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The Billion Dollar Houses Built On Sand

Ed Zitron 8 min read

When Andreessen Horowitz announced their $4.5 billion crypto fund toward the end of May, partners Simpson and Dixon (incorrectly) likened crypto to “the next major computing cycle,” a phrase that was neither questioned nor explained in any place I can find. The firm has invested billions in the cryptocurrency ecosystem, making vague claims about how this will be the future of how you use the computer without ever explaining how, why, or what exactly any of these companies do that’s even as good as what you’re using today. That might be because there are no real products in cryptocurrency, just ways of adding layers of finance to things you already do for reasons that don’t make sense other than “how can we make a venture capital firm’s investment liquid?”

I take that back. There are plenty of cryptocurrency products that “work” in the sense that they have a defined functionality, such as Celsius Network (which allows you to lend or borrow money from the platform) or Bancor (that offers “safe DeFi yields,” meaning that they give you money for lending them your crypto), or Babel Finance, who claims to “have your best interest in mind” when selling their cryptocurrency loan products. In fact, the more I write, the more I realize that the only functioning product in the cryptocurrency industry is a hodge-podge of software-based crypto options contracts and straight-up Ponzi schemes.

The net result is chaos the moment there’s a market downturn, as the company that sells unbelievable leverage against or with the markets may or may not have been playing with said leverage (and users’ funds) to make more money. Theoretically.

Celsius froze withdrawals vaguely citing “market conditions” and is yet to give any indication of whether they’ll let people withdraw again. Babel Finance imposed a $1500-a-month withdrawal limit on Friday, claiming there were “liquidity pressures,” perhaps because they’ve previously had about a billion dollars less in the bank than their outstanding loan balances. Bancor’s safe yields are no longer safe, as they have turned off “impermanent loss protection,” a term that takes far longer to explain than matters but mostly comes down to finding out your fire extinguisher is full of marshmallow the very second you find a fire.

Pausing for a second, I really do not like using the term “ponzi” too often, as it’s thrown around to describe many things that are not actually ponzi schemes. However, it would appear that the economic principle of “borrow from Peter to pay Paul” has become the defacto crypto lender mindset.

Many of these companies offered arbitrary amounts of money for you to join or “yields” that massively outstrip those offered by, say, a certificate of deposit with a bank. These unbelievable numbers - Celsius still claims to offer "17% yields” were highly dependent on the increasing value of cryptocurrency and on users not, say, “asking for the money that they have stored in the protocol.” This may be in part because some of these companies - Celsius being the obvious one - were also pursuing yields on other platforms, except at a massive scale - meaning that they were somehow at the mercy of a system that they too knew was colossally stupid and based on a financial analysis made up of mumbling “nothing bad ever happens to me” in a sing-song voice.

I must repeat how silly this all was - companies promising you a percentage return on your money, guaranteed, at rates ranging from “pretty good” to “literally impossible without some form of crime.” A user would put in a bit of, say, Ethereum, and, through no real effort of their own, they would receive a percentage back. That Ethereum would then, through the protocol, get algorithmically loaned to somebody else, who would then be able to do the same thing on another platform.

This theoretically works when things are going well because everybody is unlikely to withdraw all of their money at once. People keep their money in the system because it’s “free,” and that money is “free” because the company effectively gives it to you, and everybody’s happy. Now, imagine if instead of “people,” there were “entities with millions or billions of dollars” that would put their money into these networks, getting the same “yields” (free money) as regular folks. These platforms also offer different kinds of loans without any of that troublesome “underwriting” that generally slows down people’s ability to borrow more than they should be able to.

So, to summarize, billions of dollars within the crypto markets - tens, maybe even over a hundred, maybe even more - are floating inside a massive bubble of quasi-legal and unstable financial agreements, many of which are between totally anonymous parties. The magical freedom of decentralized finance is that there is no centralized authority to make standards, police bad actors, and penalize those who operate recklessly, both in the products they release and how they deal with users’ capital.

While I’ve been quite damning of the cryptocurrency industry in general, I don’t think there’s an awareness of how bad the DeFi industry can (and will) tank in any given downturn. These are con-men loaning to con-men to get money from con-men to pay other con-men, funded by retail investors that either don’t understand or don’t want to believe that this system could fall apart. Yahoo Finance reports:

Months ago, Sydney, Australia-based Hamish Tipene took out two loans with Celsius Network. Buying a new home above his pre-approval rate, he staunchly supported the crypto lender’s motto “Unbank Yourself” and used his crypto holdings as collateral instead of selling it for cash.

But when the value of crypto started plummeting a week ago, the collateral Tipene put up for the loan rapidly dwindled and he received a margin call. He needed to add more collateral.

Before he could, Celsius froze Tipene's account, making it impossible to meet the margin call in time. The company liquidated 69%, or $10,300, of his collateral. He now faces another margin call needing an additional $10,000 for his remaining loan, but with a shrunken crypto savings of $9,633 frozen on the platform, he’s up against the same credit hitch.

“I tried to reach them for days. You can’t remove someone’s ability to resolve a situation and then punish them for not resolving it,” the 46-year-old carpenter told Yahoo Finance. “I trusted them with my savings and it’s unfair.”

