There were a lot of things that went wrong in Crypto CeFi in the recent times; let’s looks at how we can learn from it. Before moving into the details, let’s understand CeFi in Crypto.
Centralized finance (CeFi) is a type of financial practice within the cryptocurrency sphere where users primarily can earn interest and get loans through centralized platforms.
In most ways, Crypto CeFi is very similar to traditional banking where a bank is in custody of your funds, however CeFi is not backed by any govt., instead it is backed by private individuals & corporations.
Source : Google
Which brings us to the concept of:
🔸Hypothecation – When an individual decides to lend their asset as collateral to get a loan sanction from a bank or financial institution.
🔸Rehypothecation – When the same financial institution reuses the individuals’ assets posted as collateral by their clients to secure their borrowings.
Classic example of Rehypothecation:
Raju borrows loan from Bank A for buying a house. Here, Raju made hypothecation to Bank A.
Bank A in-turn borrows money from Bank B using the asset (house) posted by Raju as collateral. This is Rehypothecation.
Source : Google
The disadvantages of rehypothecation:
🔴Consumers tend not to read the fine print while signing up for loans and may be vulnerable in times of crisis
🔴Risk of default by the lending institution
🔴Misuse during rehypothecation by lending institutions
Source : Google
Recently, Vauld, a well-known crypto exchange recently announced in its press release that it would suspend all withdrawals, trading and deposits on the Vauld platform with immediate effect citing volatile market conditions, the financial difficulties of our key business partners.
Despite having a strong investor support, the overall market forces driven by collapse of Terraform Lab’s UST stablecoin, Celsius network pausing withdrawals, and Three Arrows Capital defaulting on their loans got to them.
Source : Google
Source : Google
Their lending model has been laid out on their website, which has 3 main categories:
🔸Vauld Users
🔸Borrowers
🔸Float for Trading
Source : Google
Clearly, in times of overall market crisis, no CeFi or DeFi is ‘safe’. For the crypto exchanges, it all boils down to the liquidity at hand and staying afloat to honour end customer agreements.
Important learnings from the Vauld, Celsius, 3AC episode:
👉🏼If you cannot leverage a loan, stay away from it – applies to individuals as well as institutions.
👉🏼In Crypto always take custody of your coins, especially the ones you wish to HODL for long term (4+ years).
👉🏼Do not fall for unrealistically high & attractive yields – if it’s too good to be true, it probably is! Always do your due diligence when interacting with a CeFi or DeFi lending platforms.
👉🏼Experiment with projects / protocols with only a very minimal amount.
Hope this blog has cleared a few concepts regarding lending in Crypto.
To further understand what happened with Vauld, watch an in-depth discussion around it by Pranav & Kashif on #Web3KiDuniya here:
