Original Author: Bill Qian
Bill: Hello everyone, welcome to Bill It Up. This week's guest is Flex Yang Zhou. His vision is to make finance a service accessible to everyone globally. He has successfully founded the cash loan company Standard Financial Inclusion, the Web3 lending giant Babel Finance in the last cycle, and now the stablecoin company Stables Labs. Yang Zhou, hello, welcome to our show!
Yang Zhou: Thank you, Bill, thank you for the invitation.
Bill: Actually, we've known each other for a long time. I remember when we first met, I was still at JD.com, and you were working on Babel. In the last cycle, Babel was already very successful in its 1.0 phase. Can you share with us some highlights from Babel's peak?
Yang Zhou: Babel's peak was around March and April 2021. That was right at the top of the last bitcoin bull market, and Coinbase's listing pushed the market sentiment to a climax. Bitcoin surged to about $64,000 in April, and both the Funding Fee and arbitrage trading activity reached their highest points. At that stage, Babel's total assets under management, including lending, were about $7 billion.
Bill: $7 billion, that's even bigger than Pantera's AUM today.
Yang Zhou: Yes. In fact, the scale of centralized lending institutions has always surpassed that of decentralized ones. For example, at that time, excluding opaque cases like Tether, the largest publicly disclosed one was Genesis, with a scale of about $13.8 billion, far exceeding the scale of current DeFi lending protocols like Aave. The core reason is that centralized institutions serve a different client base. In Asia, for example, we mainly served large miners. After bitcoin rose from over $3,000 to over $60,000, we noticed that miners' assets had increased 23-fold, so some miners who started with only $100–200 million quickly became $4–5 billion players. These were the representative figures in Asia at the time. In the US, Genesis's massive scale was mainly driven by GBTC arbitrage trading. From 2018 to early 2021, GBTC was basically always at a premium, so there was a very strong driver: people borrowed BTC from Genesis to subscribe to GBTC, which had a six-month lock-up, and simultaneously sold BTC in the spot market.
Bill: You just mentioned the six-month lock-up and arbitrage of GBTC, which was a major lending scenario for Genesis at the time.
Yang Zhou: Yes, that was the main driver.
In addition, Genesis needed a supply of BTC because it had a large amount of USD deposits from clients, so it lent USD to us Asian institutions, and we supplied BTC to them. This formed a huge closed loop, with both sides getting what they needed. As bitcoin prices rose rapidly, the scale grew even larger.
Bill: So at that time, you and Genesis, representing the East and the West, did a swipe, and both sides met their needs.
Yang Zhou: That's right. The core driver at the time was: Asians needed USD, Genesis happened to have USD supply; Genesis's clients needed BTC, and we had BTC supply. The two sides hit it off, so the scale grew very quickly. However, this growth was more driven by the industry's beta, mainly the rise in bitcoin prices, rather than organic growth. Since the new supply of bitcoin is limited, once the price rises sharply, the entire lending market's scale is amplified accordingly.
Bill: I see. On this basis, I understand that Babel later also engaged in a lot of proprietary trading, which was actually the starting point for the risks that emerged later, right? Can you share more about this?
Yang Zhou: Yes, Babel's development roughly went through three stages.
The first stage was pure lending: miners pledged BTC, and Babel lent them stablecoins. This stage was relatively straightforward. But after November 2020, as the market rose rapidly, clients had new demands—they didn't just want to borrow money and leave, but wanted BTC- or ETH-denominated wealth management products. The problem is, lending alone can hardly meet this demand. For example, BTC lending yields might be only a few tenths of a percent annually, and ETH lending rates are about the same as its staking yield, around 3%-4%. That's not very attractive to clients. So we thought of using options to solve the yield problem, building positions for clients, setting up covered call or put-selling structures to create BTC- or ETH-denominated returns. In other words, at that time, Babel bundled asset management and proprietary trading together with lending. Of course, this was also due to the market environment. The entire market was unregulated, so lending companies didn't have the awareness to strictly separate lending, trading, and proprietary activities—everyone did everything together.
Bill: But this “mixing”—Wall Street does it too, right? I think what you mean is that in the process of “mixing,” risk controls may have been relaxed, right?
Yang Zhou: Yes, but Wall Street's “mixing” actually follows a cyclical pattern. At first, everything is mixed together; after a risk event, regulators force them to separate. After a while, when capital efficiency drops, financial institutions lobby regulators, things gradually loosen, and they merge again. Then another risk event happens, and they're separated again... It's a repeated cycle.
