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The recent spate of suspensions on crypto lending platforms triggered panic among crypto market participants and a sharp decline in the crypto market. By combing through the core model of centralized crypto lending platforms and their actual operation, this article explains the inevitability of such platform thunderstorms, how to avoid such funds in the future and the possible direction of DeFi in the future.
Cryptocurrency lending is a novel financial instrument that allows for quick access to liquidity, allowing mortgages of cryptocurrencies to obtain loans. Platforms that offer crypto lending generally also offer deposit services, where depositors earn interest by depositing cryptocurrency into their deposit accounts. Platforms also attract crypto deposits through higher deposit yields than market rates (typically 4–12% annualized).
Crypto lending platforms typically lend to institutions or individuals on the platform in the form of over-collateralization. They also lend over-collateralization in the OTC market to participants who are involved in crypto trading such as exchanges, market makers or hedge funds that need immediate financing (leveraged trades or short trades, etc.).
Crypto lending does not require a credit check on the borrower (but may involve varying degrees of identification and source of funds review), but the borrower is required to pledge the cryptocurrency to the lender, who generally deposits it into an escrow account after receiving the collateral. This differs from peer-to-peer lending, which is generally a credit loan for a project and does not typically involve collateral.
The role of crypto lending is to promote arbitrage, provide liquidity to crypto institutions, and improve the efficiency and inclusiveness of financial resources. In 2020 alone, assets under management across the three largest CeFi lending platforms grew by 734%. Celsius and BlockFi each hold more than $4 billion in assets, while Nexo has about $2 billion in assets under management. The three largest CeFi platforms have nearly $7 billion in assets locked up on their platforms.
The current CeFi model can be simply compared to the capital pool. This type of capital pool business generally continues to raise funds through the rolling sale of multiple wealth management products of different maturities, in order to maintain a balance between the sources of funds and the use of funds. The funds are invested in a variety of assets, including bonds, notes, and trust plans. Capital pool wealth management products usually have the characteristics of “continuous offering, collective operation, term mismatch and separate pricing”. At the same time, in order to ensure smooth fund-raising, capital pools usually have the characteristics of the high-interest collection.
Continuous offering and high-interest deposit solicitation: Continuous offering refers to the continuous offering of wealth management products for fundraising. According to the terms of certificates of deposit on most CEFI platforms, users can deposit or redeem tokens at any time, and some can even change the interest calculation method at any time. At the same time, as mentioned earlier, most platforms have a high yield to attract investors.
Pooled Operations: A pooled operation is a pooled portfolio of assets consisting of a pool of underlying assets that are subject to the investment scope of the pool. The operating income of the portfolio serves as a uniform source for determining the income of each product. According to the SEC’s investigation, BlockFi opened BIA accounts with investors in exchange for the investment of funds in the form of crypto assets. BlockFi pools the crypto assets of BIA investors and uses them for lending and investment purposes. Investment income and interest income are shared between BlockFi and BIA investors. According to the Texas Securities Association, Celsius also uses cryptocurrencies that investors hold in interest-bearing accounts free of charge, mixes coins from various sources, invests in traditional financial assets and cryptocurrency assets, lends to institutional and corporate borrowers, and engages in any other activity that Celsius determines in its sole discretion” “ The biggest problem of collective operation is the opaqueness of operation, which provides a stage for high-risk operation and benefit transfer.
Term mismatch: A term mismatch is when the term of the source party of the asset pool is not exactly the same as the term of the user (pooled package). Maturity mismatch, especially the long-term nature of the asset side, combined with the short-term nature of the debtor side, makes it easy for institutions to stampede, which in turn leads to market panic. The only way for platforms to announce withdrawal/cash withdrawal freezes. The chart below shows the market rumour that BlockFi is borrowing for a long term (3 years) at a very high LTV.
Celsius’ investment in stETH and WBTC, Three Arrows Capital’s investment in shares of grayscale trusts, and the investment of such pools in the primary market are typical of liquidity crises caused by term mismatches. Most of the funds raised by CeFi platform are current in nature and can be redeemed at any time, but their investment is long-term.
Segregated pricing: Segregated pricing refers to the level of return of each wealth management product offered in the same asset pool. It is generally not directly linked to the actual return of the collective asset package over the life of that wealth management product but is segregated based on the expected yield to maturity of the collective asset package. This pricing approach creates a mismatch between the actual risks and benefits of the customer and BlockFi. The chart below shows an example of Bitconnect. The more money a user places, the higher the guaranteed interest rate and the shorter the payback period. The interest rate is not tied to the actual return on the underlying asset.
Segregated pricing also leads to inadequate pricing of risk, creating a so-called death spiral in a down market. Institutions have been forced to invest in investments with higher returns due to the promise of high yields, similar to the sharp cooling in sentiment towards these risky crypto projects after the luna crash and Celsius is already under pressure to redeem. The value of assets locked up on the Celsius platform shrank sharply to less than $12 billion as of May 17, from more than $28 billion at the end of December. With DeFi yields shrinking overall, Celsius has had to take some risky gambles in order to meet the 17% yield promised to customers.
