The cryptocurrency tide is ebbing, and it looks more and more like Digital Currency Group (DCG) has run out of money. But let’s be clear: the current cryptocurrency contagion is not a failure of crypto as a technology or long-term investment. The DCG problem is a failure of regulators and gatekeepers.
Since its inception in 2013, DCG’s Grayscale Bitcoin Trust (GBTC), the world’s largest Bitcoin (BTC) trust, has offered investors the ability to earn a high interest rate — above 8% — simply by buying cryptocurrencies and lending or depositing them in DCG.
In many ways, The company provided an important service to the cryptocurrency industry: making cryptocurrency investing understandable and lucrative for beginners and retail investors. And during the cryptocurrency market bull run, all seemed to be going well, with users receiving market-leading interest payments.
But when the market cycle changed, the problem at the other end of the investment funnel—the way DCG leveraged user deposits—became more apparent. While not all questions have been answered, the general idea is that DCG entities lent user deposits to third parties, such as Three Arrows Capital and FTX, and accept unregistered cryptocurrencies as collateral.
The dominoes fell rapidly thereafter. The third parties disappeared. The cryptocurrencies used as collateral became illiquid. And DCG was forced to make capital calls of more than $1 billion—the same value of FTX’s FTT token that DCG accepted to back the FTX loan.
DCG is now seeking a line of credit to cover its debts, with the prospect of Chapter 11 bankruptcy if unsuccessful. Apparently, The venture capital firm fell prey to one of the oldest obstacles to investing: leverage. It basically acted like a hedge fund without appearing to, lending capital to companies without doing due diligence and accepting “hot” cryptocurrencies as collateral.. Users have been left with an empty bag.
In the non-crypto world, regulations are put in place to avoid this very problem. While not perfect, the regulations require entire portfolios of financial documents, legal disclosures, and disclosures to make investments—from stock purchases and initial public offerings to crowdfunding. Some investments are so technical or risky that regulators have restricted them to registered investors.
Um what did I miss? Didn’t we just say it was dimly $500m days ago? https://t.co/14FkXfiiyy
—Adam Cochran (adamscochran.eth) (@adamscochran) November 25, 2022
What did I miss? Didn’t we just say it was just $500 million days ago?
But not in cryptocurrencies. Companies like Celsius and FTX maintained basically zero accounting standards, using spreadsheets and WhatsApp to (mis)manage their corporate finances and mislead investors. Citing “security issues”, Grayscale has even refused to open his books.
Cryptocurrency leaders issuing “all is well” or “trust us” tweets are not an accountability system. Cryptocurrencies need to mature.
First, if custodial services want to accept deposits, pay an interest rate, and make loans, they are acting like banks. Regulators should regulate these companies like banks, including issuing licences, setting capital requirements, requiring public financial audits, and everything else that other financial institutions are required to do.
Second, VC firms need to perform due diligence on companies and cryptocurrencies. Institutions and retail investors—and even journalists—alike look to venture capital firms as watchdogs. They see the flow of investment as a sign of legitimacy. Venture capital firms have too much money and influence not to identify basic scams, con artists, and Ponzi schemes.
Luckily, cryptocurrencies were created to eliminate these very problems. Individuals did not trust Wall Street banks or the government to do the right thing for them. Investors wanted control of their own finances. They wanted to cut out expensive middlemen. They wanted direct, cheap, peer-to-peer loans and credits.
Therefore, for the future of cryptocurrencies, users should invest in DeFi products instead of centralized funds managed by others. These products give users control whereby they are able to keep their funds local. This not only eliminates bank panics, but also limits the threats of contagion in the sector.
The chain of blocks or blockchain is an open, transparent and immutable technology. Instead of trusting talking heads, investors can see for themselves how liquid a company is, what assets it holds, and how they are allocated.
DeFi also removes human intermediaries from the system. What’s more, if entities want to overleverage, they can only do so under the strict rules of an automated smart contract. When a loan comes due, the contract automatically liquidates the user and prevents one entity from wiping out an entire industry.
Critics of cryptocurrencies will say that the possible implosion of DCG is another failure of an unsustainable industry. But they ignore the fact that the problems of the traditional financial sector — from poor due diligence to overly leveraged investments — are the root causes of the challenges facing the crypto sector today, not crypto itself.
Some may also complain that DeFi is ultimately uncontrollable. But its open and transparent design is precisely why it’s flexible enough to shake up the entire financial industry for the better.
The tide may be ebbing, at least for now. But smart investments in decentralized finance today will mean we’ll be able to dive back in when the next torrent hits, and this time, in a bathing suit.
Giorgi Khazaradze He is the CEO and Co-Founder of Aurox, a leading DeFi software development company. He attended Texas Tech to earn a degree in computer science.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
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