What Caused it, How to Fix it

Liquidity Problems happen when protocol owners don’t plan for unfavorable periods, says Brian Pasfield, CTO of Fringe Finance.

The current market conditions are far from perfect for many crypto industry players, and lending platforms are no exception. For the past few months, many have been facing liquidity problems that put stress on their users and the broader crypto space.

Let’s analyze how we’ve come to face these problems – and try to offer some solutions.

Liquidity Problems: Market turbulence on the rise

Celsius made every imaginable business news outlet when it paused all withdrawals due to liquidity issues last month. After announcing it would lay off a quarter of its employees due to “extreme market conditions,” Celsius filed for bankruptcy under Chapter 11 of the U.S. bankruptcy code.

Similarly, two weeks ago (an eternity in crypto land), the Voyager Digital crypto platform announced the suspension of cryptocurrency trading and withdrawals for its users. As representatives of the company noted, the reason for this the outstanding payment of a loan from the Three Arrows Capital (3AC) crypto hedge fund. Voyager Digital is now also undergoing bankruptcy proceedings.

A third example of how the recent market downfalls keep taking a toll is Vauld, a Singaporean cryptocurrency exchange and lending platform. Vauld recently suspended its operations, citing financial difficulties amid volatile market conditions. The collapse of Terra, Celsius Network’s financial troubles, and the default of Three Arrows Capital on its loans were the main reasons cited for this suspension. 

Interestingly, it seems like the liquidity issues surrounding the crypto ecosystem can all be traced back to a precise point in time.

Does it seem simplistic to point at Terra for the ripple effects across the crypto markets? It is not. While a single event cannot be at fault for everything going on in crypto, this showcases the worrying fragility of our environment. 

And once a domino piece falls, the other ones follow, exposing who chose to rely on “too big to fail” notions.

Attempts to restore liquidity

Crypto projects commonly use two approaches to restoring liquidity. Large debt repayments can help bring back the trust in platforms’ solvency and enable withdrawals once again. An example of a debt repayments is the recent Celsius $120 million payment to multi-party vault Dai No. 25977. This avoids vault liquidation costs and reduces the likelihood of forced funds liquidation.

On a different note, DAO and DeFi projects are looking for ways to make their treasury tokens liquid without selling them. New-wave DeFi lending platforms are offering solutions. For one, Fringe Finance officially partnered with Lido Finance, another crypto-lending organization that aims to solve the problems associated with the initial staking of ETH 2.0. Problems include illiquidity, immovability, and accessibility. The aim is to make whitelisted altcoins more liquid and usable across the growing DeFi ecosystems.

Liquidity Problems: The Root Cause

Crypto lending firms were at the forefront of the crypto rally of 2020-2021. Today, however, they struggle with numerous critical issues regarding tokenomics, algorithms, and liquidity.

These problems come from the fact that we now have access to more complex financial tools than ever. At the same time, these are permissionless and unregulated. Developers had ambitions to build platforms that would bring in as much financial gain as possible.

The crucial problem is that most platforms are designed with the assumption of perpetual growth. As soon as growth halts, the bubble will burst. The more massive the platform becomes, the more destruction the explosion can cause to the broader crypto ecosystem, creating a domino effect.

As this effect spreads and the market bleeds, liquidity escapes as people withdraw from crypto-assets or move into HODLing strategies. In conclusion, if builders don’t account for the circumstances of more unfavorable periods when designing their protocols, another crisis could very well become their end.

About the Author

Brian Pasfield is the CTO of Fringe Finance. He has 10 years of expertise in blockchain, cryptocurrency, fintech, and DeFi. He has delivered technically-complex projects that have leveraged his engineering background and keen understanding of the industry trends and philosophies. Brian has also worked with industry blockchain bodies to lobby for legislation and government policy changes.

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