PARIS — Celsius and Voyager Digital were once two of the biggest names in the crypto lending space, offering retail investors outrageous annual returns, sometimes approaching 20%. Now, both are bankrupt as a drop in token prices, along with an erosion of liquidity following a series of rate hikes by the Federal Reserve, exposed these and other projects that promised unsustainable returns.
“Central banks will likely pull $3 trillion of liquidity from markets globally over the next 18 months,” said Alkesh Shah, global crypto and digital asset strategist at Bank of America.
But the easy money laundering is being welcomed by some of the world’s top blockchain developers who say leverage is a drug that attracts people looking to make a quick buck, and it takes a system failure of this magnitude to wipe out the bad actors
“If there’s anything to learn from this implosion, it’s that you should be wary of people who are very arrogant,” Eylon Aviv told CNBC on the sidelines of EthCC, an annual conference that draws developers and cryptographers to Paris for a week.
“That’s one of the common denominators among all of them. It’s like a God complex: ‘I’m going to build the best, I’m going to be amazing, and I just became a billionaire,'” continued Aviv, who is a principal at Collider Ventures, a early-stage crypto and blockchain venture capital fund based in Tel Aviv.
Much of the turmoil we’ve seen in crypto markets since May can be traced back to these multi-billion dollar crypto companies with centralized decision makers.
“The liquidity crunch hurt DeFi returns, but it was a few irresponsible central players that made it worse,” said Walter Teng, digital asset strategy partner at Fundstrat Global Advisors.
The death of easy money
When the Fed benchmark rate was practically zero and government bonds and savings accounts were paying nominal yields, many people turned to crypto lending platforms.
During the boom in digital asset prices, retail investors were able to earn outlandish returns by parking their tokens on now-defunct platforms like Celsius and Voyager Digital, as well as Anchor, which was the flagship lending product ever since. a failed US dollar pegged stablecoin project called TerraUSD that offered up to 20% annual returns.
The system worked when crypto prices were at all-time highs and it was practically free to ask for cash.
But as research firm Bernstein pointed out in a recent report, the crypto market, like other risky assets, is closely tied to Fed policy. And indeed, in recent months, bitcoin along with other major tokens have been falling in tandem with these Fed rate hikes.
In an effort to contain spiraling inflation, the Fed raised its benchmark rate by another 0.75% on Wednesday, taking the funds rate to its highest level in nearly four years.
Technologists gathered in Paris tell CNBC that sucking up the liquidity that has been seeping through the system for years means the days of cheap crypto money are over.
“We expect greater regulatory protections and required disclosures to support returns over the next six to twelve months, likely undercutting DeFi’s current high returns,” Shah said.
Some platforms put clients’ funds into other platforms that similarly offered unrealistic returns, in a kind of dangerous arrangement where a break would change the entire chain. A report based on blockchain analysis found that Celsius had at least half a million dollars invested in the Anchor protocol that offered up to 20% APY to customers.
“The domino effect is like interbank risk,” explained Nik Bhatia, professor of finance and business economics at the University of Southern California. “If credit has been extended that is not properly collateralized or reserved, failure will breed failure.”
Celsius, which had $25 billion in assets under management less than a year ago, is also accused of operating a Ponzi scheme by paying early depositors with money it got from new users.
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CeFi vs. DeFi
Until now, the consequences of the crypto market have been limited to a very specific corner of the ecosystem known as centralized finance or CeFi, which is different from decentralized finance or DeFi.
While decentralization exists along a spectrum and there is no binary designation that separates CeFi from DeFi platforms, there are some distinguishing characteristics that help place platforms in one of the two camps. CeFi lenders tend to take a top-down approach where a few powerful voices dictate the financial flows and operation of various parts of a platform, often operating in a sort of “black box” where borrowers don’t really know how the platform works. In contrast, DeFi platforms cut out middlemen like lawyers and banks and rely on code for the application.
A big part of the problem with CeFi crypto lenders was the lack of collateral to protect the loans. Celsius’ bankruptcy filing, for example, shows the company had more than 100,000 creditors, some of whom lent cash to the platform without receiving rights to any collateral to back up the deal .
With no real cash behind these loans, the whole deal depended on trust and the continued flow of easy money to keep everything afloat.
In DeFi, however, borrowers put up more than 100% collateral to protect the loan. The platforms require this because DeFi is anonymous: Lenders don’t know the borrower’s name or credit score, or have any other real-world metadata about their cash flow or capital on which to base their decision to extend a loan. loan Instead, the only thing that matters is the guarantee that a client can post.
With DeFi, instead of centralized players, money exchanges are managed through programmable code called a smart contract. This contract is written on a public blockchain, such as ethereum or solana, and executes when certain conditions are met, negating the need for a central intermediary.
As a result, the annual returns announced by DeFi platforms such as Aave and Compound are much lower than what Celsius and Voyager offered clients, and their fees vary based on market forces, rather than remaining fixed at percentages of two unsustainable digits.
The tokens associated with these lending protocols have increased massively over the past month, which is a reflection of the enthusiasm for this corner of the crypto ecosystem.
“DeFi gross returns (APR/APY) are derived from the prices of relevant altcoin symbols that are attributed to different liquidity pools, whose prices we have seen fall by more than 70% since November,” he explain Teng from Fundstrat.
In practice, DeFi loans work more like sophisticated commercial products than a standard loan.
“This is not a retail or popular product. You have to be quite advanced and have a view of the market,” said Otto Jacobsson, who worked in debt capital markets at a London bank for three years before moving in the market. crypto
Teng believes that lenders that did not aggressively make unsecured loans, or that have since liquidated their counterparties, will remain solvent. Michael Moro of Genesis, for example, has come out to say have reduced a significant counterparty risk.
“Rates offered to lenders will and have been compressed. However, lending is still a very profitable business (only after swap trading) and prudent risk managers will survive the crypto winter Teng said.
In fact, Celsius, even though it is a CeFi lender itself, also diversified its holdings in the DeFi ecosystem by parking some of its crypto-cash in these decentralized financial platforms as a way to get yield. Days before filing for bankruptcy, Celsius started doing just that return many of their own register with DeFi lenders like Maker and Aave, in order to unlock their collateral.
“This is actually the biggest announcement yet about how smart contracts work,” explained Andrew Keys, co-founder of Darma Capital, which invests in applications, development tools and protocols around ethereum.
“The fact that Celsius is paying Aave, Compound and Maker before humans should explain smart contracts to humanity,” Keys continued. “These are persistent software objects that are not tradable.”
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