Decentralized finance (DeFi) entered the public consciousness in 2021 by offering both small and large crypto owners sky-high interest rates for what was often described in the very secure language of bank savings accounts.
Now, investors are crashing into mountains of reality. With a not-very-stable stablecoin’s $48 billion collapse, followed by insolvencies or close calls by a number of crypto lenders over the past two months, attention is focusing on whether the annual rates of 5%, 10%, 20% or more promised by both DeFi and centralized finance (CeFi) lenders were always too good to be true.
It may well be time to ask whether DeFi will have to pull back from those double-digit promises, and if it can survive without them.
The poster child is Celsius, which has frozen withdrawals on about $12 billion of investors’ funds as it scrambles to avoid bankruptcy. It had been offering yields of up to 17% on various cryptocurrencies deposited in what the industry has called a way of earning passive income on digital assets people already owned and wanted to hold onto.
In November, when the bull market was still a couple of weeks from crashing into the wall and bitcoin was closing in on $70,000, Celsius had this to say in a press release announcing that it had paid out more than $1 billion in yield to investors:
“With Celsius paying out yield at a rate of $15 million per week while banks continue to pay on average 0.01% — it is easy to see why so many have chosen to open accounts with Celsius and earn yield on crypto.”
Now, even those who don’t have their funds locked away are learning that DeFi is a dangerous game that doesn’t have the Federal Deposit Insurance Corporation standing behind it — or a Comptroller of the Currency to set standards for risk governance.
Compounding the problem is an economy heading into what’s likely to be a steep recession and a crypto market going largely downhill that’s causing crypto traders to pull back — that was behind Goldman Sachs’ decision to downgrade Nasdaq-listed crypto exchange Coinbase to a “sell” rating on June 27. DeFi’s main selling point is in doubt.
Pointing to increased fears and the rising cost of lending at every level, Laura Vidiella, vice president of business development and strategy at LedgerPrime, a crypto derivatives market maker, told industry news source The Block that there’s a concern that risk will “spill over into DeFi” as whole, resulting in less lending and less funds staked in DeFi projects.
Whether that’s happening already is hard to quantify. While the total value locked (TVL) in various decentralized finance protocols was more than $100 million in the first week of November 2021, when the crypto market went to the bears, according to DeFi Pulse, it’s hard to read too much into its current TVL of just under $40 billion.
After all, the price of bitcoin is down about 70% in that time, so the lower TVL could be a factor of the lower value of the assets.
Who’s Still a Believer?
Crypto lender CoinFLEX, which froze withdrawals last week after a client failed to repay a $47 million loan, still has faith in high rates of return and is betting investors do, too.
On June 27, four days after halting withdrawals, it announced plans to sell $47 million in tokens bearing 20% to accredited, non-U.S. investors — meaning those who won’t trigger a Securities and Exchange Commission (SEC) lawsuit.
On the other hand, a client of BlockFi — a crypto lender propped up by a $250 million line of credit from crypto exchange FTX — told The Block that it said it would be “highly conservative” in its lending going forward.
It probably isn’t alone on that front.
“What is happening with Celsius will have serious repercussions for the industry,” Mahin Gupta, founder of digital-asset custody platform Liminal, told Bloomberg recently. “It’s a not-insignificant player, and its apparent failure will have ripple effects.”
And while Celsius was CeFi — although it invested in DeFi projects, as well as making large loans and other investments — what happened to it should force investors to “be keenly aware of how interconnected the different DeFi products are, as well as that they are all being impacted by Federal Reserve policy,” American University law professor Hilary Allen, a financial-stability regulation specialist, told Bloomberg. “There is no crypto ‘safe haven.’”
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