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In a sector where debt and leverage bind counterparties firmly together, dominoes can fall quickly and violently.
At its peak, Voyager Digital had 3.5 million members (about the same number as Coinbase in 2015) and $5.9 billion in assets, which is similar to a sizable regional bank or reputable wealth management business.
97% of Voyager's clients saved less than $10,000 on the platform, showing a large number of individual investors. It was one of the few digital asset brokerages listed on stock exchanges anywhere in the globe (albeit in Canada rather than the U.S., its home country).
Until recently, Voyager's future appeared to be bright. The leadership seems incapable of conceiving of a bear market, let alone its ramifications. In 2021, CEO Steve Ehrlich remarked, “I think the market looks completely different today from what it looked like in 2017. We all remember 2017.”
As it turns out, 2021 resembled 2017 in that both years were immediately followed by a severe crypto market slump. The optimistic outlook of Ehrlich has produced a bad crop.
Three Arrows Capital is now revealed to have received enormous unsecured loans from the Jersey City, New Jersey-based corporation (3AC). This collapsed hedge firm has apparently defaulted on all of its commitments, and its founders have reportedly fled the country.
This alone appears to have been a deadly wound. On 1 July, Voyager froze client money. It filed for bankruptcy protection in New York just days afterward.
Voyager is in a bleak situation. “The Debtors are facing a short-term ‘run on the bank,’” according to a statement Ehrlich filed alongside bankruptcy papers. But, also according to Ehrlich (who did not respond to a request for comment for this story), Voyager has a brighter future: “Debtors have a viable business and a plan for the future.” (Under Chapter 11, the company is seeking to reorganize rather than liquidate.)
How did a once-powerful and well-respected crypto lending company arrive to this point?
Brief version: Voyager was reasonably effective at attracting deposits. Not so much when it came to lending that money out.
Why did Voyager Digital fail?
In the company's chapter 11 bankruptcy petition, Ehrlich provided an unusually detailed account of the crypto lender's errors. According to Ehrlich, the tale begins with the breakdown of the Terra blockchain ecosystem and the subsequent spread.
In a sector where debt and leverage bind counterparties firmly together, dominoes can fall quickly and violently. Voyager portrays itself as a victim of the cryptopocalypse, undone not by direct exposure to Terra's UST stablecoin and LUNA token, but rather by unfortunate business partners.
As crypto winter began in early 2022, Voyager reportedly acted swiftly to hedge its risk, in part by lowering loans and limiting counterparty risk. All the more so to defend against the stunning May collapse of Terra. This endeavour was "in most cases" successful.
Before it was not.
Things deteriorated in June. Three Arrows Capital, a well regarded Singapore-based hedge fund with loans throughout the business and wagers across the sector, "was in danger" of defaulting on its obligations. Its own "huge" wagers on LUNA had collapsed into a losing black hole.
Three Arrows' investments in Lido staked ether (stETH) and the Grayscale Bitcoin Trust were both in the red. (Digital Currency Group, which owns Grayscale, also owns CoinDesk.) Notably, Ehrlich does not include any of these in his bankruptcy story, perhaps indicating a worrisome lack of awareness into the functioning of a firm to which he provided a $650 million unsecured loan.
In any case, Three Arrows was performing poorly across the board. Additionally, it was one of Voyager's major loan customers.
What was Voyager's true line of work?
To comprehend Voyager's demise, one must first comprehend the nature of its business.
It seemed to depositors quite similar to a bank with a few tweaks. Users first deposited bitcoin rather than government cash. In the background, while Citibank or the teachers' credit union might earn money by converting deposits into house loans, Voyager was involved in far riskier lending, as it turns out.
Voyager is one of several retail-facing crypto institutions that loan crypto assets to traders and institutions to generate interest on deposits.
These loans are utilised by investment businesses and hedge funds such as Three Arrows Capital to execute large bets. They obtain funds from lenders, long or short a plethora of (risky) assets, invest in early-stage enterprises, and, if everything goes according to plan, earn large profits pretty rapidly.
Some of these returns are made as interest payments to their loan partners. In turn, these lenders, such as Voyager, pass along a portion of the interest to clients. For depositors, the sequence of events that led to these yield payments is virtually unimportant and certainly not clear. They just see a payoff in their accounts.
Until anything goes wrong, that is.
When asset values fall or a counterparty defaults on a large loan, lenders are left with enormous gaps in their balance sheets. The systemic collapse has blown up not just Voyager, but also Celsius and Babel Finance, which have all suspended withdrawals and look insolvent for the most part.
This has had serious consequences for actual individuals, many of whom invested small sums in Voyager and similar funds in quest of larger returns. What consumers may realise too late is that these crypto lenders are not banks, and it is uncertain whether or how their money would be refunded. Voyager, for its part, is currently under regulatory inquiry for allegedly misrepresenting client deposit insurance.
Voyager is also remarkable since it is the first crypto lender to declare bankruptcy. As part of this procedure, Ehrlich has submitted a long statement explaining the company's difficulties. It offers an unfiltered look into the unstable underpinnings shared by all crypto lenders.
How it ended
Among these information are the interest rates paid by borrowers. Alameda Research, according to Ehrlich's statement, would pay up to 11.5%, Three Arrows Capital, 10%, and Genesis, 13.5%. (Digital Currency Group, which owns Genesis, also owns CoinDesk.) Three Arrows was by far the largest counterparty, having borrowed almost $660 million. This "integral aspect of the firm" was the cash cow's source of income.
