Learning from Mistakes
In a simplified overview, the mechanics of banking can be summarised as follows:
- People have money they’d like to earn interest on.
- They entrust this money to a bank, which in turn lends it to other individuals or businesses. These borrowers utilise the funds for various purposes such as starting businesses or buying homes, and they repay the bank with interest.
- This cycle fuels economic activity, contributing to the growth of the overall economy. With time, more people, increased productivity, and more goods and services become available. For instance, if I borrow $100 to purchase a house or initiate a business and commit to repaying $110 with the returns from my house or business, there is a strong likelihood that I will be able to fulfill this commitment. I invest the $100 into productive ventures, these ventures generate $120 in returns, enabling me to repay the loan with interest and retain $10 as profit.
Of course, there are instances where this process doesn’t yield the anticipated outcomes—my business may not succeed, or the value of my property may decrease. Nevertheless, the triumphs should generally outweigh the setbacks, and if banks diversify their investments and maintain sufficient capital, they can ensure they can repay their depositors.
Periodically, the entire system might overextend itself. For instance, if all banks simultaneously decide to invest heavily in the belief that home prices will consistently rise, and this bet goes awry, it can lead to a financial crisis (again).
Broadly speaking, banking represents a leveraged wager on economic growth, and this bet, while inherently risky, tends to be profitable more often than not.
Here Comes Crypto
The dynamics of crypto banking vary depending on the approach taken. In some cases, it serves as an alternative to traditional banking, emphasising transparency and user autonomy. In others, it mimics traditional banking by supporting economic growth through lending and investment. Lastly, there’s a purely financial approach, where crypto banking is primarily concerned with profiting from the crypto market’s price fluctuations, without a direct impact on real-world productivity.
In the world of cryptocurrency lending and borrowing, a recent case involving the crypto platform Voyager raises critical questions about the due diligence and risk management practices within this space. The case brought forth by the Commodity Futures Trading Commission (CFTC) delves into the details of Voyager’s operations, revealing a troubling pattern of recklessness that puts the long-term value-building potential of crypto lending platforms into question.
Voyager’s High-Stakes Gamble
The essence of the CFTC case against Voyager revolves around the platform’s apparent eagerness to wager its customers’ assets. Voyager was discovered to have transferred substantial volumes of pooled customer assets to numerous high-risk third parties, including firms referred to as Firms A through D.
Astonishingly, Voyager undertook these transfers without conducting adequate due diligence. While Voyager occasionally got lucky, with Firms B, C, and D, and others repaying their obligations, the same cannot be said for its dealings with Firm A.
With respect to Firm A, Voyager’s conduct was equally reckless, but this time luck was not on its side. Voyager transferred over $650 million worth of digital assets commodities to Firm A without any meaningful due diligence or even obtaining the basic materials required in its due diligence questionnaire.
Firm A, it turned out, was Three Arrows Capital Pte Ltd , a crypto trading firm infamous for its spectacular failure in the crypto market.
A Profit-Driven Approach
The CFTC complaint shed light on Voyager’s approach to the dealings with Firm A, which was anything but cautious. Voyager appeared to prioritise profit potential over responsible stewardship of its customers’ assets. Instead of conducting thorough due diligence, Voyager focused on expediting Firm A’s onboarding process and diligence, treating it as a high-priority endeavour.
Voyager’s attempt to conduct due diligence encountered resistance from Firm A. Firm A, notably, declined to provide audited financial statements, a standard practice in responsible financial dealings. Instead, it offered a brief “NAV statement,” a far cry from the comprehensive financial documentation typically expected.
Lack of Risk Assessment
The due diligence process for Firm A was far from adequate. Voyager’s personnel did not receive vital financial documents, such as income statements, cash flow statements, balance sheets, or a debt-to-asset ratio. Stress testing of Firm A’s liquidity was conspicuously absent. Many individuals involved in the due diligence process lacked a background in credit risk evaluation, raising serious concerns about the platform’s risk management practices.
Beyond Three Arrows
The Voyager case revealed a troubling trend of lax due diligence and risk assessment within the crypto lending and borrowing landscape. It wasn’t just Firm A; Voyager extended customer funds to multiple crypto hedge funds with limited due diligence. Unfortunately, several of these funds eventually collapsed, demonstrating the industry’s overall fragility.
In summary, the Voyager case serves as a stark reminder of the challenges faced by the crypto lending and borrowing industry. With platforms driven by the immediate gratification of profit and a lack of rigorous due diligence practices, users must exercise extreme caution when participating in these platforms.
Users must remain vigilant and consider the potential risks associated with such platforms in their quest for long-term value-building in the cryptocurrency space.
Written by Danny Placinta
📅 This Week in Crypto 📅
Decentralised finance (DeFi) is no longer confined to the digital world. As we look around at some of the most important present-day issues, from buying a house to fighting climate change, defi is increasingly playing a crucial role. From tokenising real estate, climate change, and financing developing economies.
While the past year has seen numerous setbacks for crypto regulatory efforts, the industry’s collective labour will soon bear fruit, CEO of Meanwhile‘s Zachary Townsend writes. The key to achieving balanced rules and regulations lies in good faith actors following the rules where they are clear and pushing for clarity where they are opaque, all while ensuring that both industry participants and regulators alike work together to create a robust framework that promotes innovation and safeguards consumers.
Blockchain gaming projects have seen $2.3 billion in investments in 2023, with the third quarter getting $600 million despite crypto market prices seemingly being in a bearish mood all year. According to a report from the decentralised applications (DApp) tracking platform DappRadar, the first quarter of 2023 netted $739 million in investments, while the second and third quarters saw $973 million and $600 million, respectively
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