In today’s Exponential Investor:

  • DeFi blow-ups?
  • TradFi markets are bleeding
  • How to use DeFi strategy to pay for growth

According to Bloomberg, the collapse of the platform Terra (LUNA) wiped $83 billion from the crypto sector.

This had knock-on effects, as other lending and yield-generating crypto protocols started to struggle and the mass exodus of liquidity took hold.

BlockFi, a lending and earning platform looked to be on shaky ground. But then giant crypto exchange FTX swooped in with what was effectively a bailout package, including a $400 million revolving line of credit and an option to buy BlockFi for up to $240 million.

Voyager Digital, another platform, but listed as public stock on the Toronto Stock Exchange, also began shutting out users and “pausing” activity (trades, deposits and withdrawals).

Another lending protocol, Vauld, has shut out users, suspended activity and is apparently also on the verge of insolvency. The talk is that Nexo (a bigger, more secure lending and earning platform) is looking to buy it.

In the midst of all this, “crypto mega hedge fund” Three Arrows Capital has gone bankrupt and is in the process of liquidating its assets. At one point, it was said to manage assets of over $10 billion. It also allegedly spent around $560 million on LUNA. When the latter imploded, Three Arrows’ position plummeted to $670.

This is what you might have seen or read in the mainstream media about “decentralised finance” or DeFi in crypto.

It’s enough to put even the most hardened investment professionals off the entire sector for good.

Except there’s one big problem.

One giant problem that every single mainstream publication hasn’t told you yet…

When CeFi isn’t DeFi

None of the failures just mentioned really have anything to do with decentralised finance.

They all concern centralised platforms and companies whose issues were caused by undercollateralised leverage and over-leveraged market positions. That’s not really a systemic issue in crypto, that’s just traditional finance greed bleeding into the crypto markets.

What it tells us is that it makes no difference what markets you operate in, the fact is that bad actors are everywhere. Irresponsible lending and leverage practices are rife, and, for those in power, the thirst for the fast, big buck comes at the expense of everyone else.

The issues we’ve faced in the crypto markets over the last few weeks have simply been a sequel to the same problems that continue to plague the traditional finance, or TradFi, markets.

What’s really interesting, though, is that the real decentralised protocols and platforms in crypto have consistently remained functional and operational, and haven’t shown any sign of weakness considering the massive value that has been eradicated from the system.

If anything, the last few weeks have proven with some gusto that DeFi truly can be better than CeFi (centralised finance), but only when it’s true DeFi.

Money paying for money

I’m certainly no fan of leverage in crypto markets, for the obvious reasons that we’ve just shown. I think that, as an investor in this space, you don’t need massive leveraged bets to strike the big winners and change your financial future.

But I’m also in no doubt that lending and leverage are useful and, when utilised correctly, are an interesting and enticing way to generate yields and build wealth.

But I will once again reiterate that I think it’s slightly insane to use leverage that could wipe you out (and then some). Never bet on your own house, or on someone else’s for that matter – you could end up blowing up everyone’s castle.

But what if there was a way to utilise DeFi to attain leverage and then apply the tricks and nuances of the crypto market to have it all pay itself off?

You see, some protocols, such as Aave, are lending platforms that have shown themselves to be robust during this market cleanse.

For example, you can deposit crypto into the Aave decentralised application, or dApp, and then borrow against your collateral.

What makes Aave resilient is that you can never borrow more than your collateral. In most cases, if you’re depositing a crypto or stablecoin, you will only be allowed to borrow a percentage of that deposit.

For example, you can deposit $1,000 in a stablecoin and borrow up to 80% of the collateral value.

However, what makes this interesting is that you can get some pretty attractive rates on your borrowing.

Some of the variable APYs are under 2%. And when you factor in deposit earnings, the real rate is closer to 1% APY.

Now you can borrow at under 2% APY and then take some of that money and deposit into a high-yielding platform, some of which offer in excess of 10% APYs on stablecoins.

For instance, on a $800 loan (80% LVR on $1,000), you would pay around $12 at 1.5% APY. You could take $120 of that $800 borrowing, then make a deposit into a yield account at 10% and have your servicing obligations met while utilising the remaining $680 for your investment desires.

Why would you do this?

Well it’s a matter of managing your own working capital. If you were investing in another asset on your original $1,000, you’d have to sell some of that asset to get another. By using it as deposit collateral and borrowing, you wouldn’t.

This is the kind of strategy that can be used if you want to go “long” an asset. And if the market moves against you, at least your servicing costs are met with the stablecoin deposit in the yield account.

According to Aave, these are the kinds of strategies that can be used for, “unexpected expenses, leveraging their holdings or for new investment opportunities.”

When done prudently and responsibly, this can be a useful strategy. But it’s still lending and still prone to risks of default, so it’s really for more advanced users well aware of all the risks involved.

I also still don’t think leverage is the way to go in this market.

But if you were going to do it, there are smart ways to look at it, with the right kinds of protocols that are true DeFi and not intertwined with the complex and convoluted CeFi world.

Until next time…

Sam Volkering
Editor, Exponential Investor