The Problem With CeFi

You’ve always been skeptical of crypto, however in 2019 one of your close friends (a software engineer) convinced you to buy crypto and you decided to finally do it.? You continued to buy in 2020 and have seen your portfolio go from a few thousand dollars to six figures and you are hooked.? Now you believe this crypto thing is real.??

You begin to ask yourself, what else is possible in the ecosystem.

You see, a company called Celsius Network allows you to take the Bitcoin you’ve already seen massive returns on and allows you to get yield on top of the Bitcoin.? You do some research and ask around and everyone says the company is legit and you should put your funds in to get even higher returns.

A year and a half goes by and the returns are going well, and seem legit so you do not question it. You have six figures of crypto in the company's pools and are riding high.

Then in early 2022, crypto starts to go down and you start to have a little panic.? Bitcoin goes from over $60k to under $30k and you think… should I get my money out?? But you do not as the company says they are doing fine after Terra Luna goes under.

Prices keep going down further.

A few weeks later, you start hearing that Celsius is now in trouble so you want to take your funds out.? But there’s one problem…Celsius won’t let you!

You see that your funds are going down and there is nothing you can do about it.? But it wasn’t your fault, you weren’t the only one and this wasn’t the only company either.? Voyager and BlockFi users have also had the same issues.

So what happened?

To give users the yield that these centralized platforms offered for joining their pools, they gave high risk loans, made risky investments, staked in non liquid assets, and did not do much to prepare for downside.

These companies were using other people’s funds just to get rich and it worked when the market was going up.? But as the market went down, the whole thing fell apart.

The biggest downfalls of CeFi could have been by doing hundreds of millions in unsecured loans.? They used the funds that customers gave them to give companies such as Three Arrows Capital loans with no collateral.? Meaning that the loans had no backing if they were not paid back and were just relying on good faith.

These CeFi companies were not transparent in the use of customer funds even though many claimed to be.

So how can you spot one of these CeFi companies that aren’t taking the necessary risk management?

One major warning sign is that these companies offer high yields for simply putting coins or tokens into a pool.??

This is a similar tactic to Bernie Madoff where he gave investors 1% a month in returns (12% a year) but was just using new money to pay off yields without investing.? The difference is Madoff wasn’t doing any investing, but CeFi was.

CeFi was generating these returns through taking high risk investments.

Another warning sign is putting your money into a protocol that you don’t have custody of.? In DeFi, you own the assets yourself, but CeFi you are giving others the custodial rights to your assets.

One sign you have custodial rights is you own the keys to the wallet.? It isn’t just a username and password to access the funds.??

For CeFi to succeed in the future, they should be treated like they are.? Banks, and they should be regulated the same way with risk parameters and KYC laws.

Lesson 1: There is no such thing as free money and if it seems too good to be true… it probably is.

Lesson 2: Not Your Keys, Not Your Crypto. If you don't have the private keys to the assets, then you are entrusting a 3rd party who can do as they wish with your money.