PARIS — Celsius and Voyager Digital were once two of the biggest names in crypto lending because they offered retail investors outrageous annual returns that sometimes approached 20%. Now both are bankrupt as a crash in token prices – coupled with an erosion of liquidity after a series of rate hikes by the Federal Reserve – has exposed these and other projects promising unsustainable returns.
“$3 trillion of liquidity is likely to be withdrawn from markets by central banks around the world over the next 18 months,” said Alkesh Shah, a global crypto and digital asset strategist at Bank of America.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 attracts people looking to make a quick buck — and 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 that you should be very wary of people who are very arrogant,” Eylon Aviv told CNBC on the sidelines of EthCC, an annual conference that brings together developers and cryptographers for one moves to Paris for a week.
“That’s one of the common denominators between all of them. It’s something of 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 director at Collider Ventures, a blockchain and crypto venture capital firm -Early-stage fund based in Tel Aviv.
Much of the turmoil we’ve seen in the crypto markets since May can be traced back to these multi-billion dollar crypto companies with centralized flagships calling the shots.
“The liquidity crunch impacted DeFi returns, but it was some irresponsible key players that made it worse,” said Walter Teng, digital asset strategy associate at Fundstrat Global Advisors.
The death of easy money
Back when the Fed’s interest rate was virtually zero and government bonds and savings accounts were paying out nominal yields, many people turned to crypto lending platforms instead.
During the boom in digital asset prices, retail investors were able to earn fancy returns by parking their tokens on now-defunct platforms like Celsius and Voyager Digital, as well as on Anchor, the flagship lending product of a since-failed USD-pegged stablecoin project called TerraUSD, which offered an annual percentage return of up to 20%.
The system worked when crypto prices were hitting record highs, and it was virtually free to borrow cash.
But as research firm Bernstein noted in a recent report, like other risky assets, the crypto market is closely correlated with Fed policy. Indeed, over the past few months, bitcoin along with other major cap tokens have fallen in line with these Fed rate hikes.
In a bid to curb spiraling inflation, the Fed raised interest rates by a further 0.75% on Wednesday, taking the federal funds rate to its highest level in almost four years.
Technologists gathered in Paris tell CNBC that siphoning off the liquidity that has been sloshing around the system for years means the end of the days of cheap money in crypto.
“We anticipate greater regulatory protections and required disclosures that will support returns over the next six to 12 months and will likely reduce the currently high DeFi yields,” Shah said.
Some platforms have invested client funds in other platforms that offered similarly unrealistic returns, in a sort of dangerous arrangement where a breach would turn the entire chain upside down. A report, based on blockchain analysis, revealed that Celsius had invested at least half a billion dollars in the Anchor protocol, which offered customers up to 20% APY.
“The domino effect is just like interbank risk,” explained Nik Bhatia, a professor of finance and business administration at the University of Southern California. “If a loan has been made that is not properly collateralized or reserved, failure will result in failure.”
Celsius, which had $25 billion in assets under management less than a year ago, is also accused of running a Ponzi scheme by paying early depositors with the money it received from new users.
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CeFi vs DeFi
So far, the fallout in the crypto market has been confined to a very specific corner of the ecosystem known as centralized finance, or CeFi, which is distinct from decentralized finance, or DeFi.
Although decentralization exists along a spectrum and there is no binary label separating CeFi from DeFi platforms, there are some distinctive traits that help categorize platforms into either camp. CeFi lenders typically take a top-down approach, with a few powerful voices dictating the flow of funds and how different parts of a platform work, and often operate in a sort of “black box” where borrowers don’t really know how the platform works. In contrast, DeFi platforms cut out intermediaries like lawyers and banks and rely on codes for enforcement.
A big part of the problem with CeFi crypto lenders was the lack of collateral for backstop loans. For example, Celsius’ bankruptcy filing shows that the company had more than 100,000 creditors, some of whom lent cash to the platform without receiving the right to collateral to back the arrangement.
With no real cash behind these loans, the entire arrangement depended on trust — and the steady flow of easy money to keep things afloat.
With DeFi, on the other hand, borrowers deposit more than 100% collateral to secure the loan. Platforms require this because DeFi is anonymous: lenders don’t know the borrower’s name or creditworthiness, nor do they have any other real-world metadata about their cash flow or equity on which to base their lending decisions. Instead, only the security that a customer can deposit counts.
In DeFi, currency exchange is not managed by centralized players in charge, through a programmable code called a smart contract. Written on a public blockchain such as Ethereum or Solana, this contract is executed when certain conditions are met, eliminating the need for a central intermediary.
Consequently, the annual returns advertised by DeFi platforms like Aave and Compound are much lower than what Celsius and Voyager once offered clients, and their rates vary based on market forces, rather than remaining locked in unsustainable double-digit percentages.
The tokens associated with these lending protocols have both seen massive gains over the past month, reflecting enthusiasm for this corner of the crypto ecosystem.
“Gross returns (APR/APY) in DeFi are derived from token prices of relevant altcoins allocated to various liquidity pools, which we have seen prices plunge by more than 70% since November,” Fundstrat’s Teng explained.
In practice, DeFi loans work more like sophisticated trading products than a standard loan.
“This is not a retail or mom and pop product. You have to be pretty advanced and know the market,” said Otto Jacobsson, who worked in debt capital markets at a bank in London for three years before moving to crypto.
Teng believes lenders that have not aggressively rolled over unsecured loans or have since liquidated their counterparties will remain solvent. For example, Genesis’ Michael Moro has commented that they have reduced counterparty risk significantly.
“The interest rates offered to creditors are and have been compressed. However, lending remains a highly profitable business (second only to exchange trading) and prudent risk managers will survive the crypto winter,” Teng said.
In fact, while Celsius is a CeFi lender itself, Celsius has also diversified its holdings in the DeFi ecosystem by parking some of its crypto cash on these decentralized finance platforms to generate returns. Days before declaring bankruptcy, Celsius began repaying many of its liens on DeFi lenders like Maker and Aave to free up its collateral.
“Indeed, this is the biggest promotion yet of how smart contracts work,” said Andrew Keys, co-founder of Darma Capital, which invests in Ethereum-centric applications, developer tools and protocols.
“The fact that Celsius is paying back Aave, Compound, and Maker before humans should explain smart contracts to humanity,” Keys continued. “These are persistent software objects that are non-negotiable.”
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