This article comes from MediumThis article comes from

, the original author: Andre Cronje, compiled by Odaily translator Katie Koo.

In 2022, the price decline of cryptocurrencies and the failure of some protocols and exchanges led to losses of 2 trillion US dollars. The biggest shocks to the market so far include the collapse of Terra, the bankruptcy filing of Celsius, the bankruptcy filing of Voyager Digital, and the bankruptcy of Three Arrows Capital. These shocks were not isolated, but rippled across the market, causing the overall price of Bitcoin and Ethereum to drop. Investors in exchanges who lost a lot of money during this "winter" are wondering what remedies they have and whether they can get claims from any irresponsible players in the system.

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1. Terra Luna Crash

Terra, once lauded for offering on-chain investment opportunities to users around the world, is now being blamed for being the catalyst for the 2022 crypto winter. The reasons behind it deserve the attention of the market and regulators.

In May 2022, UST worth $2 billion will be withdrawn from Anchor Protocol and liquidated. A series of problems led to the collapse of Terra: insufficient reserves, flawed algorithm, and no withdrawal limit of Anchor Protocol. If there were proper limits to control large withdrawals, maybe UST wouldn't be depegged.

Jump Crypto reviewed UST/LUNA activity in May and found that a handful of large transactions contributed to the currency's instability and collapse. These transactions have been traced to some wallets, and the identities of all wallet holders remain unknown. It is worrisome that such a small group of people will be able to destabilize the entire cryptocurrency ecosystem without consequence or responsibility. UST's $2 billion withdrawal from Anchor Protocol can be traced to 7 wallets, including Celsius.

The figure below shows that when UST withdraws from Anchor, its deviation from the peg increases.

The actions of a handful of major UST holders are enough to destabilize the Terra ecosystem and empty the pockets of wallet holders with small funds without any recourse.

2. Celsius

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Crypto trading platform Celsius files for bankruptcy in the US. This comes a month after investor accounts were frozen on June 12, a move that came with little warning and was caused by illiquid exchanges. Celsius' inability to meet investor withdrawals appears to be the ultimate culmination of overleveraged loans (and poor reserves), poor decision-making by key players, and a degree of malfeasance by major crypto asset holders and Celsius executives. result.

The ETH & stETH incident led to a run on Celsius by users who panicked and withdrew their investments, eventually causing Celsius to freeze its network. The ensuing liquidity crisis led Celsius to apply for liquidation on 17 July.

Since cryptocurrencies are not regulated as financial products or legal tender, Celsius does not violate regulation at the legal level. However, they can be found acting negligently, failing to implement prudent practices and deliberately misleading users.

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3. Three Arrows Capital

The collapse of Three Arrows Capital (3AC) in mid-2022 took many in the industry by surprise. 3AC's decline was related to its exposure to Terra. 3AC purchased 10.9 million LUNAs for $500 million, which were then locked and pledged. With the collapse of Terra, 3AC's holdings decreased, and its pledged LUNA is now worth only $670.

3AC also holds a majority stake in Grayscale’s Bitcoin Trust (GBTC). After the Terra crash, 3AC focused on GBTC arbitrage, expecting a reversal if GBTC were approved for conversion to an ETF. But that didn’t happen, and Bitcoin’s price dropped as Terra sold off its Bitcoin reserves, further depleting 3AC’s other holdings. Like Celsius, 3AC is affected by stETH - also depreciated with stETH depegged. Voyager Digital provided 3AC with a $660 million unsecured loan. Voyager Digital has now filed for bankruptcy as well.

In addition to questionable investment decisions, 3AC has been accused by Singaporean authorities of providing misleading and false information to lenders — an alleged fraud — in order to secure more loans. This highlights a lack of prudential regulation of crypto-asset lending, as the industry fails to check the excessive exposure of large players in search of quick returns.

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4. Potential Market Impact

These collapses are exacerbated by macroeconomic factors currently weighing on the global economy. Rising interest rates, wars, and fuel and food shortages all help raise consumer expectations, driving market behavior even across crypto assets.

As the global financial outlook darkens, consumers are looking to reduce risk and seek safer investments, both in cryptocurrencies and traditional investments. This includes investing in less risky crypto products such as ETH & stETH events.

The cryptocurrency market is part of the global economy and as such experiences ups and downs based on how ordinary consumers feel. Still, with regulatory intervention, the industry's up-and-down cycles can be smoothed out so that shocks to the system don't have catastrophic effects, as has happened recently.

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5. The need for regulatory reform

All of these issues are urging the law to introduce some regulation of the crypto industry in line with traditional financial regulations, so that consumers can be both protected and remedied if they suffer losses.

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6. Borrow remedies from traditional finance

6.1 Insurance Program

In the wake of previous recessions, many central banks around the world have introduced mandatory insurance, forcing banks to provide a minimum amount of insurance on deposits to ensure consumers are protected in the event of a bank failure. This provides safety to depositors and boosts confidence in banks in times of financial difficulty, ensuring fewer bank runs. Even in countries without an explicit deposit insurance scheme, central banks may, on a case-by-case basis, use discretion to compensate consumers who lose deposits at failed banks. The safety net of deposit insurance is a remedy available to consumers of traditional banks that is not available to depositors of crypto exchanges such as Celsius.

6.2 Prudential supervision

A strong regulatory regime, both to set the rules for taking consumer deposits and to oversee how those deposits are spent, would ensure that fewer banks fail and boost confidence in the banking system. Many central banks around the world regulate private banks based on the following factors: capital, asset quality, soundness of management, earnings, liquidity and sensitivity to risk. The same applies to crypto investments and exchanges.

Currently, in most jurisdictions, consumers have essentially the same rights as unsecured creditors when an exchange or investment vehicle files for bankruptcy. That leaves them at the end of a long line of creditors with little chance of paying compensation. Like most industries, there are security risks in the encryption industry. Because encrypted transactions are often jurisdiction-free and anonymous, they are difficult for hackers to trace. This is something that regulators need to keep in mind when implementing minimal regulation, which may hold exchanges liable for losses to consumer wallets.

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7. Upcoming regulation

The goal of MiCA is to harmonize regulation and “catch” cryptoasset activity that does not fall under existing legislation. The bill introduces licensing requirements for crypto asset service providers and reserve requirements for stablecoins. MiCA doesn’t deal with large areas of crypto, but it does address some of the larger issues in the market — specifically addressing the responsibilities of services provided by crypto exchanges and consumer protection. Globally, the crypto industry stands to benefit from regulations on crypto assets that curb excessive exposure to risky assets and encourage market confidence in the industry.

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8. Summary

The recent decline of the crypto market shows the flaws of the system and the need for regulation to rein in irresponsible players and protect consumers. Terra’s debacle was not isolated, it was the tipping point that exposed the overleveraged portfolios of several crypto hedge funds and exchanges. Celsius not only has excessive exposure to Terra, but is one of the main players spurring the Anchor Protocol to run. Exposure to stETH compounded Celsius' losses. 3AC is perhaps one of the most iconic examples of a "domino event" in the entire industry. As a major borrower and subsequent bad debt on the exchange's books, 3AC's over-leveraged position put it into voluntary liquidation. Amid all this turmoil, including the actions of these fund and exchange executives, is basically gambling with other people's money.

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