Dr. Karl-Michael Henneking, Chief Marketing Officer at Spool
Just last month, we learned right after Celsius Network founder Alex Mashinsky was pushed out of his CEO position that he withdrew $10 million from the platform mere weeks before it froze withdrawals. Disclosed court documents from the company’s bankruptcy proceedings publicly revealed information about Celsius users, which some have feared could lead to their doxxing.
To industry outsiders, every bit of news about this debacle further drives the nail in the coffin of crypto. That’s a huge problem, considering there are massive differences between the industry’s sub-sectors. Even though Celsius originally branded itself as “decentralized,” it’s now generally agreed upon that the company represents a centralized finance (CeFi) model, as compared with the growing industry of decentralized finance (DeFi) platforms that offer actual decentralization and self-custody of assets.
If the Celsius crash has anything to teach entrepreneurs and creators building decentralized infrastructure, a key lesson would be to make the distinctions between the two clear as day.
The wider DeFi community notes often and loudly that if Celsius were a DeFi platform, then a default wouldn’t have happened. Of course, they are right. Nevertheless, everyone should take notes when an industry trailblazer crashes and burns. Before DeFi can provide a truly viable roadmap for crypto projects to follow, it has unique challenges to address first.
The Celsius post-mortem
The first lesson everyone in crypto can learn from the bankruptcy of Celsius, Three Arrows Capital (3AC), and others is clear. While crypto can fundamentally transform the way people invest and grow their money, it’s not immune to the basic laws of gravity.
The dangers of overleveraging and failure to assess risk—considered basic in the traditional finance world—are just as essential in crypto. High yields go hand-in-hand with high risk in any financial investment.
So what can DeFi platforms offer to those burned by CeFi frameworks? Unlike CeFi platforms that take custody over investors’ assets, DeFi avoids these risks by nature as it’s non-custodial, meaning a client’s funds remain with them at all times. So in any extreme case, a client’s assets and withdrawals cannot be frozen or unreachable.
As such, there are certain aspects of traditional finance that don’t apply to DeFi the way they do to CeFi. But DeFi platforms should get a head start in identifying the “rules of gravity” that do apply to them, rather than wait to discover them the hard way.
DeFi’s limitations and advantages
Just because DeFi platforms themselves don’t face a risk of default doesn’t mean the people who invest in them don’t take on risks that can outweigh those offered by traditional financial institutions—just as the potential for rewards far surpasses most other assets.
In that sense, DeFi platforms have a duty to foster clarity and ease of use on their platforms. Acknowledging the risky nature of digital-assets investing can manifest itself in fostering financial literacy among their communities, but it must also include developing a UX that clearly and accurately communicates with users what they’re buying, trading, or staking, as well as the associated risk.
Of course, conveying to users an investment’s rewards potential too. High APYs are great and one of the key factors attracting people to DeFi, and there’s nothing wrong with offering them as long as the terms are clear.
Where DeFi can stumble in attracting adoption beyond the niches of crypto stems from the sheer complexity of many decentralized platforms. Delving into any type of investment, crypto or otherwise, requires some form of financial literacy and understanding on behalf of the individual. Many DeFi platforms require three streams of expertise for both individual and institutional investors to utilize them properly–financial, crypto, and technological.
Yes, a bank or financial institution would have superior expertise in finance but might struggle when it comes to crypto know-how or the advanced technology that typically accompanies DeFi. An individual investor that may have just entered the crypto space would likely find the technical learning curve too steep to even consider exploring DeFi options. What this requires from DeFi creators is to prioritize ease of access and solutions that provide a simplified, user-friendly infrastructure.
Given crypto’s relative newness, it’s hard but certainly not impossible to quantify what constitutes a good and healthy crypto portfolio. But the lack of attention to this aspect creates a gap in principled, institutional-grade risk management across the crypto spectrum. With DeFi, emphasizing risk management is especially important in order to navigate how to create diverse portfolios using the tools of a decentralized platform.
Moving DeFi out of the periphery
CeFi and TradFi generally bear the risk of being opaque in how they operate and conduct business, even with the high regulation of traditional institutions. Celsius, for example, didn’t disclose the sources of its high yields or the mechanics of how they were generated. It was only discovered after bankruptcy that it was through highly speculative asset owners lending out their users’ money to hedge funds like 3AC.
Asset-ownership transfers to CeFi and TradFi players also create a counterparty risk when entrusting the responsibility of a client's assets. And it’s not just crypto exchanges that are at risk—big bank players like Credit Suisse and Deutsche Bank have been ensnared in recent scandals concerning the same issue. With DeFi, transactions are fully transparent and visible, while smart contracts execute transactions instead of human beings. What does that mean? A strong smart contract operating on a highly-visible blockchain ledger won’t just let someone withdraw $10 million without any checks and balances.
Despite its challenges, DeFi is in a much better position than many CeFi projects to create the infrastructure and frameworks required to attract new audiences to crypto. But that doesn’t make DeFi development a cakewalk. Making DeFi a serious contender in the blockchain ecosystem requires a critical eye that focuses on catching potential gaps in user experience and risk management before it can truly expand into the mainstream.
About the Author
Dr. Karl-Michael Henneking, Spool's Chief Marketing Officer, has a global track record in senior marketing and strategy positions in blue-chip tech companies. He helped to build up start-ups and multi-billion dollar businesses from scratch and knows how to accelerate companies and projects in their growth journeys. Karl-Michael is well versed not only in fintech but in particular in all things digital assets for institutional investors.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.