Learn · Crypto, from first principles
The collapses of 2022
In eight months an algorithmic stablecoin, a hedge fund, several lenders and the second-largest exchange failed in sequence. The connections between them were the story.
2022 produced the field's most severe stress episode. What made it instructive was not any single failure but the order in which they arrived, because each one caused the next.
May: Terra and LUNA
Fact
An algorithmic stablecoin lost its peg and both it and its companion token fell to near zero within days
Terra's UST held its dollar peg through convertibility into LUNA. Defending the peg under selling pressure required minting LUNA in escalating quantity, which destroyed LUNA's price, which required minting still more. The mechanism accelerated the collapse rather than arresting it. A large yield program had attracted substantial deposits into the system beforehand. See stablecoins.
Terra's UST held its dollar peg through convertibility into LUNA. Defending the peg under selling pressure required minting LUNA in escalating quantity, which destroyed LUNA's price, which required minting still more. The mechanism accelerated the collapse rather than arresting it. A large yield program had attracted substantial deposits into the system beforehand. See stablecoins.
June–July: Three Arrows Capital and the lenders
A large hedge fund with concentrated exposure to the failed assets, and heavy leverage borrowed from crypto lenders, became insolvent and entered liquidation.
Its lenders had been paying attractive rates on customer deposits and lending those deposits onward. When the borrower defaulted, several could not meet redemptions. Celsius froze customer withdrawals in June 2022 and filed for bankruptcy the following month; others followed.
Interpretation
These firms were performing maturity transformation without any of the apparatus that makes it survivable
Taking deposits repayable on demand and lending them to leveraged borrowers is what a bank does. A bank does it with capital requirements, liquidity rules, supervision and a central bank able to lend against good collateral in a panic. These firms did it with none of that, while marketing the product to retail customers alongside a yield figure. The failure mode was a bank run, and it was entirely conventional.
Taking deposits repayable on demand and lending them to leveraged borrowers is what a bank does. A bank does it with capital requirements, liquidity rules, supervision and a central bank able to lend against good collateral in a panic. These firms did it with none of that, while marketing the product to retail customers alongside a yield figure. The failure mode was a bank run, and it was entirely conventional.
November: FTX
Fact
The second-largest exchange collapsed within a week and filed for bankruptcy on November 11, 2022
Reporting revealed that its affiliated trading firm held a balance sheet heavily composed of a token the exchange itself had issued. Withdrawal demand accelerated, the exchange could not meet it, and the bankruptcy filing followed. Customer assets had been used for purposes customers had not authorised. Its founder was convicted of fraud in November 2023 and sentenced in March 2024 to 25 years.
Reporting revealed that its affiliated trading firm held a balance sheet heavily composed of a token the exchange itself had issued. Withdrawal demand accelerated, the exchange could not meet it, and the bankruptcy filing followed. Customer assets had been used for purposes customers had not authorised. Its founder was convicted of fraud in November 2023 and sentenced in March 2024 to 25 years.
What they had in common
- Customer assets treated as the firm's own. The recurring failure since Mt. Gox, with nothing new about it.
- Leverage collateralised by self-issued tokens. Assets whose value depended on confidence in the borrower were used as security for borrowing — collateral that evaporates at precisely the moment it is called on.
- No independent verification. Balance sheets were asserted and not examined. Nobody could check.
- Dense interconnection. The same small group of firms lent to, invested in and traded with one another, so exposures compounded rather than diversified.
- Yields marketed without the risk that generated them. Customers were shown a rate and not told what was being done with their money.
What did not fail
Fact
The protocols continued operating normally throughout
Lending contracts liquidated positions as designed, on schedule, in public, through the sharpest declines. Over-collateralised stablecoins held. Decentralised exchanges processed trades without interruption. Every failure in 2022 was a company holding customer money — and the automated, transparent systems that many observers considered the riskier part of the field handled the stress better than the firms did. That comparison is the single most useful thing to take from the year.
Lending contracts liquidated positions as designed, on schedule, in public, through the sharpest declines. Over-collateralised stablecoins held. Decentralised exchanges processed trades without interruption. Every failure in 2022 was a company holding customer money — and the automated, transparent systems that many observers considered the riskier part of the field handled the stress better than the firms did. That comparison is the single most useful thing to take from the year.
What changed afterwards
- Proof-of-reserve publication became common, though it remains partial. See exchanges.
- Self-custody adoption rose sharply, as it did after 2014.
- Regulatory work accelerated in most major jurisdictions, producing among other things the frameworks described in regulation.
- Yield products marketed to retail without disclosure of the underlying activity became substantially harder to offer legally.
Where to check this: the FTX and Celsius bankruptcy filings are public court documents, the Three Arrows liquidation proceedings are on record, and the criminal conviction and sentence are matters of public judicial record.
Education, not advice. These lessons explain how things work. They do not tell you what
to buy, and Wealth Signal does not publish recommendations. Full disclaimer.