To The Moon

One day before Singapore's National Day celebrations on 8 Aug 2022, Hodlnaut threw a bombshell on their customers. The company was going under. Hundreds of millions(estimated $500m) in customer deposits have been frozen.

I have been following Hodlnaut closely since last year after I signed on as their customer. I even got my wife in as well. I believe I am qualified to give my opinion on what happened with Hodlnaut.

How I would react if I were a Hodlnaut victim

Although I managed to escape from the Hodlnaut disaster, I have had my fair share of gut-wrenching losses from questionable investments. I have given some thought to how I would react in a similar situation and I would like to share it with Hodlnaut victims.

• If the money lost is not too much (say, a few months of work income), it is better to focus your energy on your day job to earn back the losses than to spend further time and money on lawyers to recover the losses. This is particularly so if you are still young and potentially have great earning power ahead of you.
• If you lose your life savings and are no longer young, work out what needs to be done and estimate how much it will cost in legal fees to recover the losses. It will be nice to do this with a group of people in the same situation as you. Each individual can provide psychological support to one another in a social group. Better ideas can emerge in a group discussion. Money can be pooled to seek legal help. In today's online world, it is not hard to find fellow victims and form such a group. Unfortunately, it is also not hard to encounter toxic people online because they can hide behind anonymity.
• This is a telegram group (https://t.me/hodlnaut_backup) created by Hodlnaut customers who were worried that their posts in the official telegram group will be deleted by Hodlnaut staff.
• Since this is a public group that can be accessed by anyone, it is inevitable that some members of the public who have nothing to do with Hodlnaut will want to join in to see what is going on. There will always be busybodies around. It is ok to be a busybody as long as he does not make insensitive remarks to the victims whose mental state is already weak. One needs to be sensitive when communicating hard truths to the victims, given their vulnerable state of mind.
• A more harmful group are people who join online to gloat over the misfortune of others. Some people feel good when they see other people being worse off than them. If you encounter these people, disengage from them. They are toxic to your mental health. Stop thinking about them. Why bother with these people who have serious insecurities of their own?
• Take care of your mental health by avoiding toxic people if you have just lost loads of money. You need to be in the right frame of mind to make the right decisions to recover your financial loss.

Do not over-rely on online influencers, especially for risky financial decisions

I am not surprised Hodlnaut has been a favourite financial product that is heavily promoted by financial influencers in Singapore. Hodlnaut was generous in giving out referral fees and it is not hard for social influencers to meet their terms and conditions to receive the rewards. On top of that, Hodlnaut rewarded their promoters 10% of the interest received by the referred accounts. It was good passive income for the early influencers who captured a good chunk of Hodlnaut's market.

Influencers are good at telling you what is good about the product, but not so good when it comes to finding out what is bad. They have to report some of the bad stuff to give some semblance of objectivity and legal protection in case bad things happen, particularly for financial products.

Social influencers/celebrities are paid when you buy the product. Why would they give equal weightage to the bad stuff? The better paid they are, the more biased they become. It is the same for all sales jobs.

The consumer cannot escape from his duty to do due diligence. Doing due diligence means the consumer has to find out the bad stuff himself and verify the good stuff claimed by the promoters.

When buying cheap things, I usually do not spend too much time on due diligence. Don't sweat the small stuff. However, for risky financial products, due diligence before purchase and unending vigilant monitoring after purchase is absolutely necessary. This is what I did as a Hodlnaut customer. I do the same for safe investments in which I have huge positions in, because what causes the most financial damage is what is thought to be safe but turned out to be otherwise.

With vigilant risk monitoring, it is not hard to catch the warning shots fired before Hodlnaut's collapse.

The warning signs before Hodlnaut's collapse

When Celsius froze withdrawals in the middle of June, I made a blog update to avoid crypto lending firms such as Hodlnaut for the time being. This was the first and loudest warning shot to me. Being in the same industry, the same pressures that killed Celsius apply to Hodlnaut. If the big firms such as Celsius, Voyager and Blockfi in the crypto lending industry cannot survive, then the smaller ones such as Hodlnaut are not likely to as well. In fact, in an industry downturn, it is usually the small firms that die first. It is quite surprising that Hodlnaut managed to outlive its bigger counterparts like Celsius and BlockFi.

The second warning shot was fired by a Twitter account named Fatman in late June.

https://twitter.com/FatManTerra/status/1541101947943620609

Fatman provided information on suspicious wallet movement on the blockchain that suggested Hodlnaut had massive exposure to the failed UST stablecoin. The critical question is whether the wallet belonged to Hodlnaut. Techinasia later followed up with an in-depth article in July entitled "Hodlnaut may have had $187m exposure to Terra collapse". The article mentioned that Nansen, a reputable blockchain analytics platform, is almost sure about the wallet's ownership.

