Due to their exorbitant annual returns—which occasionally approached 20 percent—that they provided to ordinary investors, Celsius and Voyager Digital were formerly two of the biggest names in the cryptocurrency lending industry. Both are now insolvent after a drop in token prices and a decline in liquidity as a result of the Federal Reserve raising rates repeatedly exposed these and other ventures offering unsustainable yields.
″$3 trillion of liquidity will likely be taken out of markets globally by central banks over the next 18 months,” Alkesh Shah, a global strategist for cryptocurrencies and digital assets at Bank of America, said.
Some of the best blockchain technologists in the world, however, welcome the washout of easy money, claiming that leverage is a drug that attracts people wanting to make a quick buck and that it takes a system breakdown of this magnitude to purge the bad actors.
“If there’s something to learn from this implosion, it is that you should be very wary of people who are very arrogant,” From the sidelines of the EthCC, Eylon Aviv told CNBC.
“This is one of the common denominators between all of them. It is sort of like a God complex — ‘I’m going to build the best thing, I’m going to be amazing, and I just became a billionaire,’” Aviv, a principal at Collider Ventures, a Tel Aviv-based early-stage venture capital blockchain and cryptocurrency fund, continued.
These multibillion-dollar cryptocurrency businesses with centralised figureheads that make the decisions are to blame for a large portion of the unrest that has engulfed the crypto markets since May.
“The liquidity crunch affected DeFi yields, but it was a few irresponsible central actors that exacerbated this,” Walter Teng, an associate in digital asset strategy at Fundstrat Global Advisors, said.
Easy money has become extinct
Many people choose to use crypto lending platforms in place of government bonds and savings accounts when the Fed’s benchmark rate was almost zero and they were giving out nominal returns.
Retail investors were able to profit handsomely during the spike in the value of digital assets by parking their tokens on now-defunct exchanges like Celsius and Voyager Digital as well as Anchor, the flagship lending product of the now-defunct TerraUSD U.S. dollar-pegged stablecoin project, which offered up to 20% annual percentage yields.
The approach worked when the value of cryptocurrencies was at an all-time high and borrowing money was essentially cost-free.
However, the cryptocurrency market, like other risky assets, is closely tied to Fed policy, as research company Bernstein pointed out in a recent analysis. Indeed, over the past six months, as the Fed has increased interest rates, bitcoin has fallen along with other large cap tokens.
The Federal Reserve raised its benchmark rate by another 0.75 percent on Wednesday in an effort to rein in soaring inflation, bringing it to its highest level in almost four years.
Technology experts meeting in Paris tell CNBC that the days of cheap money in cryptocurrency are over once they have sucked up the liquidity that has been floating through the system for years.
“We expect greater regulatory protections and required disclosures supporting yields over the next six to twelve months, likely reducing the current high DeFi yields,” said Shah.
Some platforms invested client money into other platforms that provided similarly inflated profits, creating a risky chain reaction where one failure may destabilise the entire system. According to a report based on blockchain analytics, Celsius had at least $500 million invested in the Anchor protocol, which provided users with an APY of up to 20%.
“The domino effect is just like interbank risk,” Nik Bhatia, a professor of business economics and finance at the University of Southern California, stated. “If credit has been extended that isn’t properly collateralized or reserved against, failure will beget failure.”
It’s also alleged that Celsius, which managed $25 billion in assets less than a year ago, ran a Ponzi scheme by rewarding early depositors with funds it received from new customers.
CeFi vs. DeFi
In contrast to decentralised finance, or DeFi, the impact of the cryptocurrency market has so far been restricted to a very small portion of the ecosystem known as centralised finance, or CeFi.
Although there is no clear distinction between CeFi and DeFi platforms and decentralisation exists on a spectrum, there are a few distinguishing characteristics that help to categorise platforms into one of the two groups. CeFi lenders frequently use a top-down method in which a small number of influential individuals control financial flows and how various platform components operate. They frequently operate in a sort of “black box,” with borrowers frequently unaware of how the platform works. DeFi platforms, in contrast, eliminate intermediaries like attorneys and banks and rely on code for compliance.
Lack of security to support loans was a major issue for CeFi’s crypto lenders. For instance, it is revealed in Celsius’ bankruptcy petition that the company had more than 100,000 debtors, some of whom provided funding to the platform without gaining any rights to any underlying collateral.
The entire setup hinged on trust because there was no actual money to back these loans, and the ongoing availability of easy money helped to keep everything afloat.
However, under DeFi, borrowers provide more than 100% in collateral to support the loan. Platforms want this because DeFi is anonymous: Lenders don’t have access to real-world metadata about the borrower’s cash flow or capital, and they don’t know the borrower’s name or credit score either. The only thing that counts is the collateral a customer can post, not anything else.
With DeFi, a programmable piece of code known as a smart contract controls the exchanges of money instead of centralised parties making all the decisions. There is no need for a central middleman because this contract runs when specific conditions are met and is written on a public blockchain like ethereum or solana.
Since their rates fluctuate according to market conditions rather than remaining fixed at unsustainable double-digit percentages, DeFi platforms like Aave and Compound tout annual returns that are significantly lower than what Celsius and Voyager historically provided users.
The enthusiasm for this area of the crypto ecosystem is reflected in the enormous price increases of the tokens linked to various loan protocols over the past month.
“Gross yields (APR/APY) in DeFi are derived from token prices of relevant altcoins that are attributed to different liquidity pools, the prices of which we have seen tumble more than 70% since November,” Fundstrat’s Teng said.
DeFi loans behave more like complex trading items in real life than they do like regular loans.
“That’s not a retail or mom-and-pop product. You have to be quite advanced and have a take on the market,” remarked Otto Jacobsson, who spent three years in debt capital markets at a bank in London before switching to cryptocurrency.
Teng is of the opinion that lenders who did not aggressively issue uncollateralized loans or who have since dissolved their counterparties will continue to be in business. For instance, Genesis’ Michael Moro has publicly stated that they have significantly reduced counter-party risk.
“Rates offered to creditors will, and have, compressed. However, lending remains a hugely profitable business (second only to exchange trading), and prudent risk managers will survive the crypto winter,” said Teng.
Despite being a CeFi lender, Celsius has actually diversified its assets in the DeFi ecosystem by storing some of its crypto cash on these decentralised financing platforms in order to generate yield. Celsius started paying back several of its debts to DeFi lenders including Maker and Aave days before filing for bankruptcy in order to release its collateral.
“This is actually the biggest advertisement to date of how smart contracts work,” said Andrew Keys, co-founder of Darma Capital, which invests in ethereum-related protocols, developer tools, and apps.
“The fact that Celsius is paying back Aave, Compound, and Maker before humans should explain smart contracts to humanity,” continued Keys. “These are persistent software objects that are non-negotiable.”