(0:09) Matias: All right. What is up, everybody? Super excited to have Jack Niewold on the podcast today. I've been following him on Twitter for a good time. Now, he has very insightful threads, a very insightful newsletter; in particular, his thread on Celsius and a breakdown of what happened went viral, so we thought he would be a perfect guest to have on the show and discuss the entire situation. Break it down and go into detail about it. So Jack, thanks a bunch for jumping on. If you wanna start maybe with some quick background on yourself and then we can dive right into it.
(0:40) Jack: Yeah, absolutely. Thanks for having me. I bought crypto for the first time in 2017. Bought some Bitcoin and Ethereum trying to get rich. And I don't know. I was like, it was, I was in college like 19 or 20 or something and yeah, just like huddled through the bear, forgot about crypto for a little while and came back to it in 2020 and, you know, fell down the rabbit hole and then eventually started the newsletter Crypto Pragmatist, which is kind of how I pay the bills and I'm on Twitter a lot. So I have kind of accrued a bit of a Twitter following in the last year or so. And, yeah, always a good time in crypto. Never, never a dull moment.
(1:25) Matias: Never a dull moment, especially the last 70 days. I saw a tweet. Forget how, how long ago it was. I think it was like last week. That was discussing how, you know, Bitcoin was 48K in April. People don't realize how fast things change. And one of the big things that led to this change was obviously what happened with Luna. I think everyone's kind of aware of what happened there, but then that's spilled into Celsius. So let's dive in. I think a good place to start is what is Celsius and it's part of this broader theme of centralized DeFi..? So if you can provide some background on Celsius and this C DeFi concept that emerged over the past few years.
(2:10) Jack: Yeah, so you know, there are a number of these kind of centralized DeFi platforms and they've all sprung up. I think maybe some of them were kind of starting to come online and, you know, some variations in like 2018, 2019, and then 2020 was really when we started to see a lot of movement. And the idea is basically like okay, you know, DeFi is great and there's all kinds of ways to use assets in interesting ways and earn yields on assets or yields on stable clients, but it's complex, right? So what if we, what if me, instead of like having my MetaMask wallet and I'm going into Compound and lending it out on Compound or you know, leveraging all these assets in different ways. What if I just give it to a centralized custodian, like a company and a US based company in this case, and they kind of just do all that hard work for me? And then I get my yield and whatever - token it's, you know, I can deposit Eth and get 5% on Eth can deposit stablecoins, get 12% on stablecoins and that's kind of the concept behind all of these platforms.
(3:25) Matias: On that point is most of the investing on these platforms stablecoin yield generating type investments, or they also have more risk strategies in place as well?
(3:39) Jack: Well, it's a bit complex, right? And this is kind of the first issue is that these are kind of black boxes and that they have tons of wallets that you - they don't disclose. So you can't track kind of all the movements that are happening. They won't kind of disclose necessarily the direct strategy behind where the yields are coming from in a particular, you know, deposit you make on their platform. So it's all obfuscated. And even if you wanted to track it, you know, they're doing stuff on centralized exchanges or they're lending out assets over the counter. So it's all kind of obfuscated in some way. So that's kind of the, the first issue but they're also lenders, right? So they're also kind of operating and, and lending out capital to both like clients and to institutions; there's a lot to the business model. They're kind of acting like hedge funds plus banks, plus OTC desks, there's a lot of business units in each of these centralized DeFi platforms.
(4:55) Matias: And in general, were they marketing yields that were higher than just going on Compound yourself or just going on yourself?
(5:03) Jack: Yeah, so the - I think yes, typically yes. And these yields kind of came from a couple places. So first of all; and Celsius is a great example of this. Celsius, what they do is they pay out part of, they have an option to pay out part of the yield in the token, right? So they have the company, the company launches the token, the token is worth, I don't know, 50 cents. And then they pay you 8% in stablecoins and then they pay you an additional 2% if you wanna get all of your yield paid back in Celsius. So it's a bit of a strange dynamic with this kind of like economic model where they're paying out a yield in the native token. And where does that kind of money come from - it’s a bit like having your own money printer, right? But I think it varies, you know, sometimes the yields are advertised as being lower and a lot of faces, they advertised as being higher. And particularly, recently, almost all of the yields have been higher than you can get in DeFi and I'm sure they would argue, you know, oh, it's because we are venture backed and we kind of are using this as a growth strategy and other people would say, well, this is just not sustainable. You can't keep up these yields for very long.