As a result, Celsius has been involved in a number of high-risk projects with its clients’ tokens and has seen a series of thunderstorms:
$120 million was lost in the BadgerDAO hack last December;
The division withdrew $500 million in UST (loss avoided) on Anchor in the May Luna incident;
The tilt of the stETH/ETH pool may expose the company to liquidity risk.
This is especially true when the overall crypto market is down and customers are rushing to redeem BTC or ETH, only to find that companies have suspended withdrawal and transfer functions.
It can be seen that the current crypto lending platform in trouble has the above four characteristics at the same time, and is a typical capital plate.
At present, it seems that in the absence of effective regulation, CeFi’s operation inherits the model of a money market in traditional finance and becomes a hotbed of non-compliant financial operations, posing a major threat to the further development of the crypto ecosystem.
So is it possible that the situation will improve when DeFi addresses these issues? The answer is yes, DeFi’s smart contract solves the problem of opaqueness on the asset side and counterparty risk (de-trusting) in the process of actual execution, which effectively slows down the accumulation of financial risks.
But as to whether it will eventually form a pool of funds to form an effective risk pricing, no project has been seen to form a solution to the problem.
On June 29, Three Arrows Capital announced its bankruptcy and liquidation. Three Arrows Capital is currently one of the largest lenders and clients in the global crypto lending market, and almost every institution in the chart has done business with Three Arrows (except for NEXO and CoinLoan, which have claimed to have no exposure to Three Arrows). The liquidation of Three Arrows would have a ripple effect on the market, as a large number of institutions would be forced to take losses, write down their balance sheets, or even file for bankruptcy outright.
On July 6, Voyager Digital, a company with 3.5 million users and $5.8 billion in assets under management, declared bankruptcy. Further liquidation actions in the crypto market should be a probable event in the future.
Prestare Finance (Prestare) is a lending protocol that offers a lower collateral ratio and can even support under-collateralized loans without using off-chain information. Under-collateralized borrowing is achieved by allowing the borrower to use a portion of the previously accumulated interests as collateral to borrow more funds next time. SoulBound Token containing credit score for all users need to be minted if users want to borrow on Prestare. Users with higher credit scores can have a loan with a lower collateral ratio.
The recent spate of suspensions on crypto lending platforms triggered panic among crypto market participants and a sharp decline in the crypto market. By combing through the core model of centralized crypto lending platforms and their actual operation, this article explains the inevitability of such platform thunderstorms, how to avoid such funds in the future and the possible direction of DeFi in the future.
Cryptocurrency lending is a novel financial instrument that allows for quick access to liquidity, allowing mortgages of cryptocurrencies to obtain loans. Platforms that offer crypto lending generally also offer deposit services, where depositors earn interest by depositing cryptocurrency into their deposit accounts. Platforms also attract crypto deposits through higher deposit yields than market rates (typically 4–12% annualized).
Crypto lending platforms typically lend to institutions or individuals on the platform in the form of over-collateralization. They also lend over-collateralization in the OTC market to participants who are involved in crypto trading such as exchanges, market makers or hedge funds that need immediate financing (leveraged trades or short trades, etc.).
Crypto lending does not require a credit check on the borrower (but may involve varying degrees of identification and source of funds review), but the borrower is required to pledge the cryptocurrency to the lender, who generally deposits it into an escrow account after receiving the collateral. This differs from peer-to-peer lending, which is generally a credit loan for a project and does not typically involve collateral.
The role of crypto lending is to promote arbitrage, provide liquidity to crypto institutions, and improve the efficiency and inclusiveness of financial resources. In 2020 alone, assets under management across the three largest CeFi lending platforms grew by 734%. Celsius and BlockFi each hold more than $4 billion in assets, while Nexo has about $2 billion in assets under management. The three largest CeFi platforms have nearly $7 billion in assets locked up on their platforms.
The current CeFi model can be simply compared to the capital pool. This type of capital pool business generally continues to raise funds through the rolling sale of multiple wealth management products of different maturities, in order to maintain a balance between the sources of funds and the use of funds. The funds are invested in a variety of assets, including bonds, notes, and trust plans. Capital pool wealth management products usually have the characteristics of “continuous offering, collective operation, term mismatch and separate pricing”. At the same time, in order to ensure smooth fund-raising, capital pools usually have the characteristics of the high-interest collection.
Continuous offering and high-interest deposit solicitation: Continuous offering refers to the continuous offering of wealth management products for fundraising. According to the terms of certificates of deposit on most CEFI platforms, users can deposit or redeem tokens at any time, and some can even change the interest calculation method at any time. At the same time, as mentioned earlier, most platforms have a high yield to attract investors.
