Crypto lending has been one of the most prominent activities in the crypto markets. The activity has developed over the years with the emergence of various crypto lenders to meet the demand for crypto loans.
Centralized cryptocurrency lending platforms (CeFi), such as BlockFi, CelsiusY nexus, offer high-performance products to users. By depositing crypto funds into these products, users receive high interest payments. However, with the recent turbulence in the crypto markets and challenges to their business models, centralized platforms are facing issues that highlight the risk of depositing funds into crypto lending apps.
Celsius is the latest example. The crypto lending platform recently announced that it would be suspending all customer withdrawals for users. This has fueled controversy in an already battered crypto market.
In order to protect your funds, you will learn what risks you should assess before using centralized cryptocurrency lending platforms.
Problems at Celsius highlight risks for CeFi lenders
Amid broader market instability affecting crypto markets, Celsius announced on June 12, 2022 a pause on all customer withdrawals, trades and transfers between accounts, citing extreme market conditions and the need to balance liquidity. .
The immediate result was Celsius’s native token, CEL, plummeting by more than 70% in 24 hours. This was against the backdrop of a cryptocurrency sell-off that saw the total market capitalization drop below $1 trillion. (However, CEL has since erased all of its losses and is now trading substantially higher than it was before the crash.)
Celsius is one of the largest crypto lenders with close to two million users from all over the world. In November 2021, the crypto lender was valued at over $3 billion after raising $750 million in a funding round.
Celsius reportedly uses customer deposits to lend financial assets to institutional investors and short-term traders to generate income through arbitrage, short selling shares and certain digital assets, and market making. Celsius also uses various DeFi protocols to lock client assets into liquidity pools to generate yield.
In return, clients have earned up to 7% returns on stablecoins like USDC and USDT, 7.25% on MATIC, 6% on ETH, and 6.25% on BTC. However, the recent turmoil in the crypto market has eroded the potential returns an investor can earn with Celsius, calling into question the viability of its business model.
A short-term cause of Celsius’s problems has been the depeg of Swimming poolThe ETH staked (sETH), which is pegged to the ETH of Ethereum. Celsius had locked up funds in stETH, and a de-peg from stETH means that stETH cannot be easily sold on the open market to obtain the ETH liquidity needed to honor ETH swaps on the Celsius platform.
This comes after some regulators have in the past referred to crypto lending products like Celsius as unregulated securities.
Unfortunately, Celsius is not the only crypto lender in trouble, as Babel Finance it also halted withdrawals, creating rumors that more lenders might be staging bankruptcy to your face.
5 risks to consider before lending your cryptocurrency
The Celsius debacle has highlighted some of the vulnerabilities of centralized crypto lending platforms.
To begin with, CeFi loans are custodial, with a central entity that is responsible for the custody of all collateral. This means that you can only access your secured asset when the lender allows it, as they are the one in control of your private keys.
Unlike CeFi lenders, DeFi lending protocols provide crypto loans without centralized counterparties and use smart contracts to govern collateral, loan disbursement, and interest payments. (However, DeFi is also known to be more centralized than its name might suggest.)
With that said, here are some of the most important risks to be aware of when lending your crypto assets.
In the event of bankruptcy, all funds may be lost
In traditional finance, bank deposits are insured, which guarantees that a portion of your deposits will be returned to you in the event of bank insolvency. This means that the risk of you losing your deposits is low, and the lender is assured of some compensation should the institution go bankrupt.
In CeFi loans, only a small part of the total managed assets are insured and therefore you may lose some of your crypto assets in case of insolvency. Furthermore, since it does not have custody of its collateral, the platform provider can keep the crypto assets of the lenders and borrowers.
Since borrowers do not control their private keys, they can lose their collateralized assets if a CeFi platform goes bust. Due to these factors, you are advised to risk only a portion of your crypto assets (if any), rather than keeping all of your digital money on such a platform.
Accounts can be frozen at any time
CeFi lending platforms sometimes freeze accounts based on a number of issues, including security breaches, anti-money laundering concerns, and even platform liquidity. Unfortunately, if your account is frozen, it means that you cannot access your crypto assets or transact in any way.
Unlocking your account can be a long and tedious process, which must be approved by the platform provider. Compare this to DeFi lending platforms, which are non-custodial and anyone can lend and borrow assets without fear of arbitrary shutdowns.
Rates are not always transparent
The presence of multiple counterparties in CeFi lending systems results in layers of transaction and service fees. Depending on the CeFi platform you are using, some of the fees may be hidden or bundled together with transaction fees. The result is that CeFi lending platforms tend to be relatively expensive compared to DeFi lending protocols.
Clients who lend their crypto assets to CeFi lending platforms do not have a clear view of the counterparty’s transactions.
For example, Celsius users dealt directly with the platform and had no relationship with other asset managers and DeFi protocols that interacted with Celsius. This lack of transparency poses a risk to clients with little or no say in investment strategies and their results.
APY changes can happen at any time, without notice
Finally, the Annual Percentage Yield (APY) is subject to change on CeFi lending platforms. Platform providers can adjust the APY based on crypto market conditions or regulatory climate without much notice to users.
This has happened numerous times and highlights, once again, how risky it is to entrust your crypto assets to a centralized entity.
– Decentralization in Crypto is a difficult ideal to measure
– CEL Token Soars as Celsius Shareholder Proposes Recovery Plan, Celsius Pays Compound
– SEC’s Peirce Says Crypto’s Lack Of “Rescue Mechanism” Is A Strength; FTX CEO as a ‘White Knight’
– BlockFi Secures $250M FTX Line of Credit from Bankman-Fried
– Voyager Digital secures Alameda line of credit, can send three arrows a notice of default