Case Study 1: The DeFi Dominoes of June 2022 — How Terra's Collapse Toppled Three Arrows, Celsius, and Voyager

Case Study 1: The DeFi Dominoes of June 2022 — How Terra's Collapse Toppled Three Arrows, Celsius, and Voyager

Background: The House of Cards

In early May 2022, the cryptocurrency market appeared robust. Total DeFi TVL exceeded $200 billion. Bitcoin traded above $38,000. The Terra ecosystem — anchored by the UST algorithmic stablecoin and its sister token LUNA — held over $30 billion in TVL, making it the second-largest DeFi ecosystem behind Ethereum. The Anchor protocol on Terra offered a fixed 19.5% APY on UST deposits, attracting over $14 billion in deposits from retail and institutional investors who viewed it as a "safe" stablecoin yield. Behind the scenes, however, the conditions for a catastrophic cascade failure were already in place.

Three Arrows Capital (3AC), a Singapore-based crypto hedge fund founded by Su Zhu and Kyle Davies, had accumulated massive leveraged positions across the crypto ecosystem. Their portfolio included a $200 million position in LUNA tokens (purchased for $559.6 million), large holdings of stETH (Lido's liquid staking token), Grayscale Bitcoin Trust (GBTC) shares, and leveraged positions on multiple lending platforms. Critically, 3AC had borrowed from virtually every major crypto lending platform — Celsius, Voyager, BlockFi, Genesis, and others — often using the same collateral to secure multiple loans.

Celsius Network, a centralized crypto lending platform with over $20 billion in customer deposits, had deployed customer funds into DeFi yield strategies, including significant positions in stETH. Celsius had also lent hundreds of millions to 3AC. Voyager Digital, a publicly traded crypto brokerage, had extended a $650 million loan to 3AC — representing approximately 58% of Voyager's total loan book in a single counterparty.

The interconnections were invisible to most market participants. Retail users depositing into Anchor, Celsius, or Voyager did not know that their funds were part of an interlocking web of leveraged positions, concentrated bets, and counterparty exposures that would unravel in a matter of weeks.

The Trigger: UST Depegs

On May 7, 2022, large withdrawals from Anchor (approximately $2 billion in a single day) combined with selling pressure on UST in Curve's UST-3pool tipped the stablecoin below its $1 peg. The Luna Foundation Guard (LFG), a nonprofit established to defend the peg, began selling its Bitcoin reserves — approximately $3 billion — to buy UST and restore the peg. This created immediate selling pressure on Bitcoin across all exchanges.

The mechanism of UST's peg maintenance — burning UST to mint LUNA, or burning LUNA to mint UST — created the same reflexive death spiral that had destroyed Iron Finance eleven months earlier, but at 100x the scale. As UST traded below $1, arbitrageurs redeemed UST for $1 worth of newly minted LUNA and immediately sold the LUNA. This hyperinflated LUNA's supply: from 345 million tokens on May 7 to 6.5 trillion by May 13. LUNA's price collapsed from $80 to effectively zero. UST fell to $0.10.

The total value destruction was approximately $60 billion: $40 billion in LUNA market cap and $18 billion in UST that was not redeemed before the mechanism broke entirely.

First Domino: Three Arrows Capital

Three Arrows Capital's $200 million LUNA position became worthless overnight. But the LUNA loss was only the beginning. As Bitcoin's price dropped — partly due to LFG's $3 billion BTC sale and the general market panic — 3AC's leveraged Bitcoin positions were liquidated. The fund's stETH holdings also came under pressure: as the market crashed and liquidity tightened, stETH began trading at a discount to ETH (reaching 6% below parity) because large holders like 3AC and Celsius were selling stETH to meet margin calls and redemptions.

By mid-June 2022, 3AC was unable to meet margin calls from its lenders. The fund went silent — not responding to communications from counterparties. On June 27, a British Virgin Islands court ordered 3AC's liquidation. The eventual bankruptcy filings revealed that 3AC owed approximately $3.5 billion to more than 20 creditors, with assets of less than $1 billion.