Extracted from Techinasia's "Hodlnaut may have had $187m exposure to Terra collapse" article

Blockchains do not lie. This is a worrying revelation.

The third warning shot was the way Hodlnaut senior management responded to Fatman's sharp questions. I have learned from past losses in the stock market that when rumours of financial troubles hit, it is wiser to pay more attention to the short-sellers than to senior management. If the rumours are true, senior management will not admit them as it may lead to a self-fulfilling prophecy. If the rumours are false, the company executives can easily fight back the FUD (fear, uncertainty, doubt) since the truth is on their side. I would like to see senior management fight FUD by being more transparent. When I see senior management respond to FUD by threatening to sue their critics, I get worried. Hodlnaut CEO threatened tosueFatman.

Some Hodlnaut victims may disagree with what I am going to say next. My customer experience with Hodlnaut had been pleasant. They responded promptly to my enquiries. The community manager of Hodlnaut's telegram group, CT, was dedicated to his job and was very active in telegram. He answered queries promptly. I have never encountered technical hiccups with their website. Deposits and withdrawals went through smoothly. I believe the demise of Hodlnaut was mainly due to the current business model of crypto lending.

Today's crypto lending business is a bull-market-only business and will have trouble surviving a boom-bust cycle. Current business model is flawed. DeFi lenders have a better model.

If it is only 1 or 2 crypto lenders going bankrupt, it is a company-specific problem. If several crypto lenders go bankrupt, it is likely to be an industry-wide problem. I will argue that the current crypto lenders' business model is flawed.

Crypto lending firms operate in similar ways to traditional banks in that they borrow short-term from depositors and lend out the deposits at a longer term. If enough depositors withdraw at the same time, even a healthy lender will run into financial trouble meeting the withdrawals because the lender cannot access the assets that are currently being loaned out. This liquidity mismatch risk is inherent in the lending business.

The critical difference between banks and crypto lending firms is the behaviour of depositors in a deep bear market. Bank deposits are viewed as safe-haven deposits protected by the government. Crypto deposits are viewed as high-risk deposits with zero government protection. In a deep bear market gripped by fear, the fear will drive customers to withdraw en masse from crypto deposits into safe haven destinations such as their own hardware wallets, bigger and safer crypto exchanges, or back to fiat in bank deposits. This is akin to a bank run. Given the liquidity mismatch where even healthy banks cannot survive a bank-run, crypto lending firms have an even lower chance of survival.

On top of pressures from fearful, flighty depositors, crypto lenders face rising credit risk from degen whale borrowers of the likes of Three Arrows Capital.

The super strong crypto bull market in 2021 planted the seeds of failure for the crypto lending firms in 2022. The bull market attracted a huge flow of deposits into crypto lending firms as bull market conditions enabled them to offer high-interest deposit accounts. The huge pool of deposits attracted during a bull market becomes a liability when the bear market arrives when fearful depositors withdraw en masse. Bear market conditions also force interest rates to go down, making it less attractive for depositors to keep their funds with the crypto lenders. The risk goes up but the returns go down. Naturally, more depositors will want out.

In a super bull market such as last year(2021), Mr Market rewards recklessness and punishes prudent risk management. The tremendous success experienced during bull markets caused several crypto speculators to develop reckless habits and neglect prudent risk-management practices. The bad habits developed in bull markets will kill them when the bear market comes. We saw this playing out in 2022. Given their initial success, I humbly believe the hedge fund managers at 3AC to be much smarter and savvier than retail investors like me but their subsequent success somehow got into their heads. Too bad 3AC did not follow their own advice.

https://twitter.com/zhusu/status/1464382624848220162

When 3AC went under in the 2022 crypto winter, the bad debts it owed to crypto lending firms became the catalyst for the collapse of the crypto lending industry.

In this collapse, DeFi (Decentralized Finance) crypto lenders have proven to have a superior business model compared to their CeFi (Central Finance) counterparts. No prominent DeFi lender has gone under so far. What did DeFi lenders do right? They make over-collateralised loans with real-time liquidation of the collateral to keep the risk low even in a bear market. The strict over-collateralised loan requirement is essential to compensate for the zero KYC (Know-your-customer) risk. Real-time liquidation of collateral protects against the extremely volatile nature of crypto-currencies.

The word Hodl in Hodlnaut stands for "hold on for dear life". In all of my investments, I practice vigilant risk monitoring to determine when to exit. I do not Hodl.

My preferred approach to investing is to Hold Not. To avoid the consequence of Hold Naught.