20% returns on CeFi, DeFi lives

PARIS — Celsius and Voyager Digital were once two of the biggest names in the crypto lending space, as they offered retail investors outrageous annual returns, sometimes approaching 20%. Now both are bankrupt as a collapse in token prices – coupled with an erosion of liquidity following a series of rate hikes by the Federal Reserve – has exposed these and other projects promising unsustainable returns. .

“$3 trillion in liquidity will likely be withdrawn from global markets by central banks over the next 18 months,” said Alkesh Shah, global crypto and digital asset strategist at Bank of America.

But the washout of easy money is being welcomed by some of the world’s top blockchain developers who say leverage is a drug that lures people looking to make a quick buck – and that it takes a system failure of this magnitude to weed out the bad actors.

“If there’s anything to learn from this implosion, it’s to beware of very arrogant people,” Eylon Aviv told CNBC on the sidelines of EthCC, an annual conference that draws developers and cryptographers to Paris for a week.

“It’s one of the common denominators between them all. It’s kind 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 continued. , who is a director at Collider Ventures, a Tel Aviv-based venture capital and crypto fund.

Much of the turmoil we’ve seen in the crypto markets since May can be attributed to these multi-billion dollar crypto companies with centralized figureheads calling the shots.

“The liquidity crunch has affected DeFi returns, but it’s been a few irresponsible central players that have exacerbated this,” said Walter Teng, digital asset strategy partner at Fundstrat Global Advisors.

The death of easy money

Back when the Fed benchmark rate was virtually zero and government bonds and savings accounts were paying nominal returns, many people turned to crypto lending platforms instead.

During the digital asset price boom, retail investors were able to earn extravagant returns by parking their tokens on now-defunct platforms like Celsius and Voyager Digital, as well as Anchor, which was the flagship lending product. of a since failed US dollar pegged stablecoin project called TerraUSD which offered up to 20% annual percentage return.

The system worked when crypto prices hit all-time highs and it was virtually free to borrow money.

But as research firm Bernstein noted in a recent report, the crypto market, like other risky assets, is closely correlated to Fed policy. And indeed, over the past few months, bitcoin along with other major capitalization tokens have fallen alongside these Fed rate hikes.

In an effort to contain spiraling inflation, the Fed raised its benchmark rate an additional 0.75% on Wednesday, taking the funds rate to its highest level in nearly four years.

Technologists gathered in Paris told CNBC that sucking up the cash that has been circulating in the system for years means the end of the days of cheap money in crypto.

“We expect greater regulatory protections and disclosures required to support returns over the next six to twelve months, which will likely reduce current high DeFi returns,” Shah said.

Some platforms place client funds on other platforms that also offer unrealistic returns, in a sort of dangerous arrangement where a break would upend the entire chain. A report based on blockchain analysis revealed that Celsius had invested at least half a billion dollars in the Anchor protocol which 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 extended is not properly secured or reserved, failure will beget 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 first depositors with money it obtained from new users. .

CeFi versus DeFi

So far, the fallout in the crypto market has been contained to a very specific corner of the ecosystem known as centralized finance, or CeFi, which is different from decentralized finance, or DeFi.

Although decentralization exists on a spectrum and there is no binary designation separating CeFi platforms from DeFi platforms, there are a few defining characteristics that help place the platforms in one of two camps. CeFi lenders typically take a top-down approach in which a few powerful voices dictate the financial flows and operation of different parts of a platform, and often operate in a kind 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 enforcement.

A big part of the problem with CeFi crypto lenders was the lack of collateral to secure the loans. In Celsius’s bankruptcy filing, for example, it shows the company had over 100,000 creditors, some of whom lent money to the platform without receiving any rights to any collateral to back up the arrangement. .

With no real money behind these loans, the whole arrangement depended on trust – and the steady flow of easy money to keep it afloat.

In DeFi, however, borrowers have provided more than 100% collateral to secure the loan. The platforms require it because DeFi is anonymous: lenders don’t know the borrower’s name or credit rating, nor do they have other real-world metadata about their cash or capital on on which to base their decision to grant a loan. Instead, the only thing that matters is the guarantee a client is able to post.

With DeFi, instead of centralized players calling the shots, money exchanges are handled by a programmable piece of code called a smart contract. This contract is written on a public blockchain, like ethereum or solana, and it runs when certain conditions are met, negating the need for a central middleman.

As a result, the annual returns advertised by DeFi platforms like Aave and Compound are far lower than what Celsius and Voyager once offered customers, and their rates vary based on market forces, rather than remaining fixed at percentages. unsustainable double digits.

The tokens associated with these lending protocols have both increased massively over the past month, reflecting the enthusiasm for this corner of the crypto ecosystem.

“Raw returns (APR/APY) in DeFi are derived from the token prices of the relevant altcoins that are allocated to different liquidity pools, the prices of which we have seen fall by more than 70% since November,” Fundstrat’s Teng explained.

In practice, DeFi loans work more like sophisticated trading products than a standard loan.

“It’s not a retail or mom-and-pop product. You have to be pretty advanced and have a feel for the market,” said Otto Jacobsson, who worked in debt capital markets at a bank. in London for three years, before switching to crypto.

Teng believes that lenders who have not made unsecured loans aggressively or have since liquidated counterparties will remain solvent. Michael Moro of Genesis, for example, came out to say they have significantly reduced counterparty risk.

“Rates offered to creditors will and have been squeezed. However, lending remains a hugely profitable business (second only to forex trading), and careful risk managers will survive the crypto winter,” Teng said.

In fact, Celsius, despite being a CeFi lender itself, has also diversified its holdings in the DeFi ecosystem by parking some of its cryptocurrencies in these decentralized finance platforms as a way to earn yield. Days before declaring bankruptcy, Celsius began repaying many of its liens with DeFi lenders like Maker and Aave, in order to unlock its collateral.

“This is actually the biggest publicity to date about how smart contracts work,” said Andrew Keys, co-founder of Darma Capital, which invests in apps, developer tools and protocols around smart contracts. ‘Ethereum.

“The fact that Celsius reimburses Aave, Compound and Maker before humans should explain smart contracts to humanity,” Keys continued. “These are persistent software objects that are non-negotiable.”

Comments are closed.