The cascade mechanism was straightforward: 3AC had borrowed from almost every major crypto lender, and its inability to repay meant that every lender now had a hole in its balance sheet. The lenders' exposure to 3AC was not publicly known until the crisis was already underway.

Second Domino: Celsius Network

Celsius faced a two-pronged crisis. First, the stETH discount meant that Celsius's stETH holdings (estimated at over $400 million) could not be redeemed for ETH at par — and the Ethereum validator exit queue meant that even unstaking would take weeks. Second, Celsius had lent approximately $75 million to 3AC, which was now irrecoverable.

As word spread about Celsius's exposure, depositors began withdrawing. On June 12, 2022, Celsius froze all withdrawals, transfers, and swaps, citing "extreme market conditions." The company's 1.7 million depositors were locked out of approximately $4.7 billion in assets. Celsius filed for Chapter 11 bankruptcy on July 13, 2022. Subsequent investigations revealed that Celsius had been operating with a $1.2 billion hole in its balance sheet — losses from bad investments, failed trading strategies, and a catastrophic loss of 35,000 ETH in the StakeHound incident of 2021 (which Celsius had never disclosed to depositors).

The Celsius collapse was a DeFi-adjacent failure that illustrated a critical lesson about counterparty risk: Celsius marketed itself as offering "DeFi yields" but operated as a centralized, opaque financial institution. Users thought they were earning yield from transparent DeFi protocols; in reality, their funds were being deployed into leveraged, concentrated positions with no transparency, no auditing, and no depositor protection.

Third Domino: Voyager Digital

Voyager's exposure was even more concentrated. The company had lent $650 million to 3AC — 15,250 BTC and $350 million in USDC — representing the majority of its loan portfolio. When 3AC defaulted, Voyager's balance sheet was destroyed. On July 1, 2022, Voyager suspended trading, deposits, and withdrawals. On July 5, it filed for Chapter 11 bankruptcy.

Voyager's 3.5 million customers — many of them retail investors who had been attracted by high yields and a user-friendly app — discovered that their assets were not segregated but were part of Voyager's general estate. In bankruptcy, customer claims would be treated alongside other creditors, meaning full recovery was unlikely. The final recovery rate for customers was approximately 36 cents on the dollar.

Fourth Domino: BlockFi, Genesis, and Beyond

The cascade did not stop at Voyager. BlockFi, another centralized crypto lender, had significant exposure to 3AC and to FTX (which itself would collapse five months later). BlockFi accepted a $400 million rescue package from FTX in June 2022 — a deal that ultimately proved worthless when FTX filed for bankruptcy in November.

Genesis Trading, the lending arm of Digital Currency Group, had a $2.36 billion loan exposure to 3AC. When 3AC defaulted, Genesis absorbed the loss through its parent company — but the damage left Genesis vulnerable to the next shock (the FTX collapse), which ultimately led to Genesis filing for bankruptcy in January 2023 with $3.4 billion in claims.

Risk Stack Analysis

The June 2022 cascade demonstrated every layer of the DeFi Risk Stack operating simultaneously:

Smart contract risk: UST's algorithmic stabilization mechanism worked exactly as coded but was economically flawed at scale. The code was not buggy — the design was unsound.

Oracle risk: During the crash, oracle price feeds lagged reality. Some DeFi protocols continued to use stale prices for stETH and LUNA, leading to delayed liquidations and bad debt accumulation.

Governance risk: Terra's governance was effectively controlled by Terraform Labs and the Luna Foundation Guard. The decision to defend the peg by selling Bitcoin reserves was made by a small group, not through decentralized governance. Similarly, Celsius and Voyager's decision to deploy customer funds into risky strategies was made without customer knowledge or consent.

Liquidity risk: Every entity in the cascade faced a bank run. Anchor saw $2 billion withdrawn in a day. Celsius froze withdrawals entirely. Voyager froze withdrawals. The stETH/ETH Curve pool became severely imbalanced. Liquidity evaporated simultaneously across the entire ecosystem.

