Crypto contagion goes on – for how long?

Crypto contagion goes on – for how long?

The crypto markets have been in restructuring mode for the past few weeks. As time goes on, the market is trying to figure out, who has been owing money to whom. On the borrowing side, Singapore-based crypto hedge fund Three Arrows Capital (3AC) seems to have many open credit relations – too many. The company has already filed for bankruptcy.

Among the crypto companies having exposure to 3AC are firms like the crypto exchange Blockchain.com or Genesis, one of crypto’s largest brokerages for institutional investors. Some were only half-joking when they noted that 3AC seems to have been the entire crypto market. With 3AC being in bed with almost anyone, the question going forward is: For how long will this contagion- effect go on? After all, by now, almost half a dozen companies have been forced to reveal that they are in severe trouble.

To stop contagion from spreading, crypto lender Celsius is currently paying down their debt on decentralised lending protocols like Aave, Compound, or Maker, thereby freeing up collateral to honour other outstanding credit liabilities. As pointed out in our last newsletter post, the crypto exchange FTX has been at the forefront of doing the same by providing lifelines to ailing companies. Seemingly, this was not well-received by FTX's biggest competitor Binance. Its CEO Changpeng Zhao – also known as "CZ" – took to Twitter to critique FTX for bailing out digital asset broker Voyager.

For what it is worth, CZ’s criticism is a clear attempt at putting a competitor on the spot. Nonetheless, FTX’s deal has some oddity to it. As Voyager’s bankruptcy filing revealed, Alameda Research, founded by crypto billionaire and FTX CEO Sam Bankman-Fried, extended a $500 million line of credit to the crypto broker while simultaneously owing the same company money. The money owed is to the tune of $377 million, making Alameda Voyager’s second-largest debtor just after Three Arrows Capital. However, since FTX is one of Voyager’s largest shareholders, FTX’s move to make sure Voyager can survive is not surprising.

Also wanting a piece of the action is Justin Sun, founder of the Tron blockchain. He announced on Twitter that Tron is friends with everyone and always ready to serve. Later, the controversial crypto figure further disclosed that he is willing to spend up to $5 billion on helping embattled crypto companies. So, while Sun has hired an investment bank to advise on potential deals, the money for such deals would apparently be coming from Tron and his personal coffers.

How to truly qualify as DeFi

The recent crypto failures have led many to believe that the world of decentralised finance has experienced its waterloo moment from which it will never recover. However, the crypto turmoil of the last few weeks is not indicative of any inherent flaws in DeFi. On the contrary, well-designed DeFi protocols – apart from price oracle latency – have worked just fine. More than that, they have lost zero of their depositors’ funds during the crypto crash.

What has been imploding are centralised actors that have merely applied crypto assets to their business. Such entities must be called for what they are: centralised DeFi participants also referred to as CeDeFi players. Their true nature becomes clearest where they are not built on code, merely dabble in crypto assets and do so in a custodial manner.

Somewhat less obvious, but no real DeFi either, are protocols that have a concentrated amount of parties decide on transactions or the protocol’s execution. Consequently, for a project to be considered DeFi, a few basic elements need to be present: The protocol is ideally built around free and open software that is deployed on a sovereign and decentralised blockchain. Also, the code iseither immutable altogether or only subject to minimal on-chain governance. Furthermore, these rules are enforced at the smart contract level.

Importantly though, decentralisation should not just be a lofty goal and fancy ideal. Decentralization is also better from a practical point of view: Protocols that are based on DeFi’s true principals will make sure their loan book is always transparently visible while lenders are protected by automated enforcement. Through smart contracts the collateral of defaulting parties is automatically liquidated according to protocol enshrined parameters. No recourse to a legal system is necessary. This stands in contrast to some of the creditors that are now engaging in a lengthy process to potentially get some of their money back from failing crypto lenders.

Regulation and crypto

Judging by what has been happening in crypto this year, further regulation is an inevitability. This fact was echoed by the Financial Stability Board (FSB) just recently. A few days ago, the international body with its base in Switzerland called for new global rules for cryptocurrencies, thereby performing its role as a guardian of financial stability worldwide.

To promote the implementation of existing international standards, the FSB is going to submit a report to the representatives of G20 in October of this year. The main purpose of the report should be to lay out regulatory and supervisory approaches to stablecoins and other crypto assets. According to the FSB, activities surrounding these new types of assets posing similar risk to that of traditional financial activities should be subject to the same regulatory framework, in line with the principle of “same activity, same risk, same regulation”.

As the largest economic area, the U.S. also wants to push for clear regulation. Its Treasury Department has just published a fact sheet outlining on how the U.S. government plans on working with foreign bodies to regulate the cryptocurrency sector. As a step in the right direction, this newly published fact sheet represents the first report published by the U.S. after President Biden passed an executive order on crypto earlier this year.

North Korean hackers give crypto protocols the shivers

Crypto hacks show no signs of stopping. According to a recent report published by the team behind Atlas VPN, blockchain hackers managed to steal approximately $1.97 billion in the first half of 2022. Even more disturbing is the fact that most of that money is probably going right to North Korea.

As an analysis by the blockchain research firm Elliptic shows, several hacks can most likely be traced back to a hacker group called Lazarus Group, which is associated with North Korea and potentially even supported by the Kim Jong Un regime. Some of the biggest and most recent hacks that are attributed to the North Korean hackers include the $620 million hack of Axie Infinity’s Ronin bridge as well as the recent $100 million hack of Harmony’s Horizon bridge.

What stands out is that the hackers from North Korea are indeed targeting so-called bridge projects that aim to enable interoperability between blockchain protocols. While this is one of the reasons pointing to North Korea, another one is that the hacks usually correspond with Asia-Pacific night-time hours and are targeted towards Asian companies.

Although hardly laudable, North Korea is heading the list of the world’s most successful cryptocurrency hacking countries. According to recent estimations, the country should have an army of approximately 7,000 hackers conducting cyberattacks on a regular basis. And according to experts, these are only going to get stronger.