(6:28) Matias: Right, so basically tons of users come in, they’re attracted by the yields, they're also attracted by the convenience, the one click solutions to start earning yield, right through a web two friendly type interface on mobile. So not really having to go with MetaMask, it simplifies the entire process. So they get a ton of users. People are investing. Everything's going great, no serious issues. When did you first notice that, you know, things were potentially off and things were going to potentially start cascading and get worse and worse? When - what was that first indication that you saw that really signal that something was wrong there?
(7:09) Jack: Well I think a lot of, you know, on chain maximalists have criticized centralized DeFi for a while because of this lack of transparency, around how the funds are being managed, but there was never any like issue, right? People could always get their deposits back. It was always this liquid system. In the last kind of maybe six months, we've seen tremendous amounts of liquidity getting flushed out of the system, right? So people are looking to get their funds back, stuff like Luna has caused like massive institutional players to blow up and assets to be liquidated. So it's kind of, this slow deflation of this bubble, right? The problem with Celsius is that they had - they would lock their assets in places.
So one place where Celsius had I think about 450 million in Ethereum was on the Ethereum beacon chain, which is Ethereum proof of steak chain. And in exchange for locking, you know, Ethereum up on this chain, you can get an interest yield on your Ethereum, right? The issue with this is no one really knows - supposedly it's going to be within the next, you know, year or so or less than six months - when you're going to be able to withdraw Ethereum from this beacon chain, but for now, it's completely locked up on that. So let's say you have a billion dollars in Ethereum customer deposits, Celsius has gone and they did the math and they said, okay, well, we're going to lock up half of it so we can earn a bunch of interest and then to be able to match redemptions. So to be able to give people back their Ethereum denominated funds, we will use this other kind of pile of money, but we wanna earn interest, so we're going to lock up this money. When price comes crashing down and everyone wants their money back, now they've got a ton of money locked up, right? So it becomes this, this really big issue about like, yes, you are - it’s possible that you have enough money to kind of back up everything out there, but it's not liquid, right. So you're insolvent. So it would be like if a bank has a bunch of houses and the lender stopped paying it back. Hypothetically these loans are collateralized, but it's not like the bank can have the dollars today on hand and that's kind of the situation Celsius ended up in.
(9:51) Matias: So one component is they had this Eth that was locked up and Eth 2, that they couldn't access. The other component was Luna. Were they exposed to Luna in any way?
(10:04) Jack: Yeah. So, I think that the numbers are varying and there's kind of some different stories out in how Celsius managed the Luna kind of collapse, but basically we know that there was a Celsius product around UST. So you could deposit UST and Celsius and get a yield. They would kind of - one of their, one of their managed products was giving yield on UST. Part of Celsius' business model was, they would kind of take the excess assets that they didn't need - well they do, you know, Celsius is still existing. I shouldn't be talking about them in the past tense, but what they would do is they would take out like the, the assets beyond what they needed to redeem and they would kind of go out and do use these assets and kind of operate as a HUD hedge fund to try to make a return on these kind of excess assets right? So part of, you know, some people theorized that one thing Celsius was doing was they were taking some money and putting it into UST and earning a 20% deal on UST and using that to either pay out depositors or using that with their own funds or, you know - they were doing something with it. So now when UST blows up you've got a hundred million in client obligations that deposited UST with Celsius, but perhaps they also got wiped out on some kind of other chunk of their portfolio, right? And part of, you know, some people at nanson - kind of whale wallet tracking software dashboard - were doing some research into like what was happening on chain. And some people - the biggest wallets were Celsius and part of what caused the Luna UST depegging was Celsius pulling out liquidity from UST and from curb three pool and that's kind of what - some people say that's kind of what triggered the depeg. I think the general consensus is that Celsius lost about 130 million in the Luna depegging, which is obviously, you know, a huge amount of money but yes, they were absolutely exposed to UST as to how much it kind of affected the business model. There's some questions, but it obviously didn't help. And then, you know, every dollar that you lose is less dollar of this cushion to match redemptions.
