How the Three Arrows Collapse Changed Ethereum DeFi Lending

Decen­tral­ized finance (DeFi) lend­ing has changed—especially fol­low­ing the col­lapse of major com­pa­nies like Three Arrows Cap­i­tal (3AC) last year—and man­ag­ing risk is now key for the industry’s suc­cess, accord­ing to Maple Finance CEO Sid­ney Powell. 

Pow­ell, who co-found­ed DeFi lender Maple Finance, told Decrypt at Mes­sari Main­net 2023 this week that the DeFi lend­ing space has matured over the past year. Not that it’s had much choice. The implo­sion of cryp­to hedge fund 3AC in June 2022, and the con­ta­gion that has spread through­out the mar­ket since, has forced traders and lenders to reeval­u­ate what is real­is­ti­cal­ly possible.

“Bor­row­ers and lenders are now say­ing, ‘I’d rather take a pret­ty sure 8% [return], rather than a spec­u­la­tive 20%’,” said Pow­ell. “So we’re see­ing much more empha­sis on what is the risk-adjust­ed yield rather than what is the absolute yield,” he added.

Yield in DeFi and tra­di­tion­al finance refers to cash earned on an invest­ment over time. In the exper­i­men­tal world of DeFi, investors can lock-up funds and earn rewards.

A lit­tle over a year ago, cryp­to lenders were still promis­ing bor­row­ers astro­nom­i­cal returns on deposits, in some cas­es over 20%. But those days are now over, in large part due to the col­lapse of the cryp­to project Ter­ra in May of last year.

Ter­ra in its hey-day was a mas­sive ecosys­tem with lots of apps large­ly focused on algo­rith­mic sta­ble­coins. At one point, it was per­haps the most talked-about DeFi blockchain and the sec­ond biggest after Ethereum; its native cryp­tocur­ren­cy, LUNA, was in its prime one of the top biggest dig­i­tal assets by mar­ket cap. 

Terra’s most pop­u­lar app, Anchor, facil­i­tat­ed risky lend­ing and bor­row­ing and enabled cryp­to degens to deposit Terra’s UST sta­ble­coin and at times earn in excess of 20% returns in the form of more UST.

But when the music final­ly stopped, Ter­ra implod­ed, tak­ing hedge funds that were invest­ed in the project down along with it.

Sin­ga­pore-based cryp­tocur­ren­cy hedge fund 3AC was just one firm hit hard by the chaos. The firm promised big things to clients want­i­ng to invest in new dig­i­tal asset ven­tures. And to do so, it used cryp­to lenders promis­ing big returns. 

Fol­low­ing Terra’s blow-up and the sub­se­quent plunge in cryp­to prices, 3AC filed for bank­rupt­cy—leav­ing many cryp­to lenders wait­ing on their cash. 

Now, says Pow­ell, cryp­to lenders are much more sen­si­tive to “coun­ter­par­ty risk management.” 

“The lessons tak­en away [from the col­lapse of 3AC] are coun­ter­par­ty risk man­age­ment, man­ag­ing con­ta­gion, and kind of silo­ing the risk to the indi­vid­ual bor­row­ers that a lender is fac­ing,” he said. 

He added that “see­ing what is hap­pen­ing with funds” is now nec­es­sary so lenders can con­trol it and a bor­row­er can­not “trade itself into insol­ven­cy like 3AC did.” 

Maple Finance is a cred­it mar­ket­place which helps pro­vide loans to insti­tu­tions. It stands out in the DeFi space because it pro­vides under­col­lat­er­al­ized loans and puts them “on chain.”

Fol­low­ing the col­lapse of major cryp­to lenders, Maple in June launched a direct lend­ing desk, Maple Direct, offer­ing over­col­la­ter­ized loans.  

Pow­ell also told Decrypt at Main­net that debt is a bet­ter asset to tok­enize than equities. 

He said that this is because it is eas­i­er to mon­i­tor, while equi­ty is dif­fi­cult to track on-chain, in part due to its “chang­ing val­u­a­tion” and dif­fi­cul­ty to track cash flows.