Growing Pains in the Crypto Industry as It Develops Into A Robust Ecosystem
Since the market peaked in November 2022, the value of the global crypto market, now valued at $895 billion, has decreased by over $2 trillion. This comprises stable coins, non-fungible tokens (NFTs), centralised finance (CeFi), and decentralised finance (DeFi). Numerous market failures and bankruptcies in custodian CeFi platforms have been brought on by the bear market of 2022. DeFi platforms, on the other hand, do operate but are not secure. Cryptocurrency finance is maturing, much like traditional finance (TradeFi) has gone through growing pains. While emerging crypto finance institutions are only a few years old, it took decades for modern financial institutions and the regulatory/supervision systems around them to acquire their current level of confidence.
Millions of venture dollars invested in cryptocurrency ventures impede innovation and, regrettably, draw criminals to take advantage of them. An entire industry shouldn’t be brought down by the dishonest activities of a small number of people. The cryptocurrency market craze in 2020–2021 was fueled by a number of macroeconomic and microeconomic causes. Examples include “free money” laws that encourage global banks to take excessive risks, hockey-stick development prospects, massive investments in venture capital driven by herd mentality, fear of missing out (FOMO), aggressive messaging from the media and influencers, and many more. The need for checks and balances was reduced as a result of the crypto gold rush, which drew entrepreneurs, venture capitalists, depositors, and speculators.
TradeFi was cleaned up by the financial crisis of 2008–2009; similarly, market forces causing failures and bankruptcies are eliminating excesses and bad actors, clearing the way for a more robust crypto ecosystem.
Fiduciary obligations and due diligence on cryptocurrency initiatives were minimal. Risk management, governance, compliance, and third-party audits were either nonexistent or a mere afterthought. Ironically, many of the individuals who stoked the speculative mania are now the most vocal proponents of the crypto industry’s impending doom.
The crypto catastrophe of 2022 won’t stop Web3 in its tracks, just as the dot-com crash of 2000 didn’t kill the developing internet. That is weeding out. Bad Exit performers will have time to prepare for the next bull run, while those that remain strategic will have more time. Fundamentals of the metaverse, driven by the fusion of blockchain technology with gaming, are now established trends.
We still don’t know what blockchain and cryptocurrency technologies accelerated the industry’s growth and adoption. Self-sovereignty, transparency, and decentralisation, which are its defining characteristics, will continue to open up new prospects in growing markets and aid cryptocurrency in overcoming existing challenges. Tokennomics, peer-to-peer transactions, and asset tokenization are examples of novel developments that can only be applied within the crypto ecosystem. Sam Huber, CEO of LandVault, claims that technological advances go through hype cycles.
Crypto Finance: Just as banks and brokerages offered yield products, trading, and other financial services to holders and depositors of fiat currencies, DeFi and CeFi platforms do the same for owners and depositors of cryptocurrencies.
A decentralised, open source, transparent, verifiable, blockchain-based financial ecosystem is known as non-custodial decentralised finance, or DeFi. The intermediates in charge of managing the risk of crypto financial transactions are immutable smart contracts and programmable code. Using conventional credit checks and underwriting procedures, crypto lending protocols enable borrowers to use their current real-world assets as collateral for DeFi loans or staking. In comparison to traditional banks, DeFi normally offers greater returns; however, the loans are frequently heavily collateralized, meaning that borrowers must deposit assets worth significantly more than their loans. Even if they leave the user’s wallet and are used in a smart contract, the user’s deposited funds are still secure. Funds cannot be re-pledged, and they are always instantaneously accessible by the user with no lockup period.
Through market chaos, fully automated, transparent, and decentralized DeFi protocols, such as Aave, Maker, Rocket Pool, Compound, and more, are functioning as designed without catastrophic failure. Unlike CeFi, which has seen several market failures, frauds and bankruptcies, DeFi loans have not defaulted because they are senior loans in the overcollateralized capital pool and are the first to be paid when the market declines. If falling asset prices trigger a margin call, smart contracts liquidate positions and automatically pay back outstanding loans. There is no ability to reconstitute/reorganize smart contracts within DeFi. Darren Langley“What makes DeFi special is its focus on transparency and control,” said Rocket Pool General Manager. A good DeFi protocol has open source code and is audited by respected security professionals; Verifiable on-chain and made public, decentralized governance.” The most significant vulnerability of DeFi platforms is potentially faulty protocol design, unintentional or intentional, that can trigger market volatility and failures. Hidden bugs in open-source smart contract code can trigger unintended consequences. DeFi projects offered inflated yields, fueled speculative frenzy and created a web of interconnected undercollateralized houses of cards, which have now collapsed and threaten the entire crypto ecosystem. In May 2022, the undercollateralized algorithm Terra stablecoin (UST) lost its US dollar peg, crashing the entire Terra DeFi ecosystem and provoking contagion failures of interconnected CeFi platforms. The fiasco began due to a design flaw in the UST algorithm, which led to its de-pegging due to extreme market volatility and falling asset prices.
