CeFi Rekt Was the Main Event in Crypto's Annus Horribilis

FTX, Celsius, 3AC Left a Trail of Wreckage in Centralized Finance

By: Aleksandar Gilbert Loading...

CeFi Rekt Was the Main Event in Crypto's Annus Horribilis

Crypto has been a bloodbath this year: total market cap down more than 66%, blue-chip assets hitting multi-year lows, companies going bankrupt and freezing customer deposits.

To many, this shows the skeptics are right: crypto is inherently volatile and a “garden of snakes,” as U.S. Rep. Brad Sherman (D-CA.) put it during a recent congressional hearing. Traditional finance may have its flaws, but at least it’s got rules and watchdogs, the argument goes.

Classic Model

To those on the inside, however, the Brad Shermans of the world have it backwards. Finance the crypto way has largely weathered the myriad crises of 2022. And the rot in the industry has been festering under the surface of crypto institutions modeled after those in traditional finance by embracing a classic hub-and-spoke model. The problem is centralized finance, or CeFi.

Three Arrows Capital, Celsius, Voyager Digital, and, most infamously, FTX, were all CeFi companies that managed themselves similarly to Wall Street firms. That means hierarchy and exclusive control over assets and information about those assets.

What Happened at FTX?

What Happened at FTX?

A Step-by-Step Guide to the Collapse of the Crypto Exchange

The Defiant The Defiant

As 2022 comes to a close, each of those crypto firms is in ruins and their customers have become creditors in bankruptcy or liquidation proceedings, hoping to maybe, someday, recoup some small portion of their deposits. In the cases of Three Arrows and FTX, both blew up in spectacular fashion, threatening to take the industry down with them.

This series of failures may finally draw a sharp distinction with truly decentralized platforms. With a little — okay, a lot — of technical know-how, anyone can peek under the hood of a DeFi product. Want to know whether it’s solvent? That it isn’t over-leveraged?

What’s Truly Going On

You can do that by hopping on Etherscan and looking at the balance in the smart contract. And if you don’t like what you see, you can contribute to the protocol’s governance, by purchasing its governance tokens, which confer voting rights. (A governance model that has its flaws, to be sure.) There is no need to get a job at the company that built it and rise to the rank of chief financial officer to get a handle on what’s truly going on in the firm’s books.

What Was Terra?

What Was Terra?

The $60B Fall of Terra Worsened the Bear Market and Undermined DeFi

The Defiant The Defiant

The pitfalls of CeFi were plainly evident in the case of Three Arrows, the crypto hedge fund founded by Andover graduates Su Zhu and Kyle Davies. It managed $10B in assets and enjoyed a sterling reputation.

But some felt something was amiss as early as 2019, according to a report in New York magazine. That year, Zhu and Davies tried selling the firm’s shares in Dutch crypto exchange Deribit at wildly marked up prices. In 2021, lenders asked that it put up collateral; it offered shares in Deribit, rather than cash or liquid crypto assets. But those shares were jointly owned with other investors, who hadn’t given the hedge fund permission to use them as collateral, according to New York.

After Three Arrows failed in July, Davies blamed the collapse of the Terra ecosystem earlier in the year for the hedge fund’s demise. Three Arrows did have a huge position in Terra’s LUNA token before it nosedived to near zero in value.

Had investors known this, they may have been able to manage their risk. But they couldn’t audit Three Arrows’ financials in real time. Unlike public companies, which have to disclose accurate and standardized financial statements every quarter, Three Arrows was insular. All investors had to rely on was the word of Zhu and Davies.


Now investors are hoping court appointed liquidators can recover a fraction of the $4B in claims that have been made thus far. Earlier this month, liquidators told creditors they had secured a mere $74M, The Block reported..

Among Three Arrows’ creditors: Voyager Digital, which had lent the hedge fund some $700M, money it will probably never see again after it, too, filed for bankruptcy in July.

This series of failures may finally draw a sharp distinction with truly decentralized platforms. With a little — okay, a lot — of technical know-how, anyone can peek under the hood of a DeFi product.

As for Celsius, an exchange that catered to individual investors, the CeFi vulnerability was even starker. It suffered a run on deposits in June. But more seriously, it allegedly used customer deposits to engage in risky trading strategies while falsely claiming to be hedging against potential losses, according to a lawsuit filed against the firm by KeyFi Inc., a New York-based asset management firm.

The suit in a New York state court argues that Celsius dipped into customer deposits to manipulate the price of Celsius’ CEL token, which multiplied in value 19 times in the 12 months ending in July 2021, according to CoinGecko data.


Then, there was FTX, the No. 2 cryptocurrency exchange worldwide and the face of the industry on Wall Street and Capitol Hill. In Sam Bankman-Fried, customers had the epitome of CeFi — an all powerful CEO and co-founder who allegedly plundered the customer deposits of one company — FTX — to support the fortunes of his private hedge fund, Alameda Research.

Of course, Terra, a DeFi platform, was the ur-collapse that triggered much of the carnage this year. Yet the deficiencies of its model and management do not change the fact that CeFi failed on so many levels this year, and caught so many investors unawares. Now Binance and other platforms are racing to show “proof of reserves” and allay concerns they may be the next centralized businesses to fail.

Of course, they wouldn’t have had to do that in the first place if they were DeFi.