Pantera Capital: Centralized financial institutions have collapsed, but DeFi is still alive

Author: Pantera Capital

Compiled by: Planet Daily

"Cryptocurrency has been crashing… The chaos has spread to DeFi: Celsius, a cryptocurrency lender with about $20 billion in assets, has recently been forced to suspend withdrawals. Last week, cryptocurrency exchange FTX announced that shortly after rescuing cryptocurrency broker Voyager Digital, it was providing a $250 million loan to rescue a struggling crypto lending platform, BlockFi."

------ Jon Sindreu, The Wall Street Journal, June 30, 2022

In this report from The Wall Street Journal, the entire article is filled with condemnation of the so-called failures of DeFi.

Has DeFi — decentralized finance — really failed?

This is a huge misunderstanding; it has not failed but has shown significant effectiveness!

The five companies cited by the journalist in the article are all centralized; they are merely old-fashioned venture capital-backed startups, not DeFi at all, and they do not operate on the blockchain. These businesses are just over-leveraged startup banking entities, and the failure of such types of enterprises is old news; they have nothing novel about them.

Decentralized finance protocols — such as Aave, Compound, Uniswap, MakerDAO — have been operating perfectly 24/7. This crisis actually proves that DeFi operates very well, far better than centralized financial companies like Celsius, BlockFi, and Lehman Brothers.

First, I try to avoid reading articles that quote "tulip bubble" journalists; I have not read anything useful in such casually referenced articles from four hundred years ago. However, it is precisely because I support blockchain so strongly that I dutifully forced myself to read the entire article.

Let’s analyze the misunderstandings contained in the article:

1. "Remember how the banking system self-destructs every few decades? Now imagine if banks only lent money to other banks; you might think of the concept of a 'house of cards,' that is, 'decentralized finance' or 'DeFi'."

You don’t need to remember what the report said; it is wrong again! Celsius, BlockFi, and Voyager Digital are all banking entities; they are not decentralized in any way.

Those startups merely absorb short-term deposits and provide long-term loans to each other and others; they operate on a 20 to 1 leveraged business model run by ordinary people.

On the other hand, DeFi is not an empty house of cards. Its foundation is rock-solid and completely transparent. DeFi eliminates human subjectivity in financing decisions. All parties agree to transact openly and transparently on the blockchain, rather than through opaque, human, potentially conflicted financial actors conducting backroom deals, which is the vision we should strive for, rather than clinging to inefficient centralized financial systems.

The author holds a misleading view of the yields in blockchain. He overlooks that DeFi is the financial backbone of the entire blockchain ecosystem, powering various forms of transactions — retail, institutional, and even the green loan types he claims do not exist on the blockchain. Mortgages can secure blockchain safety and incentivize liquidity to prevent slippage; these are just some of the ways yields are generated in today’s cryptocurrency.

2. "To the delight of critics, DeFi ultimately committed the same sins as Wall Street, essentially becoming a tool for rampant speculation typical of pre-2008 investment bankers."

Oh~ so the evils of banking should have stopped in 2008? Well… I’m not sure the record supports that. Since being bailed out by American taxpayers in 2009, banks have paid an astonishing $321 billion in fines.

I remember an anti-Bitcoin advocate wrote an article titled "Bitcoin is Evil." I don’t understand why; Bitcoin is an open-source code that anyone can use. It has never done anything bad to anyone. On the other hand, banks have been found guilty of $321 billion worth of evil acts. (And that’s just the actions they got caught for).

To illustrate this figure: the United Nations food aid agency, the World Food Programme, estimates that $6.6 billion would help prevent 42 million people in 43 countries from suffering hunger.

The money banks spend on fines is 50 times the amount needed to solve world hunger; perhaps this article should be titled "Banks are Evil."

Another comparable figure is that the banks' fines are equivalent to the total GDP of 84 countries. If banks had not committed crimes, they could provide a whole year’s salary to all 363 million citizens of these 84 countries.

DeFi has never "committed a crime"; the rules of participation are encoded in smart contracts. You do not need to trust a counterparty that may be incentivized to distort the facts, nor do you need to rely on trust to conduct financial transactions. The code simply executes what both parties have agreed upon.

3. "The exclusive focus of crypto lenders on other crypto projects indicates that their problems are far more severe than a Lehman-style liquidity crisis."

No… Celsius, BlockFi, and Voyager are just like Lehman Brothers; they are centralized finance.

4. "Digital currencies like Bitcoin are too inconvenient to cash out, ultimately concentrating funds in the promises of a few banks, asset management companies, and governments."

Why would a journalist — here I like to borrow a classic line from Marc Andreessen — "who can’t have 12,000 fans" think that 300 million people are wrong? 300 million people see the potential of blockchain. If a reactionary who completely misunderstands the basic principles cannot see the potential of blockchain, that is not my problem.

However, I am a true athlete. I strive to help this young kid out of his misconceptions.

