Crypto lending and the current liquidity crisis

Despite the high level of fear and panic in the current state of the crypto market, it is very common to go through a fall; especially after a bull run. Given the epic bull run that we witnessed last year, the tumble in prices should come with no surprise. After all, as with any market, crypto evolves in cycles.

What is lending? How does it work? What are the differences between lending firms and Decentralized Finance (DeFi)? These are all questions that we will answer in today’s article. Are you ready? Let’s get started!

What is crypto lending?

One of the hottest trends during the last bull run in the crypto community is undoubtedly lending services. More and more platforms that allow users to borrow, lend, and earn interest in return with their cryptocurrency have emerged.

As we have learned the hard way since the bear market started, the extravagant interest rates offered by these lending platforms come with a lot of risks as well. In some cases, this can lead to the total loss of funds.

Why are the crypto lending firms in trouble?

As with traditional finance, when an investment or loan is not repaid, there are financial consequences for the issuing company. We remember the Lehman Brothers case that led to a global financial crisis in 2008.

For the case of lending companies, Celsius for example, the principle is the same. Celsius has indeed invested a lot of funds in stETH, which is supposed to be worth 1 ETH under any circumstances. However, during the crash, the value of stETH changed and started trading at a discount, making it much less liquid.

Celsius was left with a worthless investment that could not be disposed of. This led to a suspension of withdrawals, which deteriorates an already shaky confidence situation in this bear market.

Another cause is undoubtedly the high leverage used by some firms, borrowing from other firms to finance their own investment. If the latter fails to repay, this causes a cascading effect on the whole DeFi ecosystem and harms its development.

Why is DeFi important?

The idea of decentralization and transparency, which is often lacking in the classical financial system, is at the heart of the DeFi spirit. The absence of third parties allows lower costs but as we have seen, the current ecosystem still suffers from flaws linked to its infancy stage.

As we mentioned in a previous article dedicated to DeFi 2.0, for the DeFi ecosystem to grow and become mainstream, it will need to innovate in terms of security and transparency.

Conclusion

We will evolve and grow from this liquidity crisis and the bear market as a whole and learn from it. The next version of the DeFi ecosystem will have to be more secure.

From the investors’ point of view, the key takeaway from the current market chaos is risk diversification and management. The adage “Don’t put all your eggs in one basket” holds true. When the market is good, it is easy to get distracted and take higher bets. Leveraging, no matter if you are an experienced or elementary investor or trader, carries a high level of risk and should always be ventured with extreme caution.

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