Crypto lending has been one of the biggest activities in the crypto markets. The business has grown over the years with the emergence of several crypto lenders to meet the demand for crypto loans.
Centralized crypto lending platforms (CeFi), such as BlockFi, Celsiusand Nexo, provide high-efficiency products to users. By depositing crypto funds into these products, users receive high interest payouts. However, with recent turmoil in 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 will suspend all customer withdrawals for users. This has fueled controversy in an already battered crypto market.
In the interest of protecting your funds, you will learn what risks you should assess before using centralized crypto lending platforms.
Problems at Celsius highlight CeFi lenders’ risks
Amid broader market instability affecting crypto markets, Celsius announced on June 12, 2022 a pause on all withdrawals, trades and customer transfers between accounts, citing extreme market conditions and the need to balance liquidity.
The immediate result was Celsius’ native token, CEL, dropping more than 70% in 24 hours. This was against the backdrop of a crypto selloff that saw the total market capitalization fall below $1 billion. (However, since then CEL has erased all of its losses and is now trading significantly higher than before the crash.)
Celsius is one of the largest crypto lenders with nearly two million users worldwide. As of November 2021, the crypto lender was valued at over $3 billion after raising $750 million in a funding round.
Celsius would use customer deposits to lend financial assets to institutional investors and short-term traders to generate income through arbitrage, stock shorting, certain digital assets and holding. Steps. Celsius also uses multiple DeFi protocols to lock client assets into liquidity pools to generate yield.
In exchange, clients got up to 7% return on stablecoins such as USDC and USDT, 7.25% on MATIC, 6% on ETH, and 6.25% on BTC. However, recent turmoil in the crypto market has eroded the potential returns an investor can earn on Celsius, calling into question the viability of its business model.
A short-term cause of the Celsius problems has been the depeg of Swimming pool‘s staked ETH (sETH), which is pegged to Ethereum’s ETH. Celsius had locked funds in stETH, and an stETH depeg means that stETH cannot be sold easily on the open market to obtain the ETH liquidity needed to honor redemptions of ETH 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 struggling crypto lender as Babel Finance also halted withdrawals, sparking rumors that more lenders could stage bankruptcy in the face.
5 Risks You Should Know Before Lending Your Crypto
The Celsius debacle has brought to light some of the vulnerabilities of centralized crypto lending platforms.
To begin with, CeFi loans are custodians, a central entity taking care of all collateral. This means that you can only access your secured asset when the lender allows you to, because they are the ones who control your private keys.
Unlike CeFi lenders, DeFi lending protocols provide crypto loans in the absence of 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 suggests.)
That said, here are some of the most important risks you need to be aware of when lending your cryptoassets.
In the event of bankruptcy, all funds may be lost
In traditional finance, bank deposits are insured which guarantees that part of your deposits will be reimbursed 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 if the institution goes bankrupt.
In CeFi loans, only a small portion of the total managed assets are insured and therefore you risk losing some of your crypto-assets in the event of insolvency. Also, since you don’t have custody of your collateral, the platform provider can keep crypto-assets from lenders and borrowers.
Since borrowers do not control their private keys, they can lose their secured assets if a CeFi platform goes down. Due to these factors, you are advised to only risk a portion of your crypto-assets (if any), instead of holding all of your digital cash 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 issues, and even platform liquidity. Unfortunately, if your account is frozen, it means that you cannot access your crypto assets or perform transactions in any way.
Unlocking your account can be a long and tedious process, which must be approved by the platform provider. Compare that to DeFi lending platforms, which are noncustodial and anyone can lend and borrow assets without fear of arbitrary shutdowns.
Fees 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 use, some fees may be hidden or bundled with transaction fees. The result is that CeFi lending platforms tend to be relatively expensive compared to DeFi lending protocols.
Clients lending their crypto-assets to CeFi lending platforms do not have a clear view of counterparty transactions.
For example, Celsius users dealt directly with the platform and had no relationship with other asset managers and DeFi protocols interacting with Celsius. This lack of transparency poses a risk to clients who have 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 giving users much notice.
This has happened many times and highlights, once again, how risky it is to trust a centralized entity with your crypto-assets.
– Decentralization in crypto is a difficult ideal to measure
– CEL Token Soars as Celsius Shareholder Proposes Stimulus Plan, Celsius Pays Compound
— SEC’s Peirce Says Crypto’s Lack of ‘Bailout Mechanism’ a Strength; FTX CEO as “White Knight”
– BlockFi Obtains $250M Line of Credit from Bankman-Fried’s FTX
– Voyager Digital secures Alameda line of credit, may send Three Arrows notice of default