Quoting Cool Hand Luke (starring Paul Newman, 1967), "Some men, you just can’t reach."

DeFi Excels

The most elegant proof that DeFi surpasses centralized finance/banks is direct competition. Centralized financial companies like Celsius and BlockFi conduct business with counterparties, and then they invest funds in DeFi protocols; what happens?

Smart contracts force centralized financial companies to repay DeFi protocols.

In fact, you could say that DeFi, due to its over-collateralization discipline, can protect you from CeFi harm. Celsius was forced to prioritize repaying over $400 million in DeFi loans on Maker, Aave, and Compound to prevent its collateral from being liquidated. In DeFi, participants have no ability to go against smart contracts; "a deal is a deal" — you cannot back out.

All centralized financial companies are compelled by smart contracts to repay DeFi protocols. On the other hand, centralized financial companies can deceive their customers and then conceal their actions from them.

For example, even though Voyager explicitly advertised that its customers' deposits were FDIC insured — and the FDIC only insures failed member banks. They certainly would not bail out business losses for bank customers like Voyager.

“In rare cases, your dollar funds may be harmed due to the failure of the company or our banking partners, and you will receive full compensation (up to $250,000).” — Voyager website, 2019

“Your dollars are held by our banking partner Metropolitan Commercial Bank, which is FDIC insured, so your cash held at Voyager is protected.” — still on the Voyager website, July 11, 2022

Failed centralized financial companies remain silent about their customers; unfortunately, their customers are unlikely to recover their money.

DeFi will never do this; customers can monitor protocols on the blockchain and determine what is executed by code. Centralized financial customers only have vague websites to trust.

Why DeFi is So Important (Author: CHIA JENG YANG, INVESTMENT ASSOCIATE)

Among the large leading cryptocurrency lenders (Aave, Compound, BlockFi, and Celsius) established in 2017, DeFi protocols have performed the best. BlockFi was essentially rescued by FTX, which provided a $400 million credit line and had the option to purchase the company at a 93% discount from the high watermark observed in private markets. Celsius once managed $24 billion in assets, roughly equivalent to one of the most famous hedge funds, Point72, founded by Steven Cohen with 30 years of investment experience; Celsius now faces potential bankruptcy.

So how is DeFi more effective than CeFi in the current crash?

Let’s return to why blockchain is useful.

Blockchain provides complete transparency. Smart contracts provide automated rules for how specific financial instruments and protocols should act, executed and managed by code, not relationships.

The visibility and transparency of blockchain come with accountability. DeFi applications cannot run away with funds, cannot deploy funds in strategies that your retail investors do not agree with, cannot favor one investor over another, and cannot under-collateralize without others knowing. With blockchain, the whole world can track your actions 24/7 and see every step you take.

The statement from the SEC regarding BlockFi pointed out that BlockFi made incorrect statements about the risk levels of BIA investment opportunities. DeFi lending protocols managed by smart contracts would not allow such a situation to occur because the lending rules would be explicitly stated in the smart contracts.

This transparency refers not just to a specific DeFi application but encompasses industry-level transparency for the entire crypto community trading on the blockchain. Performance information for various assets and wallets is completely visible to everyone. For example, we can use on-chain data to see wallet addresses that have leveraged purchases of Ethereum facing significant liquidation pressure at $600 and $500 ETH. For any participant operating in the market, the visibility of the on-chain market is accessible to everyone, not just those in the know. This enhances everyone’s ability to understand what is happening in the market.

This contrasts with the trust role of CeFi, where we rely on market rumors to understand which crypto lenders are safe to store assets with. We cannot understand their balance sheets or know what actions they are taking with your funds because CeFi lacks absolute transparency.

DeFi also almost entirely uses over-collateralization in lending, providing transparent health risk management. This is similar to how banks issue mortgages on homes. The advantage of current DeFi platforms lies in over-collateralization, with most DeFi platforms having a minimum collateralization rate of 110-150%, representing a loan-to-value ratio of 60-90%. In practice, we see strong DeFi protocols (MakerDAO, Compound, Aave) with higher collateralization rates of 200-300%, representing a loan-to-value ratio of 30-50%. The anonymity of DeFi means that only those with strong risk management practices can survive long-term, and relationship-based or intuition-based underwriting/under-collateralized loans have no leeway. CeFi does not have such on-chain discipline, making under-collateralized loans to entities they think are good borrowers (who sometimes turn out not to be). In contrast, DeFi protocols cannot engage in such backroom deals without transparent smart contracts explicitly allowing it.

DeFi participants can also conduct business in the same way before, during, and after a crash without suspending withdrawals or requesting emergency funds. For example, during the LUNA crash, DEX continued to operate normally, while some CEX were forced to halt withdrawals, clearly harming users' interests, resulting in losses for users.

We should learn from the crash of 2022. The power of DeFi will be recognized, and we believe that better tools will emerge for institutions to participate in DeFi in the next bull market cycle, and its strength will continue to grow.