These people are victims of ignorance and circumstance that have lied to themselves (or been lied to and failed to do any meaningful research), trusting these platforms to be reliable stewards of their capital rather than poorly-run conga lines of quasi-secured high-risk debt:

For Northern-California based Yevhenii Marchenko, he can’t access the $85,000 in Solana, Cardano and Chainlink crypto tokens locked in the platform. He’s been a customer since November when the crypto market peaked.

“Almost every YouTube crypto related channel was recommending Celsius and that’s why I thought it was safe,” he told Yahoo Finance, adding that he had more confidence in Celsius for being a U.S. based company. “It’s a really hard and depressing situation.”

While we can laugh at how ridiculous this is, it’s also the exact thing I’ve been warning you about for months. Cryptocurrency is marketed as accessible, egalitarian, and unrestricted, but also craves the legitimacy of real financial products. “Trust” and “safety” are words that are used to describe how big the partners or venture capitalists behind a product - an unsaid promise that the product wouldn’t simply cease to exist tomorrow - rather than any kind of rigorous legal or financial rigor, or any regulation that would make it so. The reason that regulations exist is to stop people being able to enter into incredibly risky situations without sufficient protection - and so, well…here we are.

When your money is “safe” in a regular bank, you believe it is so not because the bank has a good website, or because the people funding the bank are good, but because there are staunch regulations around holdings, as well as FDIC insurance up to $250,000. When your money is “safe” in cryptocurrency, it’s because you have agreed with your peers that enough rich people have put their money into it that nothing will go wrong.

Except it would appear that the exceedingly rich people behind these DeFi projects are just as reckless and dopey as the people they’re trying to con into using their services. 3 Arrows Capital invested their investors’ funds in other projects to make themselves more money with absolutely no plan for a future where things didn’t go perfectly (including a remarkable $200 million investment in LUNA which is now worth a few hundred dollars), and, of course, not enough money to cover a loss that major. While Celsius may have operated like a bank - investing users’ investments in other investments - they didn’t operate as a bank, making sure that the money they were investing was not money that could be demanded at such a rate that the money simply didn’t exist to return to their customers. And I believe we’re going to see far more of these stories as these networks have the terrible trouble of people asking for their money back.

This entire situation feels far worse than a regular bank run, because we’ve yet to actually see one happen. If Celsius opens up withdrawals, those who have kept their money in the system are significantly more likely to now immediately sell it on the market, virtually guaranteeing hundreds of millions of dollars of sales. The longer that Celsius waits to open withdrawals, the worse it’ll be, with fear and desperation will foster as customers helplessly watch their money become worth less and less.

The Celsius situation alone is what cryptocurrency critics have been warning people about - that a borderline-unregulated and pseudonymous financial system is unbelievably dangerous to everybody that participates in it. For all of the crowing by fanatics about how “the US dollar is also belief-based,” the DeFi collapse has proven that no, you cannot run a market entirely on good vibes and saying that you’re going to make it, especially when many large players appear to have the introspection and foresight of a narcissistic labrador retriever.

And I think that’s what people need to wake up to - these are the stewards of the cryptocurrency industry. These are the cream of the crop, the people that were trusted with responsibly handling billions of dollars. These are some of the largest holders of cryptocurrency - and yes, this is the cream that rose to the top. The most important people in the industry are craven, reckless and colossally ignorant on a level that is both deeply hilarious and morally deplorable, acting with sociopathic greed long past the point that money has any meaning to a regular human being. They do not care about the lives they destroy, the markets they wreck or the people they strand with nothing - and these are the people that stood to profit when the New York Times wrote 14,000 words about how safe and cool crypto is.

I’d like to close with a particular quote from reporter Kevin Roose from that article:

I’ve heard people calling crypto a pyramid scheme or a Ponzi scheme. What do they mean?

Some critics believe that cryptocurrency markets are fundamentally fraudulent, either because early investors get rich at the expense of late investors (a pyramid scheme), or because crypto projects lure in unsuspecting investors with promises of safe returns, then collapse once new money stops coming in (a Ponzi scheme).

There are certainly plenty of examples of pyramid and Ponzi schemes within crypto. They include OneCoin, a fraudulent crypto operation that stole $4 billion from investors from 2014 to 2019; and Virgil Sigma Fund, a $90 million crypto hedge fund run by a 24-year-old investor who pleaded guilty to securities fraud and was sentenced to seven and a half years in prison.

But these cases aren’t usually what critics are talking about. They’re generally arguing that crypto itself is an exploitative scheme, with no real-world value.

No, Kevin. No. This is what people have been regularly talking about. This is what Amy Castor and David Gerard and many other critics have been warning you about - that the consequences of recklessly of both-sidesing crypto will trick regular people into trusting a system that is built on exploiting everybody, one that protects nobody but the richest in a downturn, leaving the majority of people burned.

In fact, I think a quote that David Gerard (not, as previously written, David Barnard) raised from a now-deleted piece really nails - even in jest - exactly how rotten and ignorant this industry really is:

“In Every Trade There Is An Idiot And If You Don’t Know Who It Is, It Is You.” This of course being crypto, where everyone is pseudonymous, and no one knows who anyone is, I figured that those rules didn’t apply.
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