The Risks of Centralisation

There aren’t many sectors of the economy that can rival crypto where memes, copypastas and mantras are concerned. After all, it is only natural for a community-centric, young and digital space, even if it is growing more and more entangled with the stuffy high finance world by the day. 

One of these mantras will have been resounding in a lot of crypto users’ heads this week, though with gloomy undertones. And unfortunately, it’s not the famously mispelled HODL, but rather the classic ‘not your keys, not your coins’ admonishment. 

The statement refers to a simple concept: storing one’s crypto in a hard wallet or any other wallet for which the private key can easily be accessed is the way to go. This is opposed to leaving one’s precious coins sitting in a third-party-owned wallet, like an exchange. The saying is ambivalent. On one hand, it is ethical – suggesting users stay true to the core ethos of cryptocurrency as defined by its early pioneers. An ethos focused on ‘unbanking’ and financial freedom through the escape from centralisation. On the other hand, it is very much a practical concern. It recommends users be careful in assigning custody of their hard-earned funds to third parties – in what is a wild and unregulated financial frontier. 

These concerns weren’t born out of paranoia, either. The first large-scale crypto crash was triggered by a badly run exchange called Mt.Gox, and other bear markets have been accompanied by similar controversies. Names like Bitfinex and Bitconnect, despite often being laughed off as meme-worthy disasters, were serious setbacks for the world of crypto. And they are seen as having seriously hampered its mission of gaining increased trustworthiness and recognition as a mature asset class. 

The Birth of Crypto Collateral 

It is no surprise, therefore, that one of the hubs of technical innovation and investment during the 2020-2021 bull run was the world of decentralised finance (DeFi). It shifted responsibility for custodian services, payment processing and staking rewards away from human hands into automated, predictable smart contracts. The idea was to reduce labour and enable anyone with a solid understanding of the tech to sleep easy at night. 

These decentralised innovations, however, remained in development and thus imperfect. They were also often technically clunky as any first-generation product can be. To this day, they remain an unapproachable investment solution for newbies, involving a steep learning curve. 

As the influx of new and inexperienced users reached peaks never seen before during the aforementioned period of heavy market growth, another trend was simultaneously changing the face of crypto forever: increased institutional involvement

These two factors, combined, created the perfect storm for a roaring explosion of crypto centralisation: the type of financial solution best known and exploited by traditional financial outfits and, at the same time, a familiar world for new adopters to explore. 

The most popular exchanges in the world, Binance and Coinbase, both began offering staking and custodian services aimed at luring users into never moving their newly purchased coins off the platforms to begin with. ‘Crypto banks’ popped up everywhere offering lending against token balances. American citizens were led to wish for something Satoshi would have seen as an oxymoron at best, if not an outright heresy: buying their crypto directly from their existing high street banks. Tokens of various kinds went as far as becoming official currency in a few South American and African countries between 2021 and 2022, despite volatility-induced concerns over political stability. This was seen as representing the proverbial apex of centralised blockchain. 

(Not) Too Big To Fail 

There was one thing many new investors coming into the market in the midst of turbulent and distracting positive market sentiment overlooked. There was a key difference between your average Wall Street lender and solutions such as the popular ‘unbanked’ platforms Celsius Network or BlockFi: a massive stack of regulations. 

In fact, many borrowers sought such services precisely because of the lack of red tape and the ease of approval compared to lending in a world of credit ratings and background checks. 

It did sound too good to be true. And unfortunately for many users and creditors of these platforms, the evidence pouring in over the past couple of weeks seems to all point toward one outcome. It was indeed mostly an unsustainable run. 

The crypto world was hardly having a grand time anyway when the unravelling began to take place. Macroeconomic factors had induced one of the biggest market-wide price collapses ever recorded in the sector’s relatively short history.

Just over a week ago, BTC was still at the top of what would turn out to be a steep descent from around the $30k mark down to levels reminiscent of the 2017 ATH, around $20k. What helped the price past a figurative cliff edge would affect an astounding 1.7 million users: Celsius announced it was locking most of the $12 billion in assets it controlled through an indefinite withdrawal and transaction suspension. 

Financial analysis using phone app and laptop.

The move sent a shockwave through the industry, turning Alex Mashinsky’s name into the new Do Kwon overnight. The move was forced by a combination of bad funding deals, risky investments turned south and volatility. The final blow had been a sizable bank run triggered by the initial rumours of solvency issues at the lending firm. 

The funds of all Celsius users remain locked and possibly lost forever a week after the event, while the company adamantly is working at full speed behind the scenes on a way out of the mess it has worked itself into. It didn’t stop here, though. The crisis widened significantly in the following week to engulf many other providers of similar services.

Babel Finance suspended withdrawals for similar reasons this Friday. Hedge fund Three Arrows Capital is teetering closer and closer to a full-scale collapse and was liquidated by BlockFi. Even the Solana lending platform Solent seems to be at serious risk of default. 

Many have compared the Celsius situation to crypto’s Lehman Brothers, the US bank whose collapse in 2008 is now seen as the red herring of the total financial meltdown that kickstarted the last recession. 

There is little to compare though. Not only the savings and investments made by customers of crypto lenders are unprotected by the regulatory defences put into place in the wake of the 2008 disaster, but the banks themselves also aren’t. There is no government bail-out or taxpayer help on the horizon for the likes of Celsius or Babel. Both the company employees and their clients are left to deal with the mess and potential grief. 

A Consolidated Industry Looms 

a silver bitcoin on top of american bills

No one really has an answer for this, as we’re treading very uncharted waters. Not only has crypto only ever existed in periods of economic upturn and relatively heavy growth, but it has also never needed or sought regulation as protection from its own very lawless nature.

As the investors that helped build the current model of crypto lending have smelled the fire and jumped ship, refusing to intervene to save any souls left at sea, they can’t be counted on anymore. 

The alternatives are complex and in many ways would represent a seismic shift for the sector. Some are forecasting an era of crypto acquisitions based on a desire for conglomeration and market dominance as well as a fear of snowballing negativity. Others are vocally asking for creative financial solutions to allow the ailing lending giants to get out of this mess without concentrating control of the market. 

The next few weeks are impossible to predict, but one thing is certain: the economy, and by extension, the crypto market, isn’t about to suddenly bounce back to health at once. If the crypto community wants to see this challenge to its trustworthiness won, there will be a lot of work to do and sacrifices to be made. Be they financial or ideological. 

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