The recent downturn in the crypto landscape in general has exposed several flaws inherent in proof-of-stake (PoS) networks and Web3 protocols. Mechanisms such as link/unlink and lock-in periods have been architecturally built into many PoS networks and liquidity pools with the intention of mitigating outright bank leakage and promoting decentralization. However, the inability to quickly withdraw funds has become a reason many are losing money, including some of the most prominent crypto firms.
At their most fundamental level, PoS networks like Polkadot, Solana, and the unfortunate Terra rely on validators that verify transactions while securing the blockchain by keeping it decentralized. Similarly, multi-protocol liquidity providers offer liquidity over the network and improve the speed of each respective cryptocurrency, i.e. the speed at which tokens are traded through the crypto lane.
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In its forthcoming report “Web3: The Next Form of the Internet,” Cointelegraph Research discusses the issues facing decentralized finance (DeFi) in light of the current economic backdrop and assesses how the market will develop.
The instability of stablecoins
The collapse of Terra raised many questions about the sustainability of crypto lending protocols and, above all, the security of assets deposited by users of the platforms.. In particular, the Anchor crypto lending protocol, the centerpiece of the Terra ecosystem, struggled to manage the depreciation of TerraUSD (UST), Terra’s algorithmic stablecoin. This caused users to lose billions of dollars. Before the divestiture, the Anchor protocol had more than $17 billion in total value locked. As of June 28, it stands at just under USD 1.8 million.
Assets deposited in Anchor have a three-week lock-up period. As a result, many users were unable to exit their positions in LUNA -which has since been renamed Luna Classic (LUNC)- and UST at higher prices to mitigate their losses during the decline. When the Anchor Protocol collapsed, his team decided to burn the locked deposits, driving the Terra ecosystem’s liquidity outflow to $30 billion, subsequently causing a 36% decline in Ethereum’s total TVL.
While multiple factors have led to Terra’s collapse – including UST withdrawals and volatile market conditions – it is clear that the inability to quickly withdraw funds from the platform represents a significant risk and barrier to entry for some. users.
Drop to Celsius
The current bear market has already shown that even the carefully considered, curated investment decisions made by the major market players are becoming something of a gamble due to lockdown periods.
Unfortunately, even the most thoughtful and calculated investments are not immune to shocks. The stETH token is minted by Lido when Ether (ETH) is staked on its platform and allows users to access a 1:1 Ether-backed token that they can continue to use in DeFi while their ETH is staked.. The Celsius lending protocol put up 409,000 stETH as collateral in Aave, another lending protocol, to borrow $303.84 million worth of stablecoins.
Nevertheless, as stETH de-pegged from Ether and the price of ETH fell amid the market crash, the value of the collateral began to fall as well, raising suspicions that Celsius stETH has been liquidated and that the company is facing bankruptcy.
Since there are 481,000 stETH available on Curve, the second largest DeFi lending protocol, liquidation of this position would subsequently cause extreme token price volatility and further depreciation of stETH. Therefore, lending protocol lock-up periods not only act as an additional risk factor for an individual investor, but can sometimes trigger an unpredictable chain of events that affect the DeFi market as a whole.
3AC in trouble
Three Arrows Capital is also at risk, as the ETH price drop has reportedly led to the liquidation of 212,000 ETH used as collateral for its $183 million stablecoin debt and put the venture fund on the verge of bankruptcy.
Additionally, the inability of lending protocols to deny settlements recently pushed Solend, the most prominent lending protocol on Solana, to step in and propose taking over a whale’s wallet “so that the settlement can be executed OTC and avoid push Solana to her limits.” Specific, the liquidation of the $21 million position could cause cascading liquidations if the price of SOL were to drop too low. The initial vote was fueled by another whale wallet, which contributed 95.1% of the total votes. Although a second vote overturned this decision, the fact that the developers went against the basic principles of decentralization, and revealed its lack, alarmed many in the cryptocurrency community.
Ultimately, the lack of flexibility with linking/unlinking and locked-in liquidity farming pools may deter future contributors from joining Web3 unless they have a strong understanding of DeFi design and associated risk. This is compounded by the collapse of “too big to fail” protocols like Terra and the uncertainty surrounding hybrid venture capital/hedge fund firms like Three Arrows Capital. It may be time to evaluate some workarounds to lock-in periods to enable sustainable returns and true mass adoption.
This article is for informational purposes only and does not represent investment advice, investment analysis, or an invitation to buy or sell financial instruments. Specifically, the document is not a substitute for individual investment or other advice.
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