(12:52) Matias: And then at one point, users started finding out about this, they all rushed to withdraw and Celsius just completely shut off the withdrawals. Are withdrawals still shut off today?
(13:05) Jack: I don’t know honestly, I’m not a Celsius customer, I've never used it, obviously some of the heat has died down around Celsius. But yeah. So, they kind of turned on this thing called HODL mode, which was, you know, this marketing PR stunt where they said, “Oh no, your assets are safe with us, but you can't withdraw them.” You know, so like, imagine if you went to the bank and you were like, oh, you went to the ATM, you're trying to take out 200 bucks or whatever. Like, oh no, you're in, you're in “cash HODL mode”. You know, yeah. So you just can't withdraw cash anymore. So I mean, the issue with that obviously. You know, maybe they have the assets, right. But you don't have access to it. And then it causes this cyclical thing where everyone's panicking right? Because they can't get their money out, and now everyone's trying to withdraw and then Celsius perhaps has enough money kind of on hand to match 25% of the redemptions, but they can't match all of the redemptions. So it turns into this kind of downward spiral.
(14:10) Matias: And was this any way related to the 3AC blow up or is 3AC more connected to what happened with Luna? Well, I know they're definitely connected with the Luna side.
(14:23) Jack: Right. So, 3AC, you know, this big crypto hedge fund definitely lost a lot of money on Luna. So maybe like in the neighborhood of 500 million dollars, it's hard to say if there's like a direct connection to Celsius and 3AC. To my knowledge, what happened with - part of the issue with Celsius was this liquid Ethereum staking that was going on. So there's a crypto protocol called Lido. And as we talked about with the beacon chain where you can kind of lock up Ethereum in exchange for interest, Lido provides this product that allows you to lock up Ethereum, but it gives you back a token that is representative of this staked Ethereum. For a long time, this was kind of pegged pretty close at a one to one value. So like, one staked Ethereum was equal to one Ethereum on the beacon chain. And that was great because you gotta deposit Ethereum, you could lock it up. You could get interest on it, and then you could have this token that was the same value, right? The issue is that this staked Ether token trades at a discount or trades at some discount, likely, to, you know, one Ethereum token. And that's because it's not directly redeemable immediately for one Ethereum. So there's some kind of discount that has to take place over time right? The speculation is that, you know, around the same time that the 3AC rumors started to come out, is that 3AC had a lot of staked Ether on their balance sheets and they were trying to sell all of it. So when they sell all this staked Ether that causes the price of stake Ether to drop relative to Ethereum. And then if Celsius is holding a lot of staked Ether, now it's another kind of like, you know, red mark on their balance sheet, right. But now that they thought that the stake Ether was going to be equal to one Ether, but now it's 0.93, or now it's 0.91. So you know, again, you're in this case where you have less assets than you need to be accountable for less assets, that aren't enough to match redemptions. So I don't think, to my knowledge, 3AC is not directly connected to the Celsius blowout, but this kind of, this broader idea of contagion in the crypto markets and it's - well, if one participant, if Luna blows up, then that causes 3AC to blow up. And now 3AC has to liquidate all their assets. And now Celsius has to liquidate all their assets because, you know - so it's this kind of contagion dominoes falling, right? And we've seen this with other crypto lenders, Babel and now hashed with Luna. And now Voyager, I think, just in the last couple of days, has started to not be able to match redemptions anymore. So it's this idea of contagion and these kind of dominoes falling one after each other.
(17:48) Matias: Yeah, Voyager had what? I think it was like 600 million in owed assets from 3AC or 3AC owes them around 600 million?
(17:57) Jack: Right. Yeah. I think it's like 300 million in Bitcoin and 350 million in stablecoins or something like that, that Voyager kind of entrusted with 3AC and I'm pretty sure it was, I'm not sure, I haven't been following the Voyager blow up that closely, but I think it was like an uncollateralized loan, right? They just said, oh, have it.