Custodial Centralized Finance or CeFi: Digital asset intermediaries hold custody of user funds and trust, while providing crypto products and financial services. CeFi platforms include centralized crypto exchanges (CEX), crypto lending companies and digital currency payment providers; Binance, Coinbase, Kraken, and the now bankrupt FTX, Celsius, Voyager, BlockFi, Three Arrows Capital (3AC), and more. Insiders to the CeFi platform control the crypto assets stored in custodial wallets. Although these funds are allegedly kept on these platforms, they are kept outside the user’s control and oversight. After the CeFi explosion, depositors are painfully learning that the crypto assets held in their accounts were not “theirs”, ie not your keys, not your coins. Rogue and fraudulent individuals on top of the now-defunct CeFi platforms, such as Celsius, Voyager, BlockFi, Gemini, FTX, and more, pool co-mingled users into multicurrency wallets and treat their customers as “unsecured creditors.” They re-mortgaged customers’ deposits and lent them to speculative investors and hedge funds, creating low-collateralized IOUs that eventually defaulted. The steep decline in reinvested loan values prompted a reduction in leverage, resulting in a domino effect of defaults at CeFi. Lakhs of investors and depositors are now watching their losses wiped out with horrendous suspended accounts.
CeFi executives allegedly misused their access to user wallets and laundered billions of deposited assets. They did deceitful things because they could. Acting unilaterally and recklessly, company insiders breached their fiduciary duty to protect user funds and created a trust failure throughout the crypto ecosystem. By and large, many of the individuals accused of fraud at the helm of these bankrupt platforms are now “seriously sorry” and want to help. Rise of Sefi: Participating in the DeFi banking system is a steep learning curve. Users must interact directly with the protocol, have high technical knowledge, and be more practical. These technical constraints enticed venture investors and entrepreneurs to build centralized user-friendly middleware CeFi platforms, such as BlockFi, Celsius, Voyager, and more. These CeFi platforms require users to deposit their assets with a central entity and collect promised yields in return, providing a direct and familiar entry point. CeFi companies attracted millions of depositors and experienced explosive growth in custodial assets by providing an intuitive, user-friendly interface and the promise of high returns.
“Centralized cryptocurrency platforms have acted as wolves in sheep’s clothing,” says Jessica Walker of Fluid Finance. Users were storing their funds in a black box with no eye on how they were being stored. didn’t keep.” The recent SEFI fiasco underscores the need for education and training. Ryan Horst, CEO of Blockchain Insight Group, says, “Crypto is in motion a great opportunity to make sound investments and passive income; However, without proper training, you can enter a casino. The crypto industry is in a brutal moment. It is facing serious trust and confidence issues due to private wallet exploits, exchange hacks, smart contract failures, de-pegging of stable coins, rug-pulling, and more. Following disastrous market failures, industry oversight of CeFi platforms involving consumer protection is paramount. The crypto industry can collectively create robust autonomous verifiable middleware protocols that stress test, verify proof of stores, audit protocols to verify functionality, transactional security, and more.
DeFi has fared significantly better than CeFi during the volatility on the cryptocurrency market, giving the sector a platform to expand on going forward. Amazingly, the crypto financial sector has accomplished in a short period of time what the traditional financial services sector took decades to do. In the future, these established businesses that are developing cutting-edge crypto products and services will comprehend and integrate robust risk mitigation mechanisms into their platforms. Compliance and risk management cannot be an oversight or an afterthought. The cryptocurrency sector must learn from these blunders if it hopes to achieve its goals of serving billions of users. Yes, the cryptocurrency sector is necessary and expanding.
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