How Celsius, 3AC misjudged the risk and future of DeFi in interest rate swaps?

CryptoSlate spoke with Simon Jones, CEO of Voltz, an interest rate exchange DeFi protocol that aims to create “efficient capital” within DeFi. Jones has a deep understanding of market risk assessment and talks about the mistakes Three Arrows Capital and Celsius have made over the past few months. A potentially negligent approach to risk was highlighted by Nansen in a recent report that linked issues from Celsius and Three Arrows Capital to linked Ethereum on Terra Luna.

In the interview below, Jones offers his thoughts on why DeFi needs interest rate swaps to inject stability into a volatile market, how Celsius and 3AC misjudged risk, and what the risk is. can be learned from the ensuing market capitulation.

Voltz is described as offering access to the “synthetic and capital-efficient IRS market of DeFi” – what does this mean for the average investor?

At the most macro level, interest rate swaps allow us to create products that incorporate stability. So far, DeFi has been an incredible environment for those who want high-risk, volatile products. However, let’s say we really want DeFi to become the financial system for the whole world. In this case, we must be able to meet the financial needs of the whole world. The stability of certain products is therefore extremely important.

Interest rate swaps allow this by allowing you to switch from a variable rate to a fixed rate (or vice versa). This opens up a wide range of new products and business opportunities that can be created, with the ability to go from ‘risk’ to ‘risk’ very easily.

The key to the capital efficiency and synthetic nature of the pools is that the markets on the Voltz Protocol are appropriate derivatives; you can trade with leverage and you do not need to own the underlying asset to trade. These are important attributes when trading base points and looking to use them as a mechanism to build exciting new products.

Speaking of risk, how did Three Arrows Capital misjudge this systemic risk?

Systemic risk was particularly misjudged by lenders who provided capital to 3AC. These loans were often made against some form of collateral. However, as in 2008, this collateral was overstated, suggesting that the positions were collateralized when in fact they were under-collateralized.

At the same time, the liquidation of the guarantee occurred almost simultaneously. This meant that all that capital was flooding into the market and causing prices to fall even further, creating a downward spiral in asset prices and further contributing to the under-collateralized nature of lenders. This downward death spiral was a systemic risk that had not been properly accounted for by lenders, leaving a number of insolvents.

What similarities and differences do you see between this crash and the market crisis of 2008?

The 2008 crisis had a number of similar characteristics, in particular the system’s reliance on assets that were either overvalued or at massive risk of sharp price corrections. This led to systemic risk which caused a complete meltdown when asset values ​​fell.

However, unlike 2008, there are some differences. Most notably, the existence of DeFi, a system designed not to fail, rather than having a legal infrastructure in place to tell us what to do when the system fails. This means that much of the “crypto-financial sector” has continued to operate as normal, reducing some of the impacts of mismanaged CeFi players.

It bears repeating – CeFi is not DeFi. Many DeFi founders, like me, have entered the space to build a fairer, more transparent, and antifragile financial system. Seeing many repeats of 2008 with CeFi players further reinforces my view that antifragile permissionless financial protocols are the future.

What about Celcius? What did they do wrong and what can other companies learn?

Celsius appears to have taken highly leveraged positions with retail deposits to try and offer additional yield as a form of “competitive advantage” over other CeFi players. It may have worked during a bull market, but there was still a huge risk of making them insolvent if the value of the assets dropped significantly and investors tried to withdraw their money, as happened recently.

Not only does this poor risk management, but it also reeks of the opaque and sleazy world of TradFi, which is exactly what we are trying to change.

Contrast that with DeFi, a world where transparency and system integrity are at the heart of how the system works and where the rules of the system are deliberately made known to everyone, and that’s a stark contrast to how some of these CeFi actors acted .

What do you think about FTX’s SBF offering loans in exchange for shares in companies like Voyager? Do you think his actions are in the best interests of the industry?

FTX effectively acted like the Fed did during the 2008 crisis – bailing out insolvent lenders. However, unlike 2008, it’s nice to see the industry saving itself rather than taxpayers’ money being used to save poorly run businesses.

Do you see evidence of further contagion from the Terra/Anchor collapse?

Many people lost money with the collapse of Terra/Anchor, and it will sadly leave lasting scars. However, the fundamentals of DeFi have not changed – so there are plenty of reasons to be optimistic about the future. This is also the best possible time to build; So I’m excited to see what we can create as an industry, and I’m even more excited about what we will do for society by providing everyone around the world with equal access to a global, antifragile and transparent financial system.

A recent report by Nansen highlighted the Terra Luna contagion and how it affected companies such as Celsius and 3AC. Does the report match your thesis?

The Nansen report is consistent with the fact that many CeFi players had not correctly taken systemic risk into account. Whether it’s the collapse of Terra or more generally the risk of a sharp drop in asset prices across the industry, they all had assets on their balance sheets that weren’t actually equivalent. to the “cash value” they could achieve when everyone was trying to get out of those assets at the same time. Alternatively, they had failed to properly factor in a systemic risk, meaning many of them risked being insolvent in the event of a crash.

The contrast to DeFi is quite stark – where protocols are built with worst-case scenarios in mind to ensure they cannot fail. The fact that this happened to CeFi players only reinforces the fact that decentralized, permissionless protocols are the future of finance.

Connect with Simon Jones

About Ellie Cohn

Check Also

STRATEGIC EDUCATION, INC. : MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-Q)

The following discussion and analysis of our financial condition and results of operations is a …