What caused it, how to fix it

Liquidity problems arise when protocol owners do not plan for adverse periods, says Brian Pasfield, CTO of Fringe Finance.

The current market conditions are far from perfect for many crypto industry players, and lending platforms are no exception. In recent months, many have faced liquidity issues that put stress on users and the broader crypto space.

Let’s analyze how we have come to face these problems – and try to offer some solutions.

Liquidity problems: Turbulence in the market is increasing

Celsius made every imaginable business news when it stopped all withdrawals due to liquidity problems last month. After announcing that it would lay off a quarter of its employees due to “extreme market conditions”, Celsius filed for bankruptcy under Chapter 11 of the US Bankruptcy Code.

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

A third example of how recent market downturns continue to take a toll is Vauld, a Singaporean cryptocurrency exchange and lending platform. Vauld recently suspended operations, citing financial difficulties amid volatile market conditions. The collapse of Terra, Celsius Network’s financial problems and Three Arrows Capital’s default on its loans were the main reasons for this suspension.

Interestingly, it seems that the liquidity problems surrounding the crypto ecosystem can all be traced back to a precise point in time.

Does it seem simplistic to point to Terra for the ripple effects across the crypto markets? It is not. While a single event cannot be to blame for everything that happens in crypto, this shows the worrying fragility of our environment.

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

Attempts to restore liquidity

Crypto projects typically use two approaches to restore liquidity. Large debt repayments can help restore confidence in the platforms’ solidity and enable withdrawals again. An example of debt repayment is the recent $120 million payment by Celsius to multi-party vault Dai No. 25977. This avoids liquidation costs for vaults and reduces the likelihood of forced liquidation of funds.

On another note, DAO and DeFi projects are looking for ways to liquidate their treasury tokens without selling them. New-wave DeFi lending platforms offer solutions. First, Fringe Finance officially partnered with Lido Finance, another crypto lending organization that aims to solve the problems associated with the initial stake of ETH 2.0. Issues include illiquidity, immobility and availability. The goal is to make whitelisted altcoins more liquid and usable across the growing DeFi ecosystems.

Liquidity problems: The reason

Crypto lending firms were at the forefront of the 2020-2021 crypto rally. Today, however, they struggle with a number of 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 unlicensed and unregulated. Developers had ambitions to build platforms that would provide 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 pull out of crypto assets or go into HODLing strategies. In conclusion, if developers do not consider the circumstances of more adverse periods when designing their protocols, another crisis may very well be the end.

About the author

Brian Pasfield is the CTO of Fringe Finance. He has 10 years of expertise in blockchain, cryptocurrency, fintech and DeFi. He has delivered technically complex projects that have leveraged his engineering background and keen understanding of industry trends and philosophies. Brian has also worked with industry blockchain bodies to lobby for legislation and government policy changes.

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