(18:19) Matias: Yeah. And I saw their entire token market cap, and I believe their stock market cap combined as less than the money that they're owed from 3AC.
(18:30) Jack: That's wild. Well, it might be an interesting opportunity if they can figure out how to claim, how to get those funds back. But we'll see. Again, I think what is important to talk about is: DeFi is like transparent. Right? You can see all this stuff happening on chain, but once you entrust it to a centralized custodian, you don't know where these funds are, right? I'm sure, Voyager’s in a situation where they're looking at 3AC, they're thinking, how much can we get back? Is it all out there? You know, potentially it's all out there, but there's just no certainty. So when DeFi markets liquidate, they obviously - they crash its price, right. Everyone's selling their assets and then they have other people have to sell their assets, but it happens in this very orderly way. And it's all kind of programmatic, whereas in CeFi it's like people dodging phone calls. People are trying to flee the countries - when they're not going to get extradited. There's all this kind of, you know, like obfuscation and these kind of tricks that had running and negotiations and background deals. And that's kind of,hopefully, what we're trying to move away from by being on DeFi.
(19:39) Matias: So where do you see the centralized DeFi space? Do you think it's done or do you think there's a way to do it right? What's your view there?
(19:48) Jack: You know, I've kind of always been a bit more bullish than the average person in crypto on centralized DeFi, because I think about something like, someone like my mom or my dad and - look, they're just not going to like, be willing to put a hundred thousand dollars in assets on a ledger, I'm sorry. And if you get an insured custodian, right. I can see them being like, oh yeah. I would love to earn a 5% yield on my dollar or something, right? So it's hard for me to be completely bearish on the concept of centralized DeFi and, you know, even today, centralized DeFi companies are still in business, right? Celsius is still in business. BlackFi is still in business. You know, even like Coinbase has some centralized DeFi products where they're offering yield on Ethereum, for example. So I'm not completely bearish on the concept. I think similar to kind of what happened to Tether, where Tether was sued by the US government, basically to be more transparent about what kind of assets they were holding on their balance sheet. I think it's possible we see the future of centralized DeFi go that way, where we have, we get laws and regulations around how transparent centralized DeFi companies have to be. ‘Cause the issue really isn't, you know, at least so far the issue hasn't been that CeFi companies are like trying to censor their users or they're trying to, you know, spend their money on yachts. Right? It's not like this corruption necessarily that exists in centralized DeFi. It's this lack of transparency where they’re allowed to do things that negatively impact customers, because the information isn't clear because it's not directly traceable what they're doing. So I think like my mom would gladly pay 2% a year of whatever, you know, Celsius could earn in exchange for having insurance and having a good interface. But, you know, there would need to be more transparency to make sure that all of the assets are accounted for at all moments.
(22:12) Matias: Totally. And I think public audits: super important. And I think that Tether analogy is actually great. It is probably going to move towards that space. And I completely agree ‘cause there needs to be some level of transparency. But I do also agree as well with the example of, you know, the parents or the grandparents, people want a sleek interface, that's basically automated and they don't need to, you know, jump through any hoops. And there's platforms that can do that, where the current direct-to-DeFi is great if you know how to navigate the space. For a lot of people, you know, managing their own key is kind of scary and they don't want to go through that process.
(22:49) Jack: Right. And perhaps it might be some crypto native solution. I know Argent is a wallet that incorporates social recovery. They're built on a zero knowledge proof. So it's not kind of, you're not interacting in the same way you would interact with a Metamask wallet, for example. So, you know, there’re interfaces that perhaps are more user-friendly, but they also are completely decentralized. So perhaps there's kind of a middle ground where we see more kind of retail adoption and more broad adoption. And we haven't even seen those products yet, so that's kind of another possibility, but I think there's probably still a place for centralized DeFi out there.
(23:34) Matias: Awesome. And then outside of this centralized DeFi conversation on to regular DeFi, has this made you more bullish on any particular projects?