The cycle in traditional finance is longer than in blockchain or crypto. In the past 100+ years of modern traditional finance, there have been about seven or eight such risk events. In contrast, crypto cycles are much shorter: maybe once every four years, or even every three or two years—about a quarter of the traditional finance cycle. What traditional finance does in 100 years, we do in 20 years in crypto.
So at the time, “mixing” was very common. Genesis, Three Arrows, and others did the same. After the risk events of the last cycle, everyone gradually started to “separate” again. It's a cyclical process.
Bill: What kind of position risk caused Babel to eventually face liquidation?
Yang Zhou: Actually, you can't just look at Babel itself. If you trace the entire process, the starting point of all the risks in 2022 actually comes from the high funding rates at the beginning of 2021.
Bill: Sorry, which high rate are you referring to?
Yang Zhou: I'm referring to the Funding Fee arbitrage in the crypto market. At that time, the “risk-free arbitrage” yield in crypto was 40%-50% annualized. At the end of 2020, the supply of USDT was about $20 billion; by April-May 2021, it had reached over $60 billion, so twice as much new capital quickly entered the market for arbitrage trading. And this money wasn't short-term; the intermediaries—fund managers, brokers, etc.—promised clients one- to two-year product cycles. After another boost in July-August 2021, this money was even more determined to stay, so when the market turned bearish in Q4 2021, the money didn't exit immediately.
At that time, the Fed's monetary policy really entered a tightening cycle, and things got interesting. This money couldn't leave because they didn't want to off-ramp; they had promised others a two-year management period and needed to collect those management fees. So where did this money go during this period? One major destination was Terra's Anchor protocol (UST/Luna). Terra's scale grew rapidly, and we also noticed Luna's market cap started to surge in Q4 2021. Terra/Luna's mechanism could be sustained when the scale was small, but as more money poured in, too much risk accumulated.
Some institutions noticed this risk as late as February-March 2022. Terra even publicly announced plans to buy large amounts of bitcoin, briefly sparking a “mini bull run” and raising market expectations, but Terra/Luna's flaws were eventually spotted by some institutions, who began to attack. The result is well known: in May 2022, Terra collapsed in just three days, UST evaporated $2 billion, and Luna was wiped out, causing the entire crypto industry to lose $4–5 billion in M0, or base money supply. Considering the crypto industry's money multiplier was about 30x at the time, this meant the market cap was slashed by $60 billion. The one who stepped in to “catch the falling knife” was FTX's Alameda. As a market maker, they were used to not hedging and making money from long-term pump-and-dump. But this time, they faced a direct wipeout, taking on all the liquidity fleeing from Terra and becoming the biggest bagholder.
Bill: So catching the falling knife meant instant wipeout—they were the biggest loser at the time.
Yang Zhou: Yes, Alameda probably lost $10–20 billion at that time. But as a centralized institution, they had ways to “cover it up,” so it wasn't immediately exposed. However, the shock from Terra's collapse quickly spread to 3AC, Babel, BlockFi, and a series of other centralized lending institutions.
Bill: How did this contagion work?
Yang Zhou: There weren't many centralized institutions in the industry that could provide lending exits. Those willing to pay 7%-8% high interest to borrow money mostly ended up, directly or indirectly, with Terra's Anchor protocol.
Bill: So your debtors were actually putting their money into Terra's wealth management?
Yang Zhou: Yes, directly or indirectly, the funds were connected. As a result, after Terra collapsed, almost all centralized lending institutions faced huge risks simultaneously.
Bill: Wait, so in the last bull market, your debtors were no longer miners borrowing to reinvest in production, but many people borrowing from you and then directly or indirectly putting it into Luna's wealth management?
Yang Zhou: Yes. In fact, after December 2020, miners began to gradually deleverage. As BTC went from $20,000, $30,000, $40,000 and up, they were deleveraging all the way.
Bill: Miners are actually quite risk-aware.
Yang Zhou: Yes, miners are quite risk-aware—they've been through too many cycles. Even in this cycle, the reason bitcoin can't break $100,000 is interesting: miners keep selling at $100,000. Many miners I know set their deleverage point at $100,000; as soon as it hits $100,000, they start selling. So last cycle, there was a bottleneck at $40,000, and this cycle it's stuck at $100,000—it's a similar story.
So in the last cycle, miner demand had already decreased, and the main demand for lending came from arbitrage and speculation, such as Funding Rate arbitrage. More than half of Babel's lending portfolio went to this kind of “leveraged trading.” Clients borrowed money from us at a fixed interest rate, then used trading strategies to seek higher returns to cover the interest. So, the lending exposure had shifted from miners' real production needs to arbitrage and speculation, which was also the process of risk accumulation.
