Crypto markets are extremely volatile. You never know which way the wind will blow—or how hard. On May 26, this turned out to be a disaster for US crypto exchange Poloniex.
CLAM, an obscure token that Poloniex offered peer-to-peer margin trading on, suffered a flash crash. Its price dropped so violently that margin borrowers blew their margin multiple times over. The loss was huge—1,800 BTC, worth around $14 million.
Now Poloniex has to figure out how to extract the losses from the borrowers. For now, lenders have to suck up the loss. On 14:00 UTC on June 6—a full 10 days after the incident—Poloniex applied a 16.202% haircut to the principal of all active BTC loans. Even lenders not active at the time of the crash were affected.
Prior to announcing the haircut, Poloniex suspended trading for several hours on Wednesday as part of a “planned” maintenance. It wasn’t until trading resumed that margin lenders realized a portion of their BTC was missing.
In a Medium post, Poloniex revealed that a large part of the loans were collateralized in CLAM—so both the borrowers’ positions and their collateral lost most of their value. In other words, the funds simply evaporated, and there was nothing to repay loans with.
The exchange says it has frozen all defaulted borrowers’ accounts until they repay their loans, as spelled out in the the company’s terms of service. “As we recover funds, we will return them to affected lenders. We’re also exploring other ways to help defray margin lender losses,” Poloniex said. It adds that lenders only account for 0.4% of its user base.
Naturally, the margin lenders are completely pissed off. Why did Polo not have better risk management in place? Why did it not have an insurance fund set up to absorb the loss? And why did it allow margin trades—and collateral loans—on an extremely illiquid coin in the first place?
What is margin trading?
Margin trading is risky business, even more so when you are trading crypto assets, due to their high volatility. When you trade on margin, you put down a collateral and borrow against that, doubling, tripling, quadrupling—or whatever—your trade.
Trading on margin magnifies your profits, but also your losses. If the trade goes in your favor, you can repay the loan and tuck in a nice profit. But if the price of the asset slips enough so it looks like your trade won’t pay off, the exchange can call in your margin, and you lose all of the collateral you put down for the loan.
Bitcoin derivatives exchange BitMEX loans you the funds for margin trades. Poloniex does something different. It uses peer-to-peer margin trades, where a common pool of lenders puts up BTC, CLAM, and another coins. They get paid in interest. According to Poloniex’s website (archive), only customers who are outside of the US are allowed to loan their funds on the exchange.
As a lender, you set your own daily interest rate, and Poloniex takes a fee of 15% from the interest earned. Margin traders consume lending offers starting with the lowest rate. If your rates are too high, your funds sit in the pool, and you don’t earn any interest.
CLAM, the casino coin
If you were paying close attention a year ago, you may have heard John Oliver mention CLAM on “Last Week Tonight,” along with Titcoin, Jesuscoin, Trumpcoin and a bunch of other coins with hilarious names.
CLAM stands for “Caritas Libertas Aequitas Monetas,” which roughly translates to freedom, fairness, equality coins—whatever that means. The coin launched in May 2014, as a fork of Blackcoin (BLK), which launched in February 2014 as a fork of Peercoin, an early proof-of-stake coin.
On May 12, 2014, CLAM was sent to all active users of bitcoin, litecoin and dogecoin—three popular coins at the time. Every unique wallet address pulled from those blockchains that had a balance above zero got about 4.6 CLAM. The total amount of CLAM distributed to those addresses was 14,897,662.
CLAM was mainly intended for use on Just-Dice, a gambling site created by a Canadian known only as “dooglus.” Originally Just-Dice relied on bitcoin. But due to new bitcoin regulation in Canada, dooglus decided to switch to CLAM in late 2014.
The circulating supply of CLAM is only 3,624,208. Nearly all of that—99.81%—is traded on Poloniex. At one point, CLAM was listed on Bittrex and Cryptopia, but Bittrex delisted the coin in October 2018 and Cryptopia went belly up in May 2019.
According to CoinMarketCap, CLAM has a daily trading volume of less than $100,000, meaning the coin barely has a pulse. Three months ago, two traders complained on Reddit of long delays withdrawing CLAM as they waited for the lifeless network to pick up their transactions.
“I withdrew CLAM 11 days ago. Poloniex Support said ‘as soon as a miner picks up the transaction’ How f@%#$%g long is that?,” wrote Reddit user interop5. (Technically, CLAM is a proof of stake coin, so it relies on stakers, not miners.)
CLAM’s lack of liquidity makes it extremely easy to manipulate. All you need is one person to put up a large sell order to crash the price. Poloniex has yet to release details on what happened, but we can guess it was something along those lines.
As a result of the flash crash debacle, Poloniex has removed CLAM from margin trading, along with three other coins: bitshares (BTS), factom (FCT), and maidsafecoin (MAID). The exchange outright admits these coins lacked sufficient liquidity:
“In order for margin liquidations to process in an orderly manner, the market must have sufficient liquidity, and these tokens currently lack that liquidity. We will continue to monitor them and may reinstate margin trading for them in the future”
This is not the first time Poloniex removed CLAM as a margin market and collateral coin. It was removed in early November 2017 due to low liquidity, after an earlier flash crash, despite CLAM’s liquidity never recovering, at some point, Poloniex decided to add CLAM back as a margin market and collateral coin—though I’m not sure exactly when.
And then, of course, the exact same thing happened. In February 2019, the price of CLAM started to climb rapidly on Poloniex. In a matter of six weeks, it went from around $1.50 to a high of nearly $20 on May 26. At that point, the bottom fell out with CLAM losing three-quarters of its value in the blink of an eye. It sunk down to around $5.
According to Andrew Hires, a neurobiology professor at the University of Southern California, who has been watching the exchange, Poloniex had been struggling with its CLAM wallet for months. He tweeted:
“All deposits had to be manually credited via ticket. This screwed up the sell-side liquidity. Huge bids (>500BTC), presumably margin longs, crept up over months, pushing $ price up 17x. Just after it hit $20, everything imploded.”
Spreading the loss
Socializing losses is unique to crypto exchanges. Like Poloniex, OKEx also socializes extreme margin losses, but literally requires customers to pass a test on their terms of service before they can trade futures, so they are absolutely clear on how it works.
According to crypto lawyer David Silver, socializing losses could open Poloniex to a lawsuit. Another lawyer, Stephen Palley, disagrees. Palley told The Block, he doesn’t think Poloniex breached its terms of service.
On the other hand, Emilien Dutang, who was pinged by the haircut and says he offered margin lending on the exchange after the flash crash, is threatening legal action.
None of this bodes well for Poloniex. Circle acquired the exchange in early 2018 with the intention of cleaning it up and dealing with a humongous backlog of support tickets. But at this level, Poloniex appears only slightly more competent than QuadrigaCX.
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