Notably, 3AC's interest rate is lower than that of other borrowers. Multiple lenders did provide significant loans to Kyle Davies and Su Zhu, co-founders of Three Arrows, on amicable conditions, which appears to indicate a higher-than-average level of confidence in the fund. Voyager stands out, though, for granting such a large credit to Three Arrows without needing security. As we've now seen, that trusting gesture was grossly misguided.
During the pandemic, however, when retail traders' speculative craze pushed everything from GameStop stock to dogecoin into silly season, the lending industry soared. From early 2020 to early 2022, the number of users on the Voyager platform increased from 120,000 to 3.5 million. Voyager profited from low U.S. dollar interest rates and soaring enthusiasm for the world's trendiest, hottest, and most volatile risk-on asset.
Late in 2021, however, as is typical with bubbles, the peak of the crypto-mania was reached, and the value of assets began to plummet. The crisis in Ukraine, increasing inflation, and rate rises by the U.S. Federal Reserve further rocked the cryptocurrency market's lone upward trend. Between November 2021 and April 2022, the values of all crypto assets fell by around 33 percent.
The wild card then emerged. Beginning in early May, the UST stablecoin experienced a "death spiral" that drained billions of dollars from the global crypto market. Within days, a blockchain that Ehrlich claims was “widely viewed as a project with significant promise” and had major backing from investors of all stripes, had gone all but kaput.
During this time, two less spectacular but equally hazardous sinkholes appeared. The Greyscale Bitcoin Trust began selling at a considerable discount to the underlying bitcoins in early 2021. And stETH, which is essentially a promissory note for ETH on the next Ethereum 2.0 system, started trading at a discount to ETH. Both of these situations necessitated that investors incur substantial losses in order to convert their positions in these assets into cash.
Three Arrows Capital, you got it, was a significant GBTC and stETH holder. 3AC's loss of its whole original $200 million stake in LUNA may not have been devastating if it had not already been in the red on these other bets. Nevertheless, Three Arrows, for years one of the most reputable trading organisations in crypto, accomplished the unthinkable: It vanished.
Three Arrows has previously received loans totaling $350 million in USDC and 15,250 bitcoins from Voyager. Late in June, as the market continued to decline, Voyager issued repeated requests for repayment. However, Three Arrows did not react and also ghosted other potential partners. The loss of $650 million in Voyager funds, which included a large number of consumer deposits.
The dominoes began to fall. Terra's demise led to Three Arrows' failure, which in turn led to Voyager's reckoning.
This was not an ordinary crypto winter.
The outbreak season was come.
Mid-June, Voyager negotiated a nearly $500 million credit arrangement with Alameda in an effort to staunch the company's short-term financial losses. It was at best a Band-Aid, a "partial solution" to contagion-fueled liquidity concerns that were compounded by the wider cryptocurrency market decline.
Adding insult to injury, another crypto loan behemoth, Celsius, was breaking apart at the same time. On June 12, Celsius stopped customer withdrawals, which shook faith in lenders and the markets and caused Voyager's clients to flee to safety. The reduction of daily withdrawal limitations from $25,000 to $10,000 per day on June 23 was intended to halt the exodus and buy time for Voyager.
But it wasn’t enough in the face of what Ehrlich describes as “an influx of customer withdrawals” that threatened “the Company’s ability to serve customers who remained on its platform.” As the market continued to fall, Voyager’s situation grew ever bleaker. On July 1, it froze all customer withdrawals and trading to “avoid irreparable damage to the Debtors’ business and ensure that its trading platform operated smoothly for all customers.” (Not being able to withdraw, it must be noted, seems in itself like less than smooth operation.)
The ship entered what may be regarded as panic mode. By mid-June, it had recruited legal counsel; by the end of the month, a consulting firm had joined the fray. The Canada-listed public firm urgently need "possible strategic solutions" to its impending liquidity issue. This may involve selling enterprises or raising funds.
Trading giant Alameda Research provided some temporary breathing room on June 20 in the shape of a $500 million unsecured borrowing arrangement. During the market downturn, Sam Bankman-Fried, creator of Alameda and CEO of the FTX exchange, has become crypto's greatest protector. Voyager initially borrowed $75 million, which is expected to be repaid by late 2024.
According to Ehrlich, investment bankers went out to "sixty possible financial and strategic partners" — that is, potential saviours. They received 22 prospects for a rescue agreement, but just one proposal materialised. Voyager could not accept the offer since it was too cheap. No additional alternatives were displayed.
"It became evident that a prospective strategic deal would not occur unless the Company filed for chapter 11 protection," Ehrlich explains.
Voyager informs the court that it intends to make a return. A Chapter 11 reorganisation would let Voyager to shed debt and reorganise without having to liquidate its assets. Ehrlich says, "Voyager will proceed as quickly as possible through these instances to maximise the value of its company and enable clients to fully utilise the Company's platform." A "vigorous marketing strategy" is under underway to communicate that Voyager should not be discounted.
This marketing push will need to be quite vigorous, as both larger circumstances and some of Voyager's own acts have severely eroded any public trust it once enjoyed. A reorganisation proposal proposed on Monday will recompense customers for misplaced cryptocurrency with stock shares and tokens of Voyager (whatever those are).
This is unlikely to make consumers pleased, but it may provide them with an incentive to continue using the hobbled service.
By fLEXI tEAM