD 17K could be re-tested. 

Considering the unknown potential of the contagion impacts outlined in the article earlier, it is too early to warrant any significant long-term positioning or accumulation.

See you again for the next update.

- q

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