Steep Crypto Pullback Proves Major Milestone for Crypto Yields
Crypto markets have experienced a tremendous pullback last week, and it sent the naysayers into i-told-ya-so overdrive. What many of these commentators do not realize is that the underlying products, technology and infrastructure performed exactly as required. Consider what happened when the ‘08 financial crisis took place or even sooner the 2020 Covid market crash. Bond and equity markets completely dislocated, and we even saw the WTI June 2020 crude oil futures contract go negative for the first time in history. Centralized systems were crushed under the weight of people running for the exit.
A recent Bloomberg opinion piece notes that this past week also saw centralized systems in the crypto market such as Coinbase and Voyager under massive load crumble to an unresponsive state for their users. Users were left to sit idle and wait for their respective provider to re-open often missing out on the opportunity to buy the mega-dip or get out creating frustration and anger amongst customers.
Contrast this to the defi networks exchanging coins between users across the globe. The defi infrastructure ran without issue due to the decentralized architecture enabled by distributed ledger technology (DLT) where no organization or set of servers acts as a single point of failure. Blockchain technology, being the most predominant example of DLT, allows for distribution of both records and processing across millions of computers worldwide running autonomous of any single organization free from control and manipulation. The defi approach on DLT makes Voyager look like a couple of Windows NT servers running IIS with a Cisco Local Director in front of them doing a round robin load balancing algorithm.
The defi/DLT results are in and of itself a noteworthy characteristic, but indeed fairly solvable and can be replicated with enough money in geographic failed over, load balanced and mirrored systems owned by a single organization. The issue of trust would still remain after this expensive endeavor is completed, and it of course must be maintained at a high ongoing cost.
The Real Achievement
Even more interesting than the operations that took place at scale is the performance of crypto lending and its impact on crypto interest payments. Coins like USDC on various Defi’s and crypto exchanges are paying very attractive interest rates. So attractive are these rates that many people have called it a possible scam not to be trusted. People entered with caution and some went in deep unable to resist the double digit interest rates being paid on what many cryptocurrency enthusiasts liken to cash. In this scenario, depositors deposit USDC and borrowers obtain loans collateralized with ~120% of another crypto asset. Compound is a great example of this type of network where the smart contracts on the exchange automatically deleverage the debt position as the collateral crypto falls in value thereby automatically repaying the loan. There’s no bank or centralized authority to manage this process.
Rightfully so the skeptics raised a warning flag on what happens when the sell off in the collateralized asset takes place faster than the market can fill orders. This of course would result in the lender unable to pay down the borrower’s loan possibly leaving the network out of balance with the borrower in default since there is no person or organization left to collect. Interestingly that’s not what took place during the recent steep downward spikes. The systems worked exactly as designed with borrower’s collateral automatically sold and used to pay down loans. In addition, stable coins held their $1/coin price for example and equally impressive the attractive interest rates are still in play.
DLT and defi represent a major next step in the evolution of internet based technology. Entrepreneurs and communities of developers will certainly build new, innovative solutions on this technology that are certain to bring value and convenience to our lives just as the web technologies did in the 90s and the smart phone in 2008.