I’m getting rather tired of the word “contagion.”
Yet it seems the C-word is creeping back into conversations about digital assets. By now we are familiar with the collapse of FTX, once one of the world’s largest cryptocurrency exchanges.
But this is far from over.
LUNA as an example
Although the failings here are not on the same catastrophic scale as the disgraceful collapse of UST and LUNA (to refresh my own PTSD), that scandal illustrated how devastating a sudden loss of capital can be.
Prior to Terra’s collapse in May, UST was valued at $18.6 billion and LUNA at $29.7 billion. Within two to three days those figures effectively dropped to zero. By contrast, FTX reportedly faced an $8 billion balance-sheet hole.
So the numbers aren’t directly comparable, but the domino effects can be similar. Many firms were dragged down by Terra because they held UST on their balance sheets, or they were overexposed to other crypto assets that tumbled in the wake of the scandal.
We saw Celsius file for bankruptcy with more than 100,000 creditors and $4.7 billion in liabilities. Voyager Digital, another crypto lender, also had upwards of 100,000 creditors seeking repayment, albeit for a smaller $1.3 billion in liabilities.
Then there was Three Arrows Capital, which owed $3.5 billion to as many as 27 firms. I could go on, but you get the point: the crypto industry is far from a tidy ecosystem of non‑overlapping participants. Many companies hold pieces of one another, and that creates systemic risk.
In hindsight, the entire episode reads like a cautionary tale about risk management and the need for diversification. I still struggle to understand why companies thought it prudent to swap treasuries, assets, and liquidity into the same highly volatile asset classes that their businesses themselves were already exposed to.
But they did, and the dominoes fell.
Who is exposed to FTX?
The question now is: who is exposed to FTX?
We can reasonably hope the industry learned lessons from Terra and would be more cautious. After all, much of the capital on FTX was held in stablecoins and fiat rather than highly volatile cryptocurrencies.
Just as many mistook UST for a truly stable asset pegged to $1, others simply left funds sitting on an exchange denominated in base currencies, assuming it was safe.
We now know Sam Bankman‑Fried took a different approach, moving those funds to Alameda Research, the sister trading firm. After a string of margin calls and bad loans, those funds were apparently drawn down—ironically, many of those calls came after the LUNA collapse when panicked investors tried to withdraw crypto in any possible form.
Companies began to wobble. BlockFi, another crypto lender, paused withdrawals and issued a statement acknowledging significant exposure to FTX and related entities.
“We have substantial exposure to FTX and related parties, including liabilities owed to us by Alameda, assets held on FTX.com, and amounts drawn under our credit facilities with FTX.US,” BlockFi said.
BlockFi had signed an agreement with FTX in July for a $400 million revolving credit facility. After pausing withdrawals, it is hard to see how they could recover, and we now know how lethal such pauses can be.
The losses spread beyond aggressive crypto firms. Established investors such as Sequoia Capital, SoftBank, and Tiger Global—sizable, mainstream players—saw write‑downs.
“Based on current understanding, we are reducing our investment to $0,” Sequoia said in a note to LPs, a statement many would agree was appropriate under the circumstances.
SoftBank reportedly lost $100 million, while Tiger Global trimmed its exposure by $38 million.
I was let go by Sequoia Capital today. Buck had to stop somewhere. I was the 27 year old associate responsible for copying and pasting revenue and profit numbers from a spreadsheet in the FTX data room into a PowerPoint slide in an investment memo as diligence
— Kyle Russell (@kylebrussell) November 10, 2022
The graphic below should give you a quick sense of what’s at stake:
Moving forward
As I said, I don’t expect this to become a liquidity crisis as severe as LUNA’s collapse, but it would be naïve not to anticipate further pain. That includes sudden, grim announcements from firms that are unexpectedly caught up in the mess—there will be more surprises.
$10 billion is a substantial sum, and it’s hard to imagine those losses not echoing elsewhere. Hopefully, the damage will be as limited as possible, and we will draw lessons from the LUNA fiasco.
Ultimately, this should prompt CEOs and treasurers to allocate capital more prudently, conduct rigorous stress testing, pay proper attention to diversification, and, simply put, exercise better judgment.
Should it take this to learn the lesson? One hopes not.