(23:44) Jack: Oh, that's a good question. You know, it's hard to be bullish on anything right now but I think there's some cool structured products in this space right now. DeFi obviously has been complex. You know, it started off as like money markets and exchanges, right. And then, you know, yield farming, and then it became, you know, now there's like V tokens and you've gotta lock and, and vote. And, you know, there's so many, it has become so complex to manage your money on chain and DeFi lately. So I'm kind of optimistic on structured products. So I know there's a project called Babylon Finance, that they run investment clubs. Index Co-op is a project that creates index funds for cryptocurrencies, so you can buy one token that is like, you know, 10 DeFi projects. There's a project called Gallian Dow, which allows you to like - is a single token that allows you to leverage yield farm Ethereum. But all of these allow you to kind of engage with DeFi with complex DeFi strategies, but just by buying and holding a single token. So that's another kind of approach to DeFi, in that it's kind of simplifying the user experience, but it remains completely decentralized, completely on chain.
(25:17) Matias: Yeah, I'm bullish with those concepts as well. I know Index has the DPI, which is that DeFi basket you were chatting about. Another topic I wanted to get your thoughts on. ‘Cause I, I saw you share it and we can go into, you know, quick details on this. Solend. So, Solend had this governance vote that kind of came out of nowhere. They are a decentralized lending platform on Solana. I guess if you can just break down what happened there and just get your thoughts on that entire situation.
(25:49) Jack: Right. So, Solend is a simple lending platform. So, in this case, one of their whale users deposited like $180 million in Solana onto the platform and borrowed $108 million in stablecoin. Now that's collateralized, right? So they had more than enough Solana to cover the amount of USDC and USDT that they were borrowing at that point in time. What happened later was Solana's price tanked, right? And there's a mechanism built into Solend that automatically sells Solana if it dips below a certain price, so that it can kind of like pay back the loan automatically. In this case, the Solana price was getting dangerously low to this level of liquidation. And if this $120 million loan would've liquidated, it would've just like crashed Solana price. But it also had the percentage to crash the network itself because of all these like lick small liquidation bots trying to get a piece of this loan liquidation and there might not even be enough liquidity on all of the Solana network on chain, right? So the idea that this team had was to kind of manually pass this vote, to manually take over the account and to liquidate over the counter. So they would like find buyers for all of the Solana and directly liquidate that account and pay the loan back that way. But that's not really how DeFi is designed, right? That's kind of centralized. It's people taking over an account. It's no longer recognizing the ability for people to kind of control their own assets and, you know, and there's an idea in property rights and economics around the ability to like to forfeit an asset. So like the ability to abandon your house or abandon your car is an important concept in property rights. So this idea of this whale not being able to control his own account kind of goes against what I see and a lot of people see as these ideals of DeFi. So that was kind of what was happening with that Solana/Solend situation.
(28:17) Matias: So they spun up this was the first governance vote that they had had on Solend, right. So they basically spun up this voting mechanism to address this particular problem and the vote passed. Correct?
(28:28) Jack: Correct. Yeah. Another problem with this was, I think like 90% of the vote was a single wallet who voted on this Dow proposal. So, you know, it talks about decentralization as well. Is like, is this okay if one person who owns a bunch of tokens is going to make the decision for the entire community?
(28:46) Matias: Yeah. And I think one thing that's really interesting too. How many users - and I use DeFi quite frequently and I'm not aware when I sign a transaction that they could just take over the entire wallet. And I'm assuming that's not the case for all DeFi platforms. Maybe it's the case for this one, ‘cause Solend attempts to be a bit newer. What are your thoughts on that?