Composability risk: This was the defining feature of the crisis. Terra's collapse → Bitcoin selling by LFG → BTC price decline → 3AC liquidations → lender exposure → Celsius/Voyager insolvency → further stETH selling → wider DeFi contagion. Each step was connected to the next through financial linkages that were invisible until the crisis made them visible.

Regulatory risk: In the aftermath, the SEC, CFTC, and state regulators launched investigations and enforcement actions against Terraform Labs (Do Kwon was later arrested and charged with fraud), Celsius (Alex Mashinsky was charged with fraud), and Voyager (investigated by state regulators). The crisis accelerated regulatory scrutiny of the entire crypto lending sector.

Counterparty risk: The most devastating lesson. Users of Celsius, Voyager, and BlockFi trusted these entities to be solvent and honest. The entities were neither. Even in "DeFi" contexts — like depositing into Anchor — users were trusting that the 19.5% yield was sustainable when it was being subsidized by Terraform Labs and would eventually run out.

The Human Cost

Behind the financial numbers are real people who lost real money. A 28-year-old nurse in Ohio deposited her $120,000 life savings into Celsius, attracted by the 8% APY on stablecoins. A retired couple in Australia put their retirement fund into Voyager. A college student in Singapore put his tuition money into UST on Anchor after a friend told him it was "like a savings account but better." When withdrawals were frozen, these individuals had no recourse, no deposit insurance, and no timeline for recovery.

The June 2022 cascade is estimated to have affected over 6 million people across the collapsed platforms, with total losses exceeding $60 billion. It was, at that point, the largest destruction of value in cryptocurrency history — though it would be surpassed by the FTX collapse five months later.

Lessons and Structural Reforms

The cascade prompted several structural changes in DeFi:

Risk isolation. Aave and other lending protocols implemented or expanded isolation mode, limiting exposure to single assets and preventing the kind of concentrated positions that amplified the cascade.

Proof of reserves. Centralized platforms faced intense pressure to prove their solvency. While "proof of reserves" audits have significant limitations (they show assets at a point in time but do not show liabilities), they represent an improvement over the complete opacity that characterized Celsius and Voyager.

Stablecoin scrutiny. The collapse of UST led to increased regulatory attention to stablecoins and, within the crypto ecosystem, a shift away from algorithmic stablecoins toward fully-collateralized models. MakerDAO (DAI), Circle (USDC), and Tether (USDT) all saw increased market share relative to algorithmic alternatives.

Lending protocol conservatism. DeFi lending protocols became more conservative in their collateral requirements, lowering loan-to-value ratios, reducing the list of accepted collateral assets, and implementing more aggressive liquidation parameters.

CeFi skepticism. The crypto community developed a healthy skepticism toward centralized platforms that offer "DeFi yields" without DeFi's transparency. The mantra "not your keys, not your coins" gained new resonance.

Discussion Questions

Three Arrows Capital borrowed from over 20 lenders, but none of them knew the full extent of 3AC's leverage because there was no shared credit reporting system. Could a blockchain-based credit system have prevented the concentration of risk? What are the privacy tradeoffs?
Celsius marketed itself as offering "DeFi yields" while operating as an opaque centralized entity. How should regulators distinguish between genuine DeFi (transparent, on-chain, non-custodial) and "DeFi-washing" (centralized entities using DeFi branding)?
The Anchor protocol offered 19.5% APY on stablecoin deposits. With risk-free rates in traditional finance near 0% at the time, this should have been an obvious red flag. Why did millions of users deposit anyway? What cognitive biases were at play?
If you had conducted the 15-point due diligence checklist from Section 25.12 on Anchor protocol in March 2022, which red flags would it have identified? Which risks would it have missed?
The cascade ultimately affected over 6 million people across multiple platforms and jurisdictions. Is this a failure of regulation, a failure of individual due diligence, or a structural feature of interconnected financial systems that no amount of regulation or diligence can fully prevent?