Risk-aversion and crypto
After recent crypto rallies, spurred by hopes of a wider adoption through ETFs, investors remain prudent. Despite some sporadic pumps-and-dumps, defined by memetic fads and the thrill of novelty, the crypto environment is becoming less and less an elitist technologist’s whim; it is indeed on its way to mainstream status.
That is quite a feat. Born after the Great Financial Crisis (2007–2009), and the sovereign debt crisis (2010), the blockchain may have been an umpteenth niche Ponzi. It survived so many financial shocks and downturns that one may finally call it an “investment”, like gold, ETFs and bonds. The SEC agrees to a certain extent.
It is always interesting to study the public’s stance toward new products. A relatively new discipline called behavioural finance is already taught in most of the prestigious business school around the world. Kahneman and Tversky, in the 70’s, popularised the idea that financial markets were a sort of blank canvas for all the minds participating together in the markets. From here, lawyers, bankers and PhDs begat a new paradigm.
The antiquated mantra regarding market efficiency, vastly incorrect, stems in fact from 18th century’s economics, an eternity ago with regard to the immense progresses thus made. It is understood today that, on the contrary, information asymmetry, bias, and insider trading define modern finance. To succeed in business, one needs prudence, wisdom and knowledge.
What do modern traders think of crypto? Gambling or sound money?
A recent study from Exponential dissects the attitudes of crypto-investors. At odds with the mainstream press, more often than not sensationalist, it appears that crypto-traders are actually rather conservative:
This article highlights the cautious approach taken by DeFi aficionados. What about the irrational, often hysterical narratives associated with small-cap coins? Mere isolated events. The fat cats aren’t taking the path of casino banking, a fashion largely adopted by Wall Street’s funds. In spite of Mark Carney’s ringfencing laws in the UK and the Dodd-Frank Act in the USA, credit junkies stayed at the helm.
To quote the article:
“Degens are not that degenerate after all. An overwhelming 94% of the DeFi total value locked is allocated to opportunities eExponential.fi classified as lowest risk or low risk, indicating a preference for safety over speculative yield-generating pools.”
Of the staked value in DeFi, a mere 6% concerns risky investments. A far cry from the picture sustained by the MSM.
Another very interesting trend is the reduction of yields:
“The reduction in rewards-based yields indicates a maturing DeFi market that prioritizes stability and risk-awareness for sustainable growth. Rewards-based yields dropped from a roughly 35% portion of the DeFi market in the first quarter of 2023 to a 28% share in the first quarter of this year.”
In technology-based enterprises, when a company needs to attain network effect and grow, it needs first to draw in users. That pivotal step before success is called the bootstrap effect. In order to attract users and investors, a company must therefore issue tokens and create incentives so that the network may be self-sufficient thanks to on-chain transactions and user fees. The diminution of yields is a sign of maturity and future stability for skeptics.
Stablecoins as a safety-net?
We have seen how crypto nowadays offer many safe investments, through LSTs, fiat-backed coins or overcollateralized-coins. Ledgers can materially reinforce one’s wallet, and some companies even insure crypto. The compensation is often limited, but that is similar to the FDIC scheme offered to American citizens. Here’s a summary from Investopedia:
Stablecoins represent a colossal sum of money invested in crypto. Let us look at some figures:
For Ethereum, the figures are as follows:
As of June, almost a hundred billion of dollars worth of stablecoins float on the Ethereum ecosystem.
It is true that memecoins reached a market capitalisation far superior to some well-established companies, coins which generate absolutely no value for its holders aside from the unpredictable booms (and busts). As of June 2024, Dogecoin is valued at around 20 billions USD. The beloved internet merchant Ebay, once a competitor to Amazon, sits at a meagre 26 billions USD. One is a funny orange dog, the other is a giant of the 2000’s online e-commerce, still going strong in 2024.
One may attribute this success to Elon Musk, cultivating an edgy persona at odds with Zuckerberg, Bezos of Gates. X swoons at each of his tweets, and his opponents cannot do without his social network.
Naturally, there are irrational behaviours moving crypto trends. For as long as humans will man the markets, objectivity will remain an unattainable ideal. The promises of AI are not entirely true, as it would be more proper to talk of machine learning. Generative AI is still dependent on human input, and does not exist by itself in a spacetime vacuum. Humans are, so far, the only creature capable of associating ideas with actions and thus, to produce something tangible in the physical world. Philosophy is merely mathematical abstractions at the service of logic; AI does not possess self-agency.
Some wise actors decided to leave aside the casino and instead build a bank. Circle, Tether, or Chi took the path of temperance with one idea in mind: normalising cryptocurrencies.
In our opinion, there may be two distinct reasons:
Concerning the first reason, it has to do with strategy. We have addressed the whimsical nature of memecoins in the first part of this expose; not everyone is drawn to bubbles, follies, gambling and risky bets.
As with the second reason, it has to do with stability. A strategy can be risky, especially in crypto, but nothing can match a stable, safe investment.
For the old generation, used to dapper bankers in suits, bonds, 401(k), and mutual funds are the gold standard, peddled by local fund managers of a bygone era. We call them Boomers: they call us irresponsible.
The hyper-connected generation, most especially Zoomers, has another idea of wealth. The pioneering mindset of our youth draws its inspiration from the Internet, an ineffable source of new exciting tools, whether hardware (WiFi, Bluetooth, Ledger, USB, 5G), or software (APIs, blockchain, corporate networks, social media, algorithms, cloud computing).
With the arrival of TikTok, Instagram and Telegram, the whole world is constantly exchanging information, and nowadays any 18 years old teenager can pick up trade ideas on the multitudinous channels available 24/7. Let us remember the “stimmy checks,” largely responsible for the explosion of day traders in 2020.
