What caused it, how to fix it

Liquidity issues arise when protocol owners don’t forecast bad times, says Brian Pasfield, CTO of Fringe Finance.

Current market conditions are far from perfect for many in the crypto industry, and lending platforms are no exception. Over the past few months, many have faced liquidity issues that have put a strain on their users and the broader crypto space.

Let’s analyze how we came to deal with these problems – and try to suggest solutions.

Liquidity issues: Rise in market turmoil

Celsius created every trade media imaginable when it suspended all withdrawals due to liquidity concerns last month. After announcing it would lay off a quarter of its employees due to “extreme market conditions”, Celsius filed for Chapter 11 bankruptcy.

Similarly, two weeks ago (an eternity in crypto land), crypto platform Voyager Digital announced a suspension of cryptocurrency trading and withdrawals for its users. As noted by representatives of the company, the reason for this is the unpaid payment of a loan from the crypto hedge fund Three Arrows Capital (3AC). Voyager Digital is also subject to bankruptcy proceedings.

A third example of how recent market declines continue to wreak havoc is Vauld, a Singaporean cryptocurrency exchange and lending platform. Vauld recently suspended operations, citing financial difficulties in volatile market conditions. The collapse of Terra, the financial difficulties of Celsius Network and the default of Three Arrows Capital on its loans were the main reasons given for this suspension.

Interestingly, it seems that the liquidity issues surrounding the crypto ecosystem can all be traced back to a specific time.

Does it seem simplistic to single out Terra for ripple effects in crypto markets? It’s not. While a single event cannot be responsible for everything that happens in crypto, it does show the worrying fragility of our environment.

And once one domino falls, the others follow, revealing who chose to rely on notions of “too big to fail.”

Attempts to restore liquidity

Crypto projects typically use two approaches to restore liquidity. Large debt repayments can help restore confidence in the creditworthiness of platforms and allow withdrawals again. An example of debt repayment is the recent payment of $120 million Celsius to Dai Multiparty Vault No. 25977. This avoids vault liquidation costs and reduces the likelihood of forced liquidation of funds.

On a different note, DAO and DeFi projects are looking for ways to make their cash tokens liquid without selling them. New wave DeFi lending platforms are offering solutions. For one, Fringe Finance has officially partnered with Lido Finance, another crypto lending organization that aims to address issues associated with initial ETH 2.0 staking. Problems include illiquidity, immobility and accessibility. The goal is to make whitelisted altcoins more liquid and usable in growing DeFi ecosystems.

Liquidity problems: the root cause

Crypto credit companies were at the forefront of the 2020-2021 crypto rally. Today, however, they are grappling with many critical issues regarding tokenomics, algorithms, and liquidity.

These problems stem from the fact that we now have access to more complex financial tools than ever before. At the same time, these are permissionless and unregulated. The developers had the ambition to create platforms that would yield as much financial gain as possible.

The crucial problem is that most platforms are designed with the assumption of perpetual growth. As soon as growth stops, the bubble will burst. The more massive the platform becomes, the more destruction the explosion can cause to the wider crypto ecosystem, creating a domino effect.

As this effect spreads and the market bleeds, liquidity escapes as people exit cryptoassets or adopt HODLing strategies. In conclusion, if manufacturers do not consider the circumstances of worse times when designing their protocols, another crisis could very well become their end.

About the Author

Brian Pasfield is the Technical Director of Marginal funding. He has 10 years of expertise in blockchain, cryptocurrency, fintech and DeFi. He has completed technically complex projects that leveraged his engineering background and deep understanding of industry trends and philosophies. Brian has also worked with industry blockchain bodies to lobby for changes in legislation and government policies.

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