‘Bunch of Idiots’: Crypto Pays Steep Price for Due Diligence Delinquency

crypto bankruptcies

The funniest part of the whole crypto winter may well prove to be Mike Novogratz, CEO of the large and highly regarded Galaxy Digital investment firm, criticizing the industry’s “inane risk management.”

Not in a “funny ha-ha” kind of way, because millions of people have lost billions of dollars as the cryptocurrency industry’s market cap plummeted more than two-thirds — now about $1 trillion — and left pretty much everyone who bought bitcoin in 2021 underwater.

But when Novogratz, who has almost half a million Twitter followers and is one of the most quoted voices in the industry, said at the Bloomberg Crypto conference on Tuesday (July 19) that the $48 billion collapse of the Terra/Luna stablecoin ecosystem in May showed that both industry and retail investors “really had very, very little concept of risk management” it was hard not to picture the Luna tattoo on his left shoulder.

Novogratz, who has not detailed Galaxy’s losses on Luna, did say in a shareholders’ letter after the run that caused the terraUSD stablecoin and Luna cryptocurrency that was supposed to maintain its dollar-peg with an arbitrage mechanism rather than the backing of a dollar reserve was “a big idea that failed.”

It was also one that he had very publicly talked up for a long time.

While Galaxy Digital realized $355 million in gains in the first quarter of 2022 on its Luna bets, the company also reported in May that it expected Q2 to show a loss of $300 million, so it’s unclear how his Luna bet did long-term.

Nothing New

Speaking about the crypto industry as a whole at the Bloomberg conference, Novogratz said the companies that investors and VCs were backing “took massive leverage, took asset liability mismatch — which means they had short term deposits on what they lent them out long. And those are the two ways people always go bankrupt.”

What came next was telling about the entire professional crypto investment industry.

“What I don’t think people expected was the magnitude of losses that would show up in professional institutions’ balance sheets,” he said. That in turn led to a “daisy chain” of insolvencies and bankruptcies that started with hedge fund Three Arrows Capital and led to crypto lenders Voyager Digital and BlockFi, as well as others like crypto lender Celsius.

See also: Stablecoin Collapse Sent Voyager Digital and Celsius on Different Paths to Bankruptcy

The thing is, this is not a new issue. There has been growing acknowledgement among venture capital firms that even by the standards of an industry whose business plan often resembles throw it against the wall and see what sticks, there has been a failure of due diligence.

Discussing the issue, one VC executive last year talked about the frequency with which projects created by people working under pseudonyms were backed.

It’s not something limited to one company. Crypto lenders Voyager Digital and BlockFi lent huge sums to Three Arrows without knowing much about what it was doing with the money.

In a June affidavit about the Three Arrows collapse, the chief strategy officer of Blockchain.com, which is reportedly owed $270 million by Three Arrows, said that one of the firm’s co-founders had told him it was trying to borrow $125 million to meet a margin call on another investment, according to Decrypt.

That “behavior is common within a Ponzi scheme, when earlier investors are paid with funds from newer investors,” the article noted. It’s also common when companies are desperate.

Speaking broadly, Novogratz said “companies took massive leverage, took asset liability mismatch — which mean they had short term deposits on what they lent them out long — and those are the two ways people always go bankrupt. This is a tail as oldest time and it happened and it happened in lots of ways.”

That is “frustrating as heck” he said, “because at times the whole industry looks like a bunch of idiots.”

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