The Relentless Decline of the DeFi Space: A Reassessment

The impact of the Terra crash on the DeFi sector

For a long time, staking and loan offers with promises of high interest rates have been considered a surefire way to generate a solid return in the crypto space. Yields (APYs) of 20 percentage points were also offered on stablecoins.

DeFi protocols such as the Anchor on Terra-Chain protocol were popular with investors before the Earth crash. At its peak, Anchor was managing over $ 16 billion worth of cryptocurrencies across its various liquidity pools.

In addition to retail investors, many institutional investors and competing DeFi platforms have also taken advantage of this offer and have also staked huge amounts of Terra USD (UST) and Terra (LUNA) in the anchor protocol.

High interest rates have enabled providers such as Celsius and BlockFi, as well as hedge funds such as Three Arrow Capital (3AC), to issue loans against deposited collateral (Ethereum, Bitcoin and other cryptocurrencies) and pay the promised returns to their own. customers.

Similar to the traditional banks granting a building loan to home builders, suppliers collect the difference as a profit. (Example: A bank borrows money at 2% interest from the central bank and issues that money as a loan with 4% interest.)

With the decline of the Terra ecosystem, triggered by a massive drop in the price of the internal algorithmic stablecoin Terra USD and the subsequent collapse in the prices of the cryptocurrency LUNA, the entire lending construct has had serious problems.

Vendors such as Celsius, BlockFi and even the hedge fund 3AC (Three Arrows Capital), which in turn had wagered huge amounts of UST and Luna tokens, have lost billions of customer deposits due to the decline of the Earth ecosystem. 3AC alone lost a nine-figure dollar amount.

The drop in prices in the cryptocurrency market is exacerbating the liquidity problem

In addition to the total loss of their staking deposits in the peg protocol, the collapse in the prices of all cryptocurrencies has also increased the pressure on loan providers. The capital reserves of Celsius, BlockFi and 3AC have been reduced in recent months in line with the decline in the prices of their cryptocurrencies.

The drop in the price of leveraged cryptocurrency positions also deposited as collateral on other platforms such as Aave and Compound led to the first large liquidations, also known as margin calls, in the final days of trading. In particular, Celsius and 3AC were forced to increase the collateral deposited through fresh money deposits in the last 48 hours in order to reduce the liquidation levels of their positions. As an example, the leveraged Bitcoin position of Celsius should be mentioned here, which would have led to a forced liquidation of the Bitcoin position deposited as collateral for borrowed stablecoins such as USDC and USDT if the liquidation price had been reached.

The role of DeFi investors

In the wake of Terra’s demise, investors have also withdrawn more and more funds from the liquidity pools of staking and lending platforms such as Celsius and BlockFi in recent weeks of trading, exacerbating the liquidity run-out problem in the DeFi sector.

With provider Celsius alone, investors have recently withdrawn about half of the deposits available in the various loan offerings. Loss of investor confidence and fear of losing more deposits are likely to continue to drive capital outflows from various DeFi protocols over the coming weeks and months, which is likely to exacerbate liquidity problems.

The dilemma of platform providers and liquidity providers

As some of the major providers lost nine-figure dollar amounts to their investors when Terra collapsed, and these investors are now withdrawing more and more money from loan pools, the liquidity available in these products is further reduced. The risk of a possible default on the part of the lending platforms therefore remains and could even increase.

Celsius therefore felt compelled to completely suspend payments from its various lending products for the time being in order to avoid a bank run and associated short-term insolvency. To avoid a margin call on its existing bitcoin position on the MakerDAO platform, Celsius yesterday, Tuesday, June 14, used the last remaining capital to raise the liquidation price. from $ 22.584 for $ 16,800 to reduce. While this has prevented the liquidation of the Bitcoin position, it is still unclear if and when the centralized lending platform will reactivate customer deposit payments.

Industry leader Nexo announced after announcing the impending insolvency of its competitor via Twitter known, in a so-called Letter of interest (LOI)announcing the possibility of acquiring various loan products from Celsius.

It was released on Wednesday morning Wall Street Newspaper an article claiming that Celsius hired a law firm to restructure the company. In the afternoon it was learned that Celsius had contacted leading US bank CitiGroup for advisory support.

A hedge fund before default

The role of cryptocurrency hedge fund Three Arrows Capital (3AC) in this liquidity debacle has been largely ignored. Just yesterday, Tuesday, the news of possible payment problems from 3AC caused new troubles on social media. Among others, Three Arrows Capital has invested in Ethereum (ETH) with a Equivalent to 245 million USD in the DeFi Aave protocol liquidity pool to borrow 189 million USDC and USDT. At the time of signing the loan, the amount borrowed corresponded to approximately 77 per cent of the collateral deposited. The Aave protocol allows borrowers to leverage 85% of the underlying collateral (collateral). Due to the drop in the price of deposited aether, the percentage threatened to rise to the 85 percent threshold, which would have resulted in the liquidation of the aether position. According to concordant information, 3AC has started spending more and more of its funds in the past few days deducted from other staking pools. It is currently unclear whether 3AC will use the funds to repay existing debts or to avoid possible liquidation of its Aether deposits by adding new collateral.

Is the complete collapse of DeFi imminent?

The uncertainties surrounding the Celsius central lending platform and other DeFi protocols such as Aave and Compound are currently causing a real sell-off in the DeFi sector. Uncertainty about the price level and the amount at which additional margin calls could be triggered is likely to lead to continued uncertainty among investors.

Many other protocols such as Thorchain (RUNE) and Ocean (OCEAN), but also decentralized exchanges such as Uniswap (UNI) are currently held in clan custody. Prices of RUNE and Co. have lost value disproportionately in the past 24 trading hours. If the course correction on the cryptocurrency market continues in the coming weeks, further collapses in the decentralized finance area after the Earth crash cannot be ruled out.

BTC-ECHO magazine (print and digital) ab 4.99 EUR

BTC-ECHO Magazin is the leading German-language magazine since 2014 on the topics of Bitcoin, Blockchain, NFT and cryptocurrencies.

To the magazine

About the author


Leave a Comment