Crypto Firms Reckon With Risk Following Collapse

For crypto builders hoping to move fast and break things, talk of risk management tends to really kill the vibe.

But Terra’s collapse wiping $2 trillion in nominal value from crypto markets, combined with Three Arrows Capital (3AC)’s loan default leaving a slew of lenders strapped for cash, many in the space are calling on crypto firms to manage risk more effectively.

Conversations with market participants reveal there is no silver bullet to mitigate risk, but simple corrections could limit the extent of future market downturns. Embattled crypto firms are also receptive to making changes.

Prior to the recent credit crisis, many crypto builders thought of risk management primarily in terms of hack prevention, Adam Zarazinski, the CEO of crypto analytics firm Inca Digital, told Blockworks. 

“If you’re looking at risk management and compliance just through the forensics lens, you’re looking at the market with blinders on,” Zarazinski said. “There’s a lot more data other than just Chainalysis.”

Zarazinski’s clients are now thinking more broadly about risk.

“We have seen a significant inflow of crypto companies coming to us asking for risk management solutions over the past month and a half,” Zarazinski said. 

Most companies asked for cross-market surveillance to guard against risky exposure and natural language data from social media that can identify market trends early.

Widespread leverage across crypto ramps up risk

Last week, Galaxy Investment Partners CEO Mike Novogratz admitted he was “darn wrong” about leverage risks in crypto and surmised that few could have seen the extent of dangerous exposure in the crypto space. 

Hindsight is 20/20, but some in the industry believe portions of the recent crash were preventable.

“Terra wasn’t a shock to anyone who spent time looking at the technology. People had been raising alarm bells for a long time,” Steven Goldfeder, CEO of Offchain Labs, said. “The information was out there” on which crypto firms were not trustworthy.

Meanwhile, US government officials continue to drag their feet on crypto regulation. California Rep. Maxine Waters announced Wednesday negotiations for a US stablecoin bill will be delayed until after the summer congressional recess.

“I hope people are more mindful and do further diligence,” Annabelle Huang, managing partner of Amber Group, said, “instead of saying, ‘Hey, he’s a crypto influencer, let me park my money with him,’ or ‘Just because my friends gave my money to him, it’s safe to [invest].'”

Court filings show Voyager Digital gave over-leveraged hedge fund Three Arrows Capital an unsecured $650 million loan, leading Voyager to declare bankruptcy when 3AC defaulted. 

Voyager and other investors in the $10 billion fund were drawn in part by 3AC’s reputation as a savvy dealmaker.

Remove the human element to help stay afloat

Huang comes from a traditional finance (TradFi) background and hopes crypto will pick up TradFi’s conservative borrowing practices. “If you have two to five times leverage, you risk being wiped out in a day,” Huang said. 

She also emphasized that collateral should be handled algorithmically to control for human error.

“A lot of the losses in the crash from some of the lending platforms likely resulted from the fact they exercised human discretion or extended favor to counterparties during the recession,” Huang said.

Ex-employees reported Celsius’ compliance department only contained three people, a tiny number for a crypto bank at one point handling $25 billion in assets. 

Bolstering risk management will require bear-market investment from crypto companies. 

Each of the companies Blockworks spoke to said lenders especially should look at bringing on additional full-time risk management staff.

“Companies are a little nervous to spend money but they all know they need more risk management,” Goldfeder said.

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