19 July 2022: CeFi cryptocurrency companies refer to any entities offering services to fill the gap between on-chain protocols and off-chain financial institutions. This most commonly comes in the form of a centralized exchange (CEX) like Coinbase, Binance, or Crypto.com.
Over the past market cycle within the cryptoeconomy, CeFi companies saw their values expand significantly with growth that had matched the growth of the entire sector. Out of this immense growth popped up dozens of cryptocurrency companies, many of which competed directly with decentralized financial (DeFi) protocols like Aave & MakerDAO for market share.
2021–2022 CeFi Expansion
CeFi’s massive growth came from the ability for these crypto companies to offer considerably higher yields on favorable assets over the likes of DeFi protocols. For instance, companies like Voyager and BlockFi were offering high APYs on stablecoins and popular assets like ETH, LINK, & BTC that DeFi protocols simply could not match.
Celsius Stablecoin Yields Prior to Insolvency
High yields attracted thousands of customers to trust these companies with their tokens, cashing in on high returns while seemingly having the security of a backed company versus a “risky” on-chain protocol. Companies like BlockFi experienced substantial growth, with some companies having valuations in the billions.
This business model became popular within the market, attracting millions in startup capital to create more exchanges that could offer high yields versus the open source user-owned economy. The following CeFi companies have launched since 2017:
- Binance (2017)
- BlockFi (2017)
- CoinFLEX (2019)
- Celsius Network (2017)
- FTX (2019)
- Gate.io (2017)
Much of the growth within CeFi can be linked back to the massive expansion of stablecoin market caps themselves. Companies offering high yields on stablecoins became very desirable for the market as increased emphasis continued to be put on the usage of stablecoins within the space.
Earning ~9% yield on a USD-backed asset (USDC or a similar asset) with what appeared to be a trustworthy, legally created entity in a CeFi company seemed like a no brainer for investors.
The Collapse of CeFi Companies
Problems with CeFi companies began to crop up at an exponential rate following the collapse of massively popular protocol Terra Luna. As both the TerraUSD stablecoin and LUNA token both crumbled in value, any capital that CeFi companies & lenders had tied up in the protocol was lost forever.
Keep in mind that Terra Luna, at its peak, was a $40 billion + protocol. The collapse of Terra Luna in May had massive ramifications for the entirety of the cryptocurrency space. Ultimately, what exactly went wrong?
There were a combination of factors that led to the 2022 bankruptcy wave of popular CeFi companies like Voyager, BlockFi, & Celsius. At the heart of these problems was ultimately the yield these companies had been offering their customers. In many cases, the yield was downright unrealistic and unsustainable.
CeFi companies take custody of a customer’s tokens when they are deposited. This allowed these companies to then turn around and utilize those funds to generate yields elsewhere, paying back a percentage of those gains. A big protocol that was utilized for this was through Anchor’s 20% yield opportunity being offered up with the Terra Luna protocol.
In hindsight, everyone can now understand why that was immensely unsustainable and helped lead to the rapid collapse of both UST and LUNA. While Terra Luna’s collapse was bad, the collateral damage that it caused to risk-blind CeFi companies is still becoming noticeable months later.
Basically, CeFi companies were taking custody of customer funds and plugging them into yield-generating protocols like Anchor, paying back a percentage of the gains and pocketing the rest. When Terra Luna went belly up, all those funds were lost. These opportunities for CeFi lenders going bust has helped lead to the bankruptcy wave now being seen.
The following is a list of crypto companies that have struggled during the market contracting since the Terra Luna collapse:
- Three Arrows Capital (insolvent)
- BlockFi (bailed out)
- Voyager (bankrupt)
- Celsius (restructuring)
- Coinbase (layoffs)
- Gemini (layoffs)
- Crypto.com (layoffs)
Of course, not every company’s struggles are related to the Terra Luna incident. However, risk exposure being as high as it was, this creates catalysts within the market that leads to a cycle of decline like the cryptoeconomy is seeing now. Money gets wiped out, capital dries up, contractions continue. Firms like Binance and FTX willing to take on water to buy up distressed companies are helping to soften that blow.
Summary
The prospect of risk-free, high yields on stable assets like USDC or USDT attracted thousands of customers to CeFi companies since 2017. Unfortunately, these yields were not without risks as many learned during the 2022 market contraction that caused Terra Luna to fail.
DeFi often gets a bad wrap for having unfavorable or boring yields on assets. This has been a common criticism of Aave and others. The problem with high yields is always sustainability as it is expensive long term to service. Eventually, the liquidity runs dry and the yield is no longer viable.
This is what occurred with CeFi in 2022. As CeFi companies took on more risk exposure than they should have, customer funds were lost and an onslaught of struggles ensued. Despite these damages, the cryptoceconomy continues to churn on as companies recover and projects find their footing.
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