(29:11) Jack: Yeah. There's a whole debate in the community around immutable code. So I think in this case, the contracts were like adjustable, basically. So they could go in and - and the system is obviously designed to do this in a decentralized way, but it was open enough. These contracts were not immutable, so they could go in and kind of adjust how this liquidation was going to happen. Yeah, there are immutable protocols that exist. One of them is called Solidly and it was Andre Cronje - there's this big Def DeFi developer named Andre Cronje. He created this project and then he basically abandoned it. Like he completely left a month or two weeks after he launched this protocol. And it was completely immutable. He had designed this protocol and shipped it and he hadn't made any changes to - he made it so that no one could change the code. And then when there were problems with the project, then no one could fix it. And he kind of just like left DeFi and you know, now he's doing something else entirely. So yeah. You know, I think that kind of ideal situation would be that we have perfect protocols and that there's - they all run on immutable code that we can't change. But the reality of the situation is at this stage in DeFi, we can't just like ship stuff because it's probable that something's wrong or something needs to be changed so it's, it's a difficult question and I don't think anyone has kind of a clear answer on what's better but, I think as a space, we should all strive to get to this idea of a immutable code so that the rules are programmed in, we know what the rules are. We can go on chain, we can check what the rules are and kind of operate in that paradigm. Right?
(31:03) Matias: Awesome. And I agree with that point. One last question and you've been great and extremely insightful. So I appreciate that; one last question. For the rest of the year, we’re about to reach the six month mark for the rest of the year. What are you looking at in crypto? What are you excited about and kind, What are you watching?
(31:23) Jack: You know, it's an exciting time to network. It's an exciting time to build, right? We're clearly in the bear market as to if we're in a crypto winner yet, I'm not sure as if we have hit the bottom yet, I'm not sure. But what I'm kind of watching out for is what are going to be the new narratives to drive adoption to the space, and we saw NFTs was an example of something that brought a lot of people to crypto and over the last, you know, year or two, DeFi in 2020 brought hundreds of thousands of people in and billions of dollars into the crypto space. So, what are those going to be for the next cycle? Is it going to be Gamify? That's something, you know, I haven't really, I'm not a video gamer. I have not really studied that very closely, but I think if there's a good chance that, you know, crypto gains could drive an enormous amount of retail participation or perhaps, you know, the tokenization of real world assets right now, we’ve seen US treasuries have higher yields than DeFi, you know, where are we going to make up that, that gap in? Is there somewhere we can, you know, earn sustainable 10% yields on real estate, for example, perhaps it's that. Or, you know, perhaps it's structured projects to drive retail adoption. I don't know, but I think that's what I'm thinking about is, ok, what's going to drive retail adoption in the years to come? And really getting a good handle on that.
(32:55) Matias: Identifying the next narrative is super important. I wouldn't be surprised if it ends up being something around NFTs again, personally, like maybe the DeFi component of NFTs. But I also think Bitcoin in particular is going to have another second win. But I think when these crazy things happen, people start to appreciate Bitcoin more and people appreciate the fact that it doesn't change and sometimes the item that doesn't change ends up being - that's kind of like the beauty behind the component, right? To not change.
(33:30) Jack: Right. And you look at - it's funny because, you know, as someone who loves Ethereum and loves DeFi, it's tempting to be like, you know, oh, Bitcoin's ancient, Bitcoin's like gargantuan, that's never going to change. It's broken. Right. No, you know, there are some good aspects about Bitcoin that make it much more durable than other protocols. So I just tweeted yesterday, ‘There's a Bitcoin area inside of all of us'' or something like that. ‘Cause it's true. Right. It's kind of this ideal situation of crypto is like the - something that can't be changed, something that we all agree on and it's a cool aspect of Bitcoin.
(34:10) Matias: Totally agree. And especially for the entire space too, to have Bitcoin in a strong place where you have this one foundational component that's not changing, I think actually allows for more experimentation around the crypto ecosystem, ‘cause you have this fallback component as well. So let's see how that pulls out. Where can people find you, follow you, subscribe to your newsletter so they can stay up to date with your thoughts throughout the entire bear cycle?
(34:37) Jack: Yeah. you can find me on Twitter @JackNiewold, and you can subscribe to my email newsletter called cryptopragmatist@cryptopragmatist.com
(34:49) Matias: Awesome. Well, I really enjoyed this. You are a great guest, very insightful, and hopefully we have you on again during the bear market so people can get more insights, but definitely subscribe to the newsletter. I know we will. And again, thank you for jumping on.
(35:04) Jack: Hopefully we'll talk during the bull market
(35:06) Matias: Yeah, in 2 years.
