DeFi is still bullshit


So. More than a year ago I wrote that decentralized finance was bullshit. At the time I was thinking of companies like Celsius, since they were obviously, transparently, bullshit. Celsius was one of the biggest "yield farming" crypto loan platforms, offering something ridiculous like 20% yield per year on various cryptocurrencies. I've warned friends away from them because of how obvious the scam was, and how it was just too good to be true.

This week Celsius filed for bankruptcy. This is weeks after they "paused" customer withdrawals. Celsius and everyone like Celsius is insolvent because it turns out - no, you cannot pay 20% yield indefinitely on cryptocurrencies, because nobody wants to borrow at those rates. There is no counterparty. The yield farms have just been paying out earnings and withdrawals with other people's deposits in a classic Ponzi scheme.

There are seemingly hundreds of copycats like Celsius. They're all bullshit, and all freezing withdrawals as they run out of money. I'm not saying "some of them are bullshit" or "most of them are bullshit." Literally all of them, without exception, are bullshit. And like all Ponzi schemes, the perpetrators often convince themselves that "maybe it's a Ponzi today, but any day now we'll come up with a way to make it legit." This actually made it worse, because the scammers themselves often fell for other scams that looked on paper like the math would pencil out. So it was easy to fool people! The perps fooled themselves! They believed what they were saying! But its not possible even in theory for the math to pencil out, because crypto doesn't have any productive uses.

It is not possible to pay a risk-free 20% yield on a useless unproductive asset. This is like, an iron law of finance. By definition, there's just no way to turn 1 bitcoin into 1.2 bitcoins (faster than the risk-free rate) without taking on some level of risk. And like John Oliver said, "crypto combines everything you don't know about money with everything you don't know about computers."

So what did these platforms actually do with their assets, aside from paying out earlier investors? Mostly they ended up (directly or indirectly) lending to 3 Arrows Capital, a "cryptocurrency hedge fund," which apparently took out massive high-yield unsecured loans in cash and cryptocurrency[1] and then…lost it all. But of course they did! Again, there was never any way (even in theory) for 3AC to (for example) borrow crypto at like 25% annual interest and get risk-adjusted returns that actually exceed that interest rate. Cryptocurrencies are not a productive asset.

So 3AC apparently did the only thing they could, which is: load up on risky trades and hope for the best. If the bet works out, great, they can repay the loan + interest and keep some of the profit, and everyone makes money. But if it doesn't...oh well, they're insolvent but its their creditors that are screwed. Heads I win, tails you lose! Like, this is the dumbest business model ever, and I imagine these lending platforms were like "wow that sounds like a terrible deal, but I'm desperate so...YOLO." Or maybe they are all morons and they were like "Sounds great - I don't see any problems with that - what's your wallet address?"

I honestly don't know which is more likely.

Anyways, since 3AC is insolvent and cannot repay these loans, their lenders, like Celsius, also discovered they are insolvent and cannot repay their "depositors." I use the term "depositor" lightly here, because they don't work like bank deposits: they're more like unsecured non-recourse loans, because there are no rules around what can be done with them. Your bank can't take the contents of your checking account and (directly or indirectly) bet it all on black down at the casino; your cryptocurrency yield farm can. And did! And now it's not even clear where in the priority stack these "deposits" line up in bankruptcy proceedings - you might think that (like in traditional finance) equity and other unsecured lenders would get wiped out first before depositors. But maybe something else unexpected will happen. How exciting!

It's important to emphasize this is not "the bad part of town" or some weird corner of the cryptocurrency economy. Yield farming and speculative trading (NFT wash trades, pump-and-dumps, "HODL to the moon!", etc.) encompasses like 99% of all activity in the cryptocurrency/blockchain ecosystem. Some people pretend that crypto is about more than that, but they are either lying or misinformed.

Again, this is all very sad. Lots of lots of people who have no business in this industry (and have no idea how crypto/blockchain/finance works) got suckered in and will lose their life savings and such over this. This is not a "crypto winter." It was never summer. It was always a bunch of clowns trying to get rich telling Joe Plumber that he would get rich if he bought $SHITCOIN and deposited it in a yield farm that would - through the magic of blockchain! - somehow defy the rules of math and grow 20% a year risk-free. And shouting NOT YOUR KEYS NOT YOUR COINS is useless - rounding to the nearest whole decimal, 0.0% of the general population wants to "self-custody" because - and I must emphasize this, cryptocurrencies are not a useful, productive asset. The pain-in-the-ass to benefit ratio is too high for most people.

We've literally made no progress on a useful application for blockchain technology since "digital money." Now we're just painfully rediscovering and reimplementing the complete history of financial regulation, deposit insurance, underwriting, etc., all over again. BUT IN CRYPTO. Yawn. Next.

[1] Here's something I don't understand: 3AC often took large cash loans to, I suppose, speculate on cryptocurrency and make money trading it somehow. Presumably this is mostly a bunch of long bets, because they got wiped out when prices cratered. But why did they borrow cryptocurrencies? Usually you'd only do that if you wanted to sell them short, betting on a price decline. But we know 3AC didn't (on net) sell crypto short, because they got wiped out on the massive price declines. My speculation: they borrowed the cryptocurrency (unsecured) so they could go and use it as collateral with another lender to borrow cash. After all, there was likely LOTS of crypto chasing "yield" and converting this demand into cash at absurd, stupid high levels of risk is just the thing these guys at 3AC would do, because...moral hazard? Also, this smells a lot like the inverse of what these yield farms did to leverage up and attempt to juice their returns: rehypothecation of collateral to borrow more assets, and then loaning out those assets to make money. Effectively, you can make money on both ends by charging interest on a loan you make, then charging interest again on the collateral that the first borrower put up (as a loan to another borrower). This works great! Unless prices decline slightly, in which case a chain of margin calls happen and the entire web of players simultaneously find themselves insolvent.