Disclaimer: Opinions expressed below belong solely to the author.
Bitcoin was created to address the weaknesses of a trust-based financial system. It would allow people to store and spend their money without handing it over to a bank or financial institution. This way, their funds couldn’t be lent out, or worse, used for risky trades without their knowledge.
Holding Bitcoin was meant to be as good as keeping cash in your wallet — even safer, actually. Other cryptocurrencies followed suit, and eventually, the concept of decentralised finance (DeFi) was coined. With this, you could not only conduct transactions without the need of a bank, but partake in other financial services too. Lending, borrowing, margin trading — it all became accessible through DeFi.
Since these functions worked using smart contracts, they left no room for human error. Loans were over-collaterised and liquidations happened exactly when they were meant to. In fact, DeFi protocols have, by and large, remained unaffected by the market crash.
As the CEO of Compound Finance — one of the biggest DeFi protocols — tells Axiom, “They’re radically transparent, you can see exactly what’s happening. But more importantly than that, they operate based on open source code that can’t change its mind on a whim.”
History repeats itself
Investing in crypto isn’t synonymous with participating in DeFi — not when the crypto is held and managed by a third party. As companies including Celsius, Vauld, and most recently, Hodlnaut freeze withdrawals, it seems crypto has fallen victim to the problems it set out to solve.
Hodlnaut has come under fire for misrepresenting its risk profile. When the UST stablecoin lost its peg, the company’s CEO denied that they had incurred any losses as a result. These claims came into question as users scanned through Hodlnaut’s blockchain transactions, which seemed to suggest otherwise.
Regardless of who’s telling the truth, what’s apparent is that companies such as Hodlnaut have the ability to lie. They can misrepresent positions, fail to convey risks, and mismanage funds.
All of these firms were operating, essentially, as proprietary hedge funds using customer money, and the reason this was able to occur was because these businesses were opaque. Nobody had any visibility.
– Robert Leshner, Compound Finance CEO, in an interview with Axiom
Anyone using the platform — whether they knew it or not — had placed their trust in Hodlnaut to make good on their promises. Promises of 14 per cent returns on a US-dollar-pegged stablecoin at a time when banks weren’t even giving out three pe rcent. Where would that money have come from?
In hindsight, it seems apparent — much like the 2008 Financial Crisis — that this was all too good to be true.
DeFi doesn’t lie
DeFi protocols are accessible to everyone. If you make use of them directly — with crypto stored in your own wallet — the main risk is potential weaknesses in the smart contract. In case someone finds an exploit, your crypto would be at risk.
Instead, say you invest with a company like Celsius or Hodlnaut, the smart contract risk remains just as valid. These companies use the same DeFi protocols which you could access directly. On the plus side, you don’t need to learn how to navigate the protocols or find the best possible interest rates. However, this also means that you have no idea how your crypto is being used.
While there’s an absence of regulations — and these makeshift crypto hedge funds are free to operate behind the curtains — the only way to be certain of your risk is to manage your crypto yourself.
There are DeFi platforms which offer 2x leverage, 50x leverage, and everything in between. The collateral requirements are clearly laid out, as are the terms of liquidation. These are part of the smart contract and can’t be manipulated, even by the creators of the protocol.
Trust and transparency
DeFi doesn’t require trust, and a look at Hodlnaut’s Telegram group explains how valuable that is.
As it stands, the company plans to make its next announcement — regarding next steps and recovery — on August 19. This has left open a wide window for speculation among community members.
Some claim the team has gone AWOL, since their social media accounts can no longer be found. Others have voiced out that staff members were given advance notice to withdraw their funds from Hodlnaut, prior to the freeze.
Most notably, there’s uncertainty surrounding the return of deposits. The Telegram group admins have reiterated that any further details remain “private and confidential” at this point of time.
In comparison, DeFi offers the gift of certainty. Once a smart contract has been deployed, there’s no more room for human input. Anyone can track the position and movement of all the funds being managed by a protocol.
Withdrawals can’t be frozen out of the blue. Users can still lose their funds — that’s the nature of investing — but at the very least, they’ll know where they ended up.