ChainLinkGod Podcast - Crypto Contagion 2022: Run It Back Turbo
Primer: This year, we have seen the collapse of multiple entities in the crypto market. What were the causes? What are some of the possible solutions to the problem? ChainLinkGod and Crypto Oracle demystifies these topics in this episode of the ChainLinkGod podcast.
The Collapse In The Crypto Markets
💡 Context: This year, we have seen the collapse of LUNA, 3AC, Celsius, and FTX.
Lots of people got rekt
This was contagion from the LUNA collapse
CeFi institutions did no due diligence and used massive leverage
Things unfolded on Twitter:
Digging through on-chain addresses
Hearing firsthand accounts from FTX employees
Is The FTX Situation Larger Than Mt. Gox?
Crypto Oracle was not around during the time of Mt. Gox
The FTX situation has a larger impact as more people were affected
Great ammo for regulators to put controls on the crypto industry
Except LUNA, all the major collapses has been CeFi institutions
Unfortunate that people commingle CeFi and DeFi together
CeFi Taking Massive Risks
CeFi institutions are largely unregulated:
Operate overseas
Taking massive risks
CeFi was competing for unsustainable yields in DeFi
DeFi was able to print money out of thin air for people to farm. This boosted the yield to ponzi levels
For CeFi, the more capital you have, the harder it is to generate a yield. They progressively took on more risk
The quality of collateral went down, from Bitcoin and Ethereum to self-issued tokens (CEL & FTT), and finally to entirely uncollateralized loans
The US needs to have some form of regulatory clarity for projects and institutions to step into Web3
Crypto Markets Taking Off
Crypto Oracle does not see crypto markets taking off until large institutions come in
The idea that crypto is some alternative sub-underground economy is limited
Might have to sacrifice some trust minimization to get institutional adoption
Moving forward, the industry will focus on providing proof of things
Unlike TradFi, crypto allows people to look on-chain. This helps in determining the institution’s risk profile
Comparing Exchanges To Banks
People are confused because they compare exchanges to banks
If you are looking purely at the Exchange portion, a bank run should not be possible as deposits are one-to-one
In contrast, banks do lending and borrowing (though some exchanges do it too)
It’s not clear where the yield for lending products on CeFi comes from
On-chain analysis shows CeFi farming yield in DeFi
Could CeFi Make Their Yield Sources Transparent?
Should at least know the methods
They do not necessarily have to disclose the term agreements of each position
There’s a trade-off spectrum:
More opacity about the strategies: less risk of a bank run
Provide more assurances and transparency: more risk of a bank run, lose alpha
There’s a middle ground area where you can use a ZK rollup
Over time, the spectrum of CeFi and DeFi will become more blurry
What is tricky is that a lot of people use CEXes as an off-ramp
Future Of DEXes
Crypto Oracle thinks that order books are going to be the future of DEXes
Order book exchanges are being looked at on Layer 2s
dYdX has 100 validators. Users have to trust these validators
Most people Crypto Oracle knows custody their own assets even though they do not want the responsibility to do so
Don’t think crypto will become mainstream until there’s a better UX and secure key recovery methods
Speed Running Finance
An analogy used by ChainLinkGod
In the late 1800s/early 1900s, there were liquidity crunches, bank runs, and ponzi schemes
The same thing is happening in crypto, except that it’s a 100 times faster
Will eventually catch up to TradFi and exceed them
“I was surprised that J.P. Morgan was saying that the CeFi institutions, not the DeFi protocols that actually caused this particular mess. I was very shocked that they actually said that.”
- Crypto Oracle
Moving From Speculation To Value
Have to move beyond speculation and start building products and use cases
Some protocols are shifting towards real world asset
Due to the lack of interoperability between the on-chain/off-chain world and between blockchains, there are lots of wrapped tokens within DeFi
Any cross-chain token is some bridge/entity holding custody and minting a representation of an asset
“People escaped to DeFi for trust minimization, but then they end up just interacting with assets issued by the same parties that they were trying to get away from in the first place.”
- ChainLinkGod
If a wrapped token is insolvent or unredeemable, its value goes straight to zero
As usage of wrapped tokens increases, this introduces more risk to the ecosystem
Proof of Reserves would become increasingly important
Gets tricky when you apply Proof of Reserves to exchanges that are off-chain:
They have off-chain liabilities that are not represented as tokens
They can rehypothecate collateral
They can borrow funds just before snapshots are taken
Vitalik’s Post
Vitalik described a Merkle tree being able to collect user account balances into a cryptographic tree structure where a user can verify their balance is included without seeing anyone else’s balance
If enough people check the tree, people can be assured that the liabilities are accounted for
The tricky thing is that:
You can ignore some liabilities/account addresses
Does not take into account other types of liabilities (e.g. lending assets out to others)
This is not a foolproof method and they can still be manipulated
Different types of implementation of Proof of Reserves:
Chainlink Proof of Reserves is focused on DeFi wrapped tokens
Merkle tree designs are focused on CEXes
Proof Of Reserves
This topic is on people’s minds right now
There’s risk of implementing a solution and then a new solution comes out
There’s a cost associated to implementation
Conclusion
If the space does not evolve, it will just slowly bleed
Don’t think we are going down that path
Need the market to move from speculation to utility
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