The “I Hate to Have Told You So” Moment With the Crypto Lending Industry | Viktor Tachev


Photo by Ehud Neuhaus on Unsplash

In times like these, I feel nothing but empathy for the community and the wealth lost over the past few weeks. However, I am not going to act surprised about the collateral damage and the events that shook the crypto lending industry.

Two years ago, I published my most read article — The Crypto Lending Industry — a Ticking Time Bomb, Rather Than a Shortcut to Mainstream Adoption.” At the time, I was aware that many would have considered the headline a prime example of sensationalism, but I believed the piece held some truth to it. In hindsight, it seems it did, indeed — just not as convenient as most would have wanted.

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People in the comments started arguing that…

…“there is little to no risk of the platform getting burnt even if the lender doesn’t pay up or the collateral price falls significantly.”

…or that I didn’t understand cryptocurrencies…

…or that the industry’s mammoth market cap was a solid benchmark (which anyone remotely familiar with cryptocurrency fundamentals knows it is as unreliable as they come)…

…or even that I thought lending companies (the interesting thing is that Celsius and BlockFi were the cited examples) didn’t understand risk management…

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Regarding the last point — of course, I think they do. I have been working with some of the leading crypto lending service providers since the industry’s early days, and I have witnessed that first-hand. However, not all are equal.

After I published the article, Celsius’ CEO gave me a follow on LinkedIn — maybe he liked the article, or perhaps it touched some nerves.

Fast forward two years and the crypto market is in a downward spiral.

Celsius, one of the bigger cryptocurrency lending platforms, with more than $11 billion in customer assets, has paused all withdrawals and frozen the funds of over 2 million clients due to “extreme market conditions.”

So did the Hong-Kong-based Babel Finance, while BlockFi, another prominent player in the industry, had to be bailed out.

Cases like these are why SEC officials describe the industry as “a plague with no regulatory oversight, no consumer protections, and no fiduciary infrastructure of any type.” If the crypto industry is to thrive, it should be working to change such notions.

In 1849, French writer Jean-Baptiste Alphonse Karr wrote, “the more things change, the more they stay the same.”

Nowadays, people try to portray the crypto industry as something way better and more refined than the traditional financial system. Yet, so far, it has been making the same mistakes.

As much as people want, crypto markets lack the safety net of having a lender of last resort. As a result, insolvency is always around the corner.

The truth is crises arise from irresponsibility, not as a result of the market conditions. In fact, there is nothing “extreme” with the current market conditions – crypto winters take place every few years or so. The only extreme is the inability to withstand them.

The bottom line is that everyone should start reading between the lines. Crypto winters will inevitably continue in the future, and the only way to survive them is by keeping your feet on the ground. Acting as if the market has matured overnight will only further deceive those with heads already in the clouds.

And there are many of them. The bull market of the past years has made many market participants, both retail and institutional, feel invincible, even cynical at times. However, as Sir John Templeton says, “markets die on euphoria.”

The truth is we are all Warren Buffets when the market is going up, but when it starts going down… well, this is when chaos takes over.

Instead of being overly ecstatic about an extended bull market (we are in bull markets most of the time, anyway), lending companies’ clients should start asking the tough questions.

The bear market has just started, and companies are already falling like flies. What if it lasts a year or two?

What exactly is the lending company doing with your money?

How much of its funds are liquid?

What is its contingency plan in case of the so-called “extreme market events?”

As Benjamin Graham notes in the “Intelligent Investor,” the intelligent investor is “a realist who sells to optimists and buys from pessimists.” Crypto markets need more realists, rather than optimists.

Here’s to hoping Celsius, like all other affected companies, will survive the latest crypto winter.

However, the problem isn’t whether a particular company will make it out alive or not. In fact, a business model that thrives only in bull markets but crumbles once bulls take over isn’t worth breaking a sweat for, either way, since it isn’t healthy for the niche’s reputation. This isn’t a dig at the crypto industry — just the natural evolution of financial markets. We have seen it with the traditional financial system, and we are seeing it now with the digital one. So why turn a blind eye?

More importantly, companies and individuals should rethink their operational models and behavior.

No matter what some may argue, there is simply one way for lending companies to ensure stability in a highly-volatile crypto market environment, and it is over-collateralization. Furthermore, to operate resiliently, platforms should prioritize their own stability. The adopted operational models should be unforgiving to clients — margin calls during times of excessive volatility that trigger collateral liquidations in case of need. The volatility risk should be shifted to the client, not the service provider. Otherwise, a problem like the one we are seeing now would become systematic rather than idiosyncratic.

On the other hand, clients must always keep their LTV at healthier and relatively lower levels than during calmer market periods. That way, they can ensure their capital won’t be impacted in case of sudden volatility spikes.

This simple formula should be enough to keep the system stable, at least on paper.

In reality, lending service providers should strive for transparency and adopt way more advanced risk management practices, including real-time auditing of assets, publicly verifiable data of their financial health, licenses, the latest security infrastructure, and more.

The current crisis is a blessing in disguise. It is a healthy reality check — a “survival of the fittest” scenario that will clean up the stage from companies with shaky operational models.

Whether the affected businesses survive or not, the damage is already done. The current situation has sent a worrying signal to clients that once cryptocurrencies start nosediving (which is every couple of years), their funds might be at risk. In a world of skyrocketing inflation, the last thing investors want is to expose their funds to greater risk.

What remains ahead, in my opinion, is stricter regulations. Similar to the aftermath of the dot-com bubble, we can also expect significant industry consolidation. And this consolidation will give birth to the new market leaders — the Amazons of the cryptocurrency space.


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