Pooled Operations: A pooled operation is a pooled portfolio of assets consisting of a pool of underlying assets that are subject to the investment scope of the pool. The operating income of the portfolio serves as a uniform source for determining the income of each product. According to the SEC’s investigation, BlockFi opened BIA accounts with investors in exchange for the investment of funds in the form of crypto assets. BlockFi pools the crypto assets of BIA investors and uses them for lending and investment purposes. Investment income and interest income are shared between BlockFi and BIA investors. According to the Texas Securities Association, Celsius also uses cryptocurrencies that investors hold in interest-bearing accounts free of charge, mixes coins from various sources, invests in traditional financial assets and cryptocurrency assets, lends to institutional and corporate borrowers, and engages in any other activity that Celsius determines in its sole discretion” “ The biggest problem of collective operation is the opaqueness of operation, which provides a stage for high-risk operation and benefit transfer.
Term mismatch: A term mismatch is when the term of the source party of the asset pool is not exactly the same as the term of the user (pooled package). Maturity mismatch, especially the long-term nature of the asset side, combined with the short-term nature of the debtor side, makes it easy for institutions to stampede, which in turn leads to market panic. The only way for platforms to announce withdrawal/cash withdrawal freezes. The chart below shows the market rumour that BlockFi is borrowing for a long term (3 years) at a very high LTV.
Celsius’ investment in stETH and WBTC, Three Arrows Capital’s investment in shares of grayscale trusts, and the investment of such pools in the primary market are typical of liquidity crises caused by term mismatches. Most of the funds raised by CeFi platform are current in nature and can be redeemed at any time, but their investment is long-term.
Segregated pricing: Segregated pricing refers to the level of return of each wealth management product offered in the same asset pool. It is generally not directly linked to the actual return of the collective asset package over the life of that wealth management product but is segregated based on the expected yield to maturity of the collective asset package. This pricing approach creates a mismatch between the actual risks and benefits of the customer and BlockFi. The chart below shows an example of Bitconnect. The more money a user places, the higher the guaranteed interest rate and the shorter the payback period. The interest rate is not tied to the actual return on the underlying asset.
Segregated pricing also leads to inadequate pricing of risk, creating a so-called death spiral in a down market. Institutions have been forced to invest in investments with higher returns due to the promise of high yields, similar to the sharp cooling in sentiment towards these risky crypto projects after the luna crash and Celsius is already under pressure to redeem. The value of assets locked up on the Celsius platform shrank sharply to less than $12 billion as of May 17, from more than $28 billion at the end of December. With DeFi yields shrinking overall, Celsius has had to take some risky gambles in order to meet the 17% yield promised to customers.
As a result, Celsius has been involved in a number of high-risk projects with its clients’ tokens and has seen a series of thunderstorms:
$120 million was lost in the BadgerDAO hack last December;
The division withdrew $500 million in UST (loss avoided) on Anchor in the May Luna incident;
The tilt of the stETH/ETH pool may expose the company to liquidity risk.
This is especially true when the overall crypto market is down and customers are rushing to redeem BTC or ETH, only to find that companies have suspended withdrawal and transfer functions.
It can be seen that the current crypto lending platform in trouble has the above four characteristics at the same time, and is a typical capital plate.
At present, it seems that in the absence of effective regulation, CeFi’s operation inherits the model of a money market in traditional finance and becomes a hotbed of non-compliant financial operations, posing a major threat to the further development of the crypto ecosystem.
So is it possible that the situation will improve when DeFi addresses these issues? The answer is yes, DeFi’s smart contract solves the problem of opaqueness on the asset side and counterparty risk (de-trusting) in the process of actual execution, which effectively slows down the accumulation of financial risks.
But as to whether it will eventually form a pool of funds to form an effective risk pricing, no project has been seen to form a solution to the problem.
On June 29, Three Arrows Capital announced its bankruptcy and liquidation. Three Arrows Capital is currently one of the largest lenders and clients in the global crypto lending market, and almost every institution in the chart has done business with Three Arrows (except for NEXO and CoinLoan, which have claimed to have no exposure to Three Arrows). The liquidation of Three Arrows would have a ripple effect on the market, as a large number of institutions would be forced to take losses, write down their balance sheets, or even file for bankruptcy outright.
On July 6, Voyager Digital, a company with 3.5 million users and $5.8 billion in assets under management, declared bankruptcy. Further liquidation actions in the crypto market should be a probable event in the future.
Prestare Finance (Prestare) is a lending protocol that offers a lower collateral ratio and can even support under-collateralized loans without using off-chain information. Under-collateralized borrowing is achieved by allowing the borrower to use a portion of the previously accumulated interests as collateral to borrow more funds next time. SoulBound Token containing credit score for all users need to be minted if users want to borrow on Prestare. Users with higher credit scores can have a loan with a lower collateral ratio.
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