In the age of hyper-individualism, it was only a matter of time before retail handles also its financial planning.
Stablecoins are the gold of crypto. Aside from all the Solana coins, fiat-backed or stables-backed coins present as an alternative to depreciating USD holdings gathering dust in bank accounts. Stablecoins are the only safety-nets available in crypto, mirroring the US dollar itself guaranteed by the US Army (or the Fed, but one goes with the other).
Chi Protocol identified many weaknesses with this mechanism. The first issue has to do with decentralization; the eternal nemesis of libertarian technologists.
When Satoshi published his white paper, his first words in the abstract expressly rejected the TradFi approach to money, viz. the need for a banker:
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
Lower, he says:
“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.”
What’s more, the apparent stability of USDC and USDT comes with a lot of skeletons in the closet. In 2023, when Circle revealed its dealings with SVB, USDC depegged and fell to $0.80. Why? Circle was tied to a financial institution, centralised, dependent on the Fed, holding dollars, filled with distressed assets.
For more information, this article illustrates more trials and tribulations relation to fiat-backed stablecoins:
Centralisation is antagonistic to crypto. This is precisely why BTC was created; to remove third parties, or intermediaries. On top of that, centralisation amplifies risk. At the LSE, I did a thesis on the CCPs (Central Counter-Parties), akin to clearing houses. Instead of distributing the risk, this actor crystallises all the market risk within one node, supposed to pool transactions in a more efficient way. I already wrote in 2017 about the flaws inherent to more centralisation in a world where individuals seek to divorce from untrustworthy institutions, liable to collapse and infamous for mismanagement scandals.
Stablecoins transform the risk associated to the dollar into a more palatable “crypto” asset; at the end of the day, the risk is neither reduced nor suppressed, it is rebranded.
Liquid Staking Tokens, the essence of primitive banking
lUSD or crvUSD appear as alternatives to USDC/USDT, relying on ETH as collateral. But there is a caveat: investors need flexibility. ETH is mostly used to fund protocols (staking) and pay for gas fees, so that the chain may function and keep incentivise participants. PoS has proved its merits compared to PoW and nowadays most new chains are L2s based on ETH.
Chi Protocol came up with a system that would provide both decentralisation and capital efficiency. More on LSTs later; first, let’s see some figures concerning DeFi:
The Coin Telegraph reported this weekend fantastic news for Ethereum stakers, I quote:
“The total value locked (TVL) in decentralized finance (DeFi) applications reached $192 billion in May, the largest amount since February 2022, according to a report from blockchain analytics platform DappRadar. Despite the rise in TVL, the number of unique active wallets (UAW) using DeFi declined by 21%.”
There is as of now almost 200 billion dollars staked in DeFi protocols.
Who is leading the charge ?
It appears that Lido, the behemoth of LSTs (also called LSDs, Liquid Staking Derivatives, which is a more apt description to this relatively novel financial instrument) captures most of the market share.
Here is a snapshot of LTSs ecosystem:
This snapshot from Liquid Collective explains in more details how LSTs function:
In short, LSTs are at the core of true banking, meaning: liquidity, flexibility and security. Banking is said to be born to allow traders to pay for certain goods without transporting huge sums of money, lest they get robbed; instead, intrepid merchants received a certificate of deposit to prove the ownership of the required funds. Nowadays, bank checks serve more or less the same function.
LSTs, thus, are an abstraction, a token which proves that the owner of said token owns the corresponding assets. When an investor adds liquidity to a LP, he receives in exchange a token which represents the amount invested. So, after thousands of years of innovation, one may say that some financial concepts are truly timeless. The issue with staking has been definitely solved with LSTs, and even if Lido relies, as a matter of fact, on the most ancient tenet of banking, its simplicity stems from pure necessity.
The Dual Stability Mechanism, best of both worlds
How to harness the features of LSTs to power stablecoins ? Chi Protocol found the answer. However complex the algorithms involved with the protocol are, the mechanism is of a simple elegance.
This article demonstrates the virtues of this proprietary mechanism:
A glance at this diagram illustrates the dynamic logic behind the DSM:
Whenever USC falls below $1, depending on the status of the reserves, the arbitrage contract will either mint USC or buy USC and either replenish the reserves or lower them.
Conversely, whenever USC rises above $1, the contract will reward stakers with the excess USC or buy USC with Chi and thus reattain market equilibrium.
Another interesting feature of the protocol is how stakers earn rewards from the yield generated by the reserves. Unlike other stables relying on centralized assets, USC is fully backed by LSTs.
For more information on the rewards, here’s a thread I wrote on Twitter that sums up the perks of Chi.
A more consistent article from the team details the yield generation mechanism:
For the visual readers, here’s a holistic diagram covering the whole paradigm of Chi:
To conclude:
- Chi offers the advantage of a decentralised stable, with the safety of a fiat-backed stable, and an absolute capital efficiency, allowing stakers to both find a safe haven in USC and accrue rewards from the LPs offered by Chi
- Stakers can participate in the governance of the company through CHI, the in-house token, itself stakable for maximal gains
- Chi hinges the LSTs, the most liquid, flexible asset currently available on-chain. The abstractive nature of derivatives has been pushed to its limits in order to deliver an actual feat of financial engineering to Chi’s users. The conversion is automatic upon staking
- The yield of the reserves is currently being distributed to all protocol’s stakeholders (stCHI, veCHI, stUSC, CHI/ETH LP and USC/ETH LP)
- Chi partnered with Arrakis, a new Web3 liquidity player offering massive APRs on its new V2 Vaults (yes, I kept the surprise for the end
To enjoy a three digits percentage APR, follow the link